Financing of Infrastructure Projects

Adv. Tal Danon Shenhav, Manager of the Tenders, Infrastructure and Project Finance Department - Gross, Kleinhendler, Hodak, Halevy, Greenberg, Shenhav & Co.

In recent years, significant developments have taken place in the execution of infrastructure projects in Israel according to the PPP (Public Private Partnership) model, on both the national and municipal levels. This accelerated development is a continuation of the initial instances of use of the PPP model in the late 1990’s and early 2000’s, including the Highway 6 project (the first toll road in Israel), the Carmel tunnels project, and the construction of the desalination facilities in Ashkelon and Palmachim. [...]

Today, various PPP projects are underway in diverse sectors, with figures amounting to billions of Shekels:

- In the transportation sector (Jerusalem light rail, Tel Aviv light rail, new Jerusalem access road (Highway 16);

- In the water sector (construction and expansion of the desalination facilities in Ashdod and Sorek, construction of Sorek B);

- In the energy sector (construction of solar photovoltaic power plants (Ashalim), construction of thermo-solar power plants);

- In the construction sector (the "City of Training Bases" in the Negev, telecommunication center in the Negev, Ashdod hospital);

- In the waste management sector (urban waste treatment facility, pneumatic waste collection system).

According to the PPP model, the state enters into a concession agreement with a private concessionaire for the construction and operation of critical public infrastructure for a defined period (usually an extended period of 25-30 years). During the concession period, the concessionaire receives the right to charge payment from the users of the “public asset” (e.g., tolls from highway users, water purchased by the state). Sometimes the state requires specific legislation which confers upon the concessionaire a tool for enforcement of the fee (such as the imposition of damages and reimbursement of expenses, vehicle hold). According to the PPP model, the project (the road or facility) is returned to the state at the end of the concession period, without consideration, and in good operational condition (allowing the continued operation of the resource, such as roads following deep restoration and layering) using the BOT (Build Operate Transfer) method, or remains owned by the project concessionaire, according to the BOO (Build Operate Own) method.

The concession agreement determines the distribution of risks between the parties. Efficient distribution of risks is such that it imposes the risk on the side that is able to best mitigate or hedge the risk. Thus, for the most part, the state (the orderer) bears the statutory planning risk, the availability of the land and the risk of demand in the project (for example, water consumption or scope of travel on the road or rail). However, the concessionaire bears the construction risks (including detailed planning), the collection and enforcement risks, risks involving the realization of outputs, and the level of the required services (e.g., the quantity and quality of water, or the availability of trains and the quality of ride times therein), as well as the financial risks associated with the financing of the project (including changes to interest rates and/or exchange rates, inflation).

The financing of the infrastructure project is usually estimated at hundreds of millions of Shekels. In light of the credit crisis, due to the shortage of monetary sources and the “individual borrower” restriction which applies to banking corporations, the project is financed by a consortium of financing entities, usually including an Israeli bank (which also serves as the financing entities' representative) and institutional investors (insurance companies, pension and provident funds). Recently, the “market of financing entities” in infrastructure projects was developed through a welcome initiative of the state to create marketable investment funds, through which the public can invest in the infrastructure sector (an initiative involving legislative amendments which have not yet been completed). The marketable funds will join two old funds (the Tashi Fund and the Noy Fund) which were established by Israeli insurance companies and institutional investors, and which each raised approximately NIS 6-7 billion for investment in infrastructure.

Along with the concession agreement which is signed between the state and the concessionaire, the financing agreements are signed between the financing entities and the concessionaire, and between the concessionaire and its shareholders. The loan agreements with respect to the senior debt, which constitute approximately 80%-90% of the project’s required financing, are in the form of a non-recourse loan (with no option of recourse to the concessionaire’s shareholders). These agreements are complex agreements, which include undertakings of the concessionaire throughout all stages of the project, sections regarding debt service and the provision of first priority pledges in favor of the financing entities. Under the PPP project, the concessionaire pledges the project’s revenues and receipts in favor of the financing entities; however, since it has no property rights to the “public infrastructure”, it cannot pledge it (for example, the road itself, or the installed gas pipes). The concessionaire’s shareholders provide approximately 10%-20% as equity in the project, usually by way of a shareholder's loan (subordinated debt). In order to secure the state’s rights to the public asset, the state has step in rights with respect to the concessionaire in situations involving default by the concessionaire, default by the state, or force majeure, under risk-free borrower conditions.

In order to allow financing of the specific project, the state usually supports the project through various mechanisms, including construction bonuses and the distribution of a safety network to secure the concessionaire’s revenues. On the other hand, the state benefits from the distribution revenues in situations involving increased use of the public resource (revenue sharing), and even receives royalties.

The implementation of projects according to the PPP model offers several clear advantages: - Rapid and efficient construction of public projects of economic and strategic importance for the economy;

- Extra-budgetary financing for the construction of the “infrastructure” (freeing up the budget for the allocation of resources in accordance with priorities); - Combining the advantages of the private market with the planning! and execution of the project (including innovation, technological leadership, solutions ensuring protection of the environment); - Ensuring operation of the “infrastructure” at a high level and over an extended period;

We believe that the acceleration of infrastructure projects on the national level is a result of the need to dramatically reduce the gap between the public’s needs and the currently available infrastructure, to the standardization of the tender documents and PPP agreements to the (relatively) high returns in infrastructure projects relative to the other alternatives and the expansion of financing sources.

We believe that in order to deepen this trend, it is necessary to promote a five-year plan (and preferably, a plan for the coming decade) for the tenders which will be published, and to update this plan from time to time, and also to accelerate the statutory proceedings and pre-planning with respect to those projects. In parallel, it is necessary to expand the projects’ financing sources by providing the opportunity for foreign institutional investors or foreign funds specialized in infrastructure to invest in Israeli projects, subject to the restrictions on the scope of financing, holding and diplomatic relations with Israel.

It is also tremendously important for municipal authorities to be familiar with PPP agreements and the use thereof, while leveraging their inherent advantages, in order to develop the infrastructures in their sectors, including with respect to waste removal, waste purification facilities, construction of public buildings, parking lot, etc. Furthermore, as the number of projects in Israel grows, and as local experience is accumulated, Israeli companies will be able to participate or increase their participation in PPP projects in developing countries (in the continent of Africa, for example), while maximizing their profits.

Gross, Kleinhendler, Hodak, Halevy, Greenberg, Shenhav & Co., Law Offices