Down the Flexible Road

DOWN THE FLEXIBLE ROAD

THE SALIK FINANCING COULD BE A TEMPLATE. BY CHRISTOPHER HALL, CRAIG NETHERCOTT, PARTNERS, AND AARON BIELENBERG , CHIRAG SANGHRAJKA AND ARJUN AHLUWALIA, ASSOCIATES, LATHAM & WATKINS.

his past July, the Government of Dubai’s revenues on a weekly basis to a special purpose Department of Finance together with vehicle (SPV) in exchange for (a) an upfront the Road Transport Authority of Dubai payment by the SPV to the Government of T (together, the Government) successfully approximately US$800m and (b) a series of closed one of the most innovative infrastructure monthly deferred payments comprised of the financings in MENA that can serve as a template surplus Salik revenues after payment by the SPV for flexible structured infrastructure and real of its financing expenses, principal and estate financings within and outside of the region. interest/profit repayments and the top-up of a Infrastructure monetisations are often liquidity reserve account. unappealing to government entities because of The SPV is initially funded by the upfront the resulting loss of ownership, control and payment by the investors under the following revenue stream attendant to more traditional tranches of senior debt facilities incurred by the models, as well as the usual implications of SPV: issuing on the capital markets, if relevant. Dirham-denominated conventional tranche of However, the Salik financing, which was US$200m equivalent; structured as a dual-tranched (conventional and US dollar-denominated conventional tranche of Islamic) secured syndicated bank financing, US$400m; and addressed typical sovereign concerns as it provided Dirham-denominated Sharia-compliant tranche for limited recourse to the Government and no of US$200m equivalent. transfer of ownership or operations of the toll road Citigroup , Commercial Bank of Dubai , Dubai asset. It additionally satisfied investor requirements Islamic Bank and Emirates NBD were appointed and was consequently oversubscribed as it by the Government as mandated lead arrangers provided investors with a sound security package and bookrunners for the senior facilities debt. with recourse to the asset’s revenue stream. The financing structure is further described in Figure 1. The toll road The Salik financing is the first toll road The Salik toll road system (Salik) is the first free- financing in the MENA region and the first toll flow electronic tolling system in the Gulf region road financing globally to include a Sharia- and is operated by the Government. Salik applies compliant tranche. It was also the first use of a at four gates along the E11, or Sheikh Zayed Road, Dubai International Financial Centre Special the principal highway that runs through Dubai to Purpose Company SPV . Abu Dhabi and the Northern Emirates and along The clear and positive response of the market which the emirate’s main commercial and to the Salik financing is indicative of the market’s residential districts, including the port of Jebel Ali appetite (at the level of both local UAE banks and and the Dubai International Airport, are located. international financial institutions) for projects Since becoming fully operational in September with strong underlying economics and the 2008, Salik has enjoyed consistent traffic volumes flexibility that the market is willing to offer to in excess of 800,000 trips per day and produced such projects. This article seeks to identify a consistent revenues for the Government in excess number of those areas of flexibility, which may in of US$230m in both 2009 and 2010, despite turn be helpful to other sponsors considering the volatility in the global economy. feasibility of similar monetisation arrangements.

The ﬁnancing structure Ownership and operational ﬂexibility The Salik financing monetised tolls and other Given the importance of the Sheikh Zayed Road revenues associated with Salik , including (and, by association, Salik) as one of Dubai’s key revenues collected from users relating to the infrastructure assets, two of the Government’s purchase of Salik tags, the recharging of Salik key concerns with regards to the Salik financing cards and the payment of fines relating to failure were that: to comply with Salik rules and regulations. The Government should retain full ownership Under the Salik financing arrangements, the rights in respect of Salik assets and the (legal and Government agrees to turn over gross Salik beneficial) right to receive Salik revenues; and

4 October 2011 Middle East Report MIDDLE EAST SALIK

FIGURE 1 - ONGOING PAYMENT FLOWS DURING THE LIFE OF THE SALIK FINANCING UNDER THE CONVENTIONAL AND SHARI’AH COMPLIANT FINANCING ARRANGEMENTS

Salik users

Payment of Salik toll, Payment for Salik charges and associated vouchers States ﬁnes

Sponsor

Return of surplus Proceeds of Salik Appointment of Sponsor to Turnover of gross Salik SalikProject revenues SPV voucher sales distribute Salik vouchers on revenues after debt service behalf of investors

SPVSPV

Application of Salik Proceeds of Salik Appointment of SPV to revenues to service voucher sales paid to distribute Salik vouchers conventional tranches investors in Shari’ah complaint tranche on behalf of investors

Investors in convention Investors in Shari’a complaint debt tranches debt tranches

Conventional ﬁnancing arrangements Shari’ah complaint ﬁnancing arrangements

The Government should retain full operational Government subject to a defined cash waterfall to control over Salik assets and its relationships with service its financing costs under the senior debt Salik customers, including the right to set the toll facilities and to maintain a liquidity reserve, with rate and the right to maintain and amend policies the surplus being returned to the Government for relating to toll charging and its enforcement. its own use. These requirements can be difficult to The risk to the investors that the Government reconcile with traditional securitisation-based may fail to collect sufficient revenue from Salik monetisation arrangements, which would usually receivables to service the senior debt facilities is require a sale of receivables (or at the very least a mitigated by the fact that the turnover obligation grant of security over such receivables) in favour applies to gross revenues; that is to say, revenues of the SPV, together with customary control before any deduction, including in relation to any rights over how the receivable-generating assets operational or maintenance costs of Salik. The are managed and operated and how the investors do, however, take traffic risk in this receivables are collected. financing. As a result, the securitisation model is often As a result of this, the Government will only inappropriate in circumstances where ownership receive funds to the extent that Salik revenues and control over the receivables to be monetised collected exceed the amounts required to meet are to remain with the originator of the the financing obligations owed to the investors receivable, particularly where the receivables under the senior debt facilities. In other words, come from a wide customer pool and are not and in contrast to most infrastructure or subject to fixed contracts. The flexible Salik corporate financings, the financing obligations financing structure also was more appealing to owed to the investors under the senior debt the Government than a typical PPP or concession facilities are effectively senior to the operating based infrastructure financing, which usually and maintenance costs of the Government, and involves a transfer of ownership and/or operating the “first loss” is effectively for the account of the rights for a defined term. Government. Operation and management costs The Salik financing accommodates these are outside of the transaction and continue to be requirements, while also providing investors with paid for by the Government funded from its own the requisite degree of comfort on how Salik internal revenues and through the Government’s revenues would be collected, through use of a budgeting processes. turnover obligation and a finely balanced series of termination events (the events). Events In structuring the financing, certain events were Turnover obligation defined to create a risk allocation structure that Under the Salik financing arrangements, the principally exposes investors to traffic risk only, Government retains ownership of Salik assets with other risks mitigated through tiered degrees and Salik receivables, together with all rights to of recourse to the Government. There are six manage and operate the assets and collect the categories of event: receivables, but has an obligation to turn over the Notification events arise on the occurrence of gross receipts of Salik receivables to the SPV. The certain risk events that fall outside of typical SPV applies the amounts received from the traffic risk, including a material change to the

October 2011 Middle East Report 5 SALIK MIDDLE EAST

basis for toll charging, a repeated reduction in the security package granted by and in respect of the number of available lanes on the Sheikh Zayed SPV, subject to a cap and compliance with certain Road or failure to enforce Salik toll charging. The funding coverage tests. occurrence of a notification event may impose While such “accordion” facilities or mechanics additional information obligations. were not at one time unusual in the context of Lock-up events include compensation events leveraged finance transactions for strong and certain other defaults. The occurrence of a sponsors, they have become increasingly rare and lock-up event results in a block on the return of are almost unheard of in the context of a project surplus Salik revenues by the SPV to the financing absent an anticipated change in a Government. That surplus is instead retained in a project’s economics (such as would result from a separate lock-up account pending satisfaction of significant increase in a project’s capacity). certain release conditions. The inclusion of this feature in the Salik Compensation events are notification events financing is indicative of the market’s positive that are accompanied by a reduction in certain response to Salik assets and financing structure, funding coverage ratios below specified but also is another bespoke feature of the thresholds. These are designed to catch notifica- financing that is applicable to many other tion events that have a material and adverse effect infrastructure assets, particularly new assets in on Salik revenues. The occurrence of a compensa- emerging growth economies, where there is tion event may trigger an obligation on the limited traffic history but robust growth prospects. Government to make a payment to the SPV to “top up” Salik revenues and restore the relevant Sharia compliance funding coverage ratios to a specified level, in a A further important element of the Salik manner broadly analogous to an equity cure to financing was the inclusion of a Sharia-compliant Ebitda in the context of a leverage covenant. tranche. The Government required that investors Monitoring events arise if compensation events in the Sharia-compliant tranche be put on an occur for a specified number of consecutive equal footing with investors in the conventional periods and may result in the appointment of an tranches and that all material business terms of independent expert to prepare a revised traffic the conventional tranches applied equally to the report. Such report may form the basis of the Sharia-compliant tranche. calculation of the amount required to be prepaid This was ultimately achieved by applying if a prepayment event subsequently occurs. concepts developed for mobile Prepayment events arise if compensation events telecommunications provider Mobily in Saudi occur for a further specified number of Arabia (and later applied by Etisalat in the UAE), consecutive periods. Upon the occurrence of a in which airtime was recognised as a intangible prepayment event, the Government may be asset with economic value that could form the required to make a payment to the SPV (which basis of a Sharia-compliant financing structure. shall be applied in prepayment of the senior debt In the case of the Salik financing, the financing facilities) in an amount sufficient to restore the documentation provides for the sale of Salik relevant funding coverage ratios to a specified “vouchers”, representing intangible rights to use level, in a manner broadly analogous to a the road network, to investors in the Sharia- straightforward equity cure against net debt in compliant tranche who (acting through their the context of a leverage covenant. investment agent) in turn appoint the SPV and Termination events include traditional events of (indirectly, through a sub-distribution agreement) default such as non-payment by the Government, the Government to sell Salik vouchers to the misrepresentation, insolvency or cross-default. ultimate road users. The proceeds of such sales Upon the occurrence of a termination event, the are distributed through the SPV to the Government may be required to make a payment investment agent for onward distribution to the to the SPV in an amount sufficient to prepay the investors in the Sharia-compliant tranche. outstanding senior debt facilities in full. An intercreditor agreement ensures that This complex series of events is also of benefit investors in the conventional and Sharia- to the Government because, in contrast to fully compliant tranches rank pari passu and each class sponsor-guaranteed debt, there are only limited benefits equally from the security structure. circumstances in which there may be full recourse to the Government for the amounts due A roadmap for flexible financings under the senior debt facilities. The Salik The market’s positive response to the Salik financing demonstrates that, through this financing, which was more than twice structure, a strong sponsor may be able to take oversubscribed in the conventional tranches, is the benefit of limited recourse while also indicative of its demand for projects with strong achieving pricing levels that would be consistent underlying economics and of the high degree of with fully sponsor-guaranteed debt. structural flexibility that the market is willing to offer to such projects. The lessons learnt on the Leverage flexibility Salik financing may provide a useful roadmap to The Salik financing also incorporates provisions such areas of flexibility that may be applied more that allow for additional indebtedness to be widely to monetisations for infrastructure and incurred on the basis of Salik revenues and the other assets.

6 October 2011 Middle East Report