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WorldApril 2 2012

Kuwait looks to private sector funding in PPP push

Now Kuwait has joined many other Gulf states in pushing through private financing across a range of sectors and overhauling its infrastructure, it boasts one of the Middle East's largest and most diverse public-private partnership programmes. But as the country's government opts for PPPs, will the banks follow?
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Kuwait looks to private sector funding in PPP push

There was a time when a wealthy oil-rich Gulf country such as Kuwait would not have to think twice about funding a multi-billion dollar mega project off the state’s balance sheet. The established norm across the Gulf Co-operation Council (GCC) region was to let projects on an engineering, procurement and construction (EPC) basis, with contractors delivering projects for a fee, and the government – or its parastatal affiliates – taking complete ownership of the venture.

More than 10 years of successful build-operate-transfer experience in power and water sectors in the GCC has shifted the ground in favour of the private sector. Kuwait, like other GCC states, has become a belated convert to private financing across a range of sectors. With a public-private partnership (PPP) law on the statute books, a dedicated government PPP unit and the Partnerships Technical Bureau (PTB) up and running – the country is looking to push through a pipeline of more than 30 PPP projects valued at tens of billions of dollars as part of a national five-year plan to overhaul the country’s creaking infrastructure and build an economy fit for purpose.

Project diversity

The proposed PPP projects have branched out from the power and water sector to embrace a range of sectors – rail, urban transport, hospitals and postal services. Though state coffers are flush in line with robust oil prices, the model still ticks a number of boxes for the Kuwaiti authorities – transferring project risk to the private sector, enabling private companies to keep a tighter rein on costs and assisting in the transfer of technology and expertise back to the public sector. 

The collective value of the PPP projects in Kuwait in the 2010 to 2015 period stands at about $30bn, taking in projects such as the Al-Zour independent water and power project (IWPP), the first phase of which is now under negotiation with preferred bidder GDF Suez; the Umm al-Hayman Waste Water Treatment; the Kuwait Metro; and the GCC Railway.

“This is indeed one of the largest and most diverse PPP programmes in the region,” says Shaikha al-Bahar, CEO of National Bank of Kuwait (NBK), the country's largest lender. “While other GCC countries’ PPP programmes have focused on the power and water sectors, Kuwait’s covers power and water, housing, transport, communication, health, education and leisure.”

Power and water is the focus for much of the early project activity. Ms Bahar predicts that as many as eight PPPs could be created in the power sector, worth more than $15bn and providing an additional 11 gigawatts of power. PPPs will also be important in the housing sector.

“One proposed project, Khairan City, targets the construction of 36,000 new units. This would go some way to clearing the backlog of applications for government housing, which currently stands at more than 90,000,” says Ms Bahar.

PPP-focused framework

As in the rest of the Middle East, the definition of PPP is drawn widely, with the PPP badge applied to most forms of a public project involving private finance. Where Kuwait has established a lead over other Gulf states is in the establishment of a specific institutional framework to roll out PPP projects. The PPP law passed in 2008 set up a ministerial-level high committee for PPPs that is responsible for approving the PPP projects, which the PTB sits alongside.

The law sets out some strict parameters of PPPs. A project vehicle or special-purpose vehicle must be established as a publicly quoted joint stock company in which Kuwaiti private shareholders will secure, through a public offering, 50% of the shares.

With capital costs associated with the PPP projects running into the tens of billions, Kuwait’s attempts to improve its infrastructure delivery record will depend heavily on the availability of commercial bank financing.

Some of Kuwait’s largest lenders are eager to participate in the project financings that are expected. “NBK will inevitably play a lead role in the financing of these projects,” says Ms Bahar, who points to the bank’s experience in financing and syndicating large projects in the past, including the Equate ethylene project and the Sulaibiya wastewater plant.  

“One rationale for the PPP structure is to inject private sector practices and discipline – which includes financing and the pricing of risk,” she says. “It also gives local banks an opportunity to diversify their loan portfolios and participate in high-quality infrastructure projects, with revenue streams often underwritten by the government. Naturally, there is also an advisory role for local financial institutions in what has been a thinly used project delivery method in Kuwait to date.”

Bankers acknowledge that PPPs in Kuwait are not a risk-free endeavour, with difficulties in assessing commercial attractiveness over long payback periods, potentially expensive and protracted bidding processes, and the potential for borrowing costs for private sector bidders to be higher than for governments.

“One example is in pricing. In developed markets, long-term interest rates provide a useful benchmark for pricing returns on projects with long payback periods. Developing economies with less mature financial markets are typically more volatile, and reliable reference rates are more difficult to find,” says Ms Bahar.

PPP projects can be a sure thing if the projects have a clear off-take agreement, guaranteed by the government and well defined cash flow. IWPP projects – with a long track record in the GCC – represent such a case in point.

Realistic about risk

Others are likely to prove tougher sells, however. “Projects such as the metro and the railway offer challenges since the cash flow is not well defined. We will have to find ways and means to address these issues, which will be in the form of government support, either through a fixed capital payment for debt service or through fixed subsidies. In addition, the financiers seem to have concerns about the perfection of mortgages of these projects to the financiers, which to a certain extent are restricted under the current laws,” says Ms Bahar.

Governments do need to be realistic about what can be achieved, says Adrian Creed, a lawyer specialising in regional project financings at law firm Clyde & Co. “This is especially evident in the transport sector, which are some of the hardest projects to get financed. People have to have a realistic view of what market risks they are prepared to take,” he says.

“The last major rail project discussed in the region some seven or eight years ago was the Saudi Landbridge project. The idea was to do it on a project finance basis. Notwithstanding the pre-bid concerns about bankability, the government decided to proceed with the transaction on a project finance basis. After a timely and expensive bid process, it became clear that attractive bids could not be solicited from the private sector, and eventually the project had to be re-bid several years later on a traditional procurement basis.”

In general, says Jonathan Robinson, regional head of project finance at HSBC, the Kuwait authorities need to make sure that all sides are comfortable with the apportion of risk. “First and foremost, one needs the right consideration about risk allocation – an appropriate allocation between the private and public sector and between debt and equity,” he says.

On the equity side, there are some challenges that need to be addressed by the government, warns Ms Bahar. For example, there is a lack of clarity on what happens if the Kuwaiti public fails to fully subscribe to its share of the initial public offering for a PPP company. “Will the private sector bidder be forced to fund the shortfall? These types of problems should be resolved over time, but there remains a risk in relying heavily on a project delivery method which is relatively untested,” she says.

Global appetite

There are also Kuwait-specific issues that banks will have to grow more comfortable with. “There is a learning curve for new banks to the region,” says Debby Burton-Shaw, a senior associate with law firm Trowers & Hamlins. “Sometimes there is uncertainty over land rights – whether you can arrange a mortgage that is fully enforceable and rights over accounts. If a foreign company is not allowed to acquire rights in relation to land, there are ways to structure transactions that take these into account.”

Kuwait PPP sponsors may find it a challenge to attract international banks. One issue is the sheer scale of the project pipeline, which means that once a particular bank or institution has done one big power project financing, it may start to bump up against country and sector limitations. 

While Kuwait banks clearly have the appetite to lend to PPP schemes, they may also find the currency a challenge. So long as the financing can be arranged in Kuwaiti dinars, there is enough liquidity and depth in the market to meet these requirements. However, that is not always the case.

“The situation is that in the power and water deals, all the bid calculations are linked to the US dollar, so everything falls back mechanically to a dollar pricing scenario,” says Tom Lind, head of corporate finance at Kuwait-based Gulf Bank. “Local banks don't have the competitive dollar funding as international banks have, so in that matter we’re at a bit of a disadvantage. My hope is that the PPP bidding requirements are going to look at that aspect of the equation so that there is a mix of dollar and Kuwaiti dinar financing. Hopefully they will wake up to that ahead of the next PPP bidding process and ensure that Kuwaiti dinar funding will be part of the equation.”

Exchange rate fixing

The PPP projects will need relatively inexpensive and long-term financing – north of 10 years in most cases. The government can help on this score.

“Given current worldwide market conditions, long-term financing for anything over five years will be difficult to fund and hedge, and would certainly be expensive. And here is where the government can play a role, for example, by fixing the [Kuwaiti dinar/dollar] exchange rate on specific projects for the duration of the project, or securing long-term funding to address the asset-liability mismatch that could arise from financing these projects by placing large deposit amounts for long tenors in the local banks, or by providing certain guarantees to the local banks to help fund these projects,” says Ms Bahar. 

One option would be for the PTB or the client to say that irrespective of the fact that dollar funding is cheaper, they want the local banking population to be involved in lending to these projects in order for the wider economy to benefit, and to insist that bids have a requirement for a certain portion in Kuwaiti dinar and a certain portion in offshore lending. 

This, says Mr Lind, would require local banks to step up to the plate, which until now they have been reluctant to do. “So far, it’s only Gulf Bank and NBK,” he says.

Refinancing options

With shorter senior debt tenors now a fact of life in the wake of the financial crisis, it has become more onerous securing long-term senior debt. This in turn makes refinancing in the middle of a project a likelihood.

One possibility is that the government could provide refinancing support by undertaking to procure a full refinancing of the private sector debt within seven years. “This means that the private sector only needs to raise short-term debt [seven years] – which would be more attractive to local banks. Another possibility for the mega project may be for the government to be a co-lender on pari passu terms with private sector banks in the event that there isn’t enough appetite from banks,” says Ms Bahar.

In the power and water sector, both assets and concession periods tend to be very long term, with long-term financing calculated back to cash flow that is predictable. If there are fluctuations in exchange rates or interest rates, this can sometimes create difficulties.

The Al-Zour IWPP financing had allowed for the dinar/dollar rate to be artificially pegged so there was no currency issue there. However, it could not immunise itself against interest rate fluctuation as there is no long-term Kuwaiti dinar interest rate.

“That’s another thing that needs to be developed, to see how banks can work together with the central bank in developing long-term hedging on this,” says Mr Lind. “We cannot have open-ended risks over so many years. If you could fix for 10 to 15 years, that would solve a lot of problems.”

Financial considerations aside, the legal undergirding for project financings is more or less in place now. “As far as collateral goes, the existing project finance structures – wherein we have non-recourse financing in place with assignment of rights and contract proceeds and mortgage of property, plant and equipment – is reasonably suitable,” says Ms Bahar.

Bankable projects

For some of the projects such as the railway and the metro, government support would make the deals more bankable. This support could be manifested in many ways; guarantees, off-take agreements and long tenor deposits in the local banking system.

“For example, for some projects, the government could underpin the debt financing by providing private sector debt providers with undertakings to ensure the repayment of a proportion of their debt post construction completion. Banks would therefore be more attracted to the project because a portion of their risk exposure converts to a sovereign risk once the project reaches the operating phase,” says Ms Bahar.

PPP is no cure for all of Kuwait’s needs. But at a time when governments across the region have put investment in infrastructure and public services at the top of their agenda, it should ensure better project delivery and at a better price. For local, regional and international banks, the raft of public-private schemes on Kuwait’s books should ensure a healthy line of project finance activity for years, if not decades, to come. 

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