RFF: First lessons learned from its four PPPs

Railway investment requires long-term funding. Sometimes the State will choose to take direct ownership or may even prefer to transfer all or part of the responsibility and risk to the private sector. Public-Private Partnerships (PPPs) can offer a highly flexible way of combining public and private funding.

These highly flexible approaches include:

• The terms of the contract reflect the extent of the business risk that the public sector wishes to transfer to the private sector. Part nership contracts delegate the task of designing, financing, building and operating specific infrastructure in return for payments to be made throughout the operating period. With a concession, the private sector takes on not only the above risks but also the business risk.
• The length of the contractual period reflects the extent of the maintenance risk trans ferred. In the rail sector, contracts in excess of 30 years are synonymous with transfer to the private sector of the risks inherent in track renewal.

The life-cycle of railway infrastructure is long and the risk of obsolescence sufficiently small to make private debt a realistic option, even on the basis of relatively small net assets. In such cases, partnership contracts (DFBM) tend to be the norm as opposed to concessions (DFBMO), for which the potential is more limited: concessions have to produce revenues specifically from the new line, whereas in many cases the extra revenues are diluted as they ripple out over the rest of the adjoining network.

Réseau Ferré de France (RFF) is trying out different contractual approaches: the second phase of the East European HSL – work on which is being carried out under direct RFF authority; the Tours–Bordeaux HSL under a concession arrangement – the line barely interfacing with the rest of the network; and the Le Mans–Rennes HSL and Nîmes and Montpellier bypass as partnership contracts.

These contracts were all signed fairly recently and it is only when they come to the end of their life-cycle that it will be possible to draw any final conclusions with regard to their comparative advantages. But the conditions in which these ‘giant PPPs’ have been finalised, at a time of major financial crisis, are significant pointers to the potential scope of application of PPPs for investment projects.

The rationale behind private funding and risk sharing

There are three reasons why the French State and RFF have chosen to opt for PPP funding for new line projects:

1. PPPs cover both line building and operation over extended periods under a single contract. With this type of approach, it is possible to ring-fence maintenance costs, a factor often ignored in public-sector projects, and encourage line builders to internalise the impact of their investment choices on maintenance costs

2. PPPs are an opportunity for full-scale trials into the potential for self-financed projects, by motivating undertakings to make efforts to boost traffic and, with concessions, to exploit users’ ability to pay, in other words, their willingness to spend more in return for faster travel

3. PPPs enable project risks to be shared on the basis of transparent analysis, trans – parency being vital to private investors contemplating putting their own resources into a project but also a valuable aid in quantifying the general interest of a project. The risks inherent in individual projects are not always fully apparent in the evaluation exercises performed on projects conducted exclusively with public-sector funding. Transferring the risk of extra costs from the public to the private sector may be advantageous but also comes at a price: in return for accepting a larger proportion of the risks, private investors expect internal rates of return that are substantially higher than the interest rates on publicsector borrowings.

First feedback from major railway PPPs

By comparison with other transport infra – structure projects, there are specific risks inherent in railway projects: major construction risks due to their scale and works duration (five to six years for a new line), and risks associated with the interfaces between the new line and the rest of the network. These types of risk are not normally associated with road and airport projects.

Not only do these risks have to be managed but, in addition, and since 2008, there has been the added difficulty of having to deal with a market where the traditional sources of funding for PPPs have seized up as a result of the crisis hitting the banking sector – a crisis that has had a number of different repercussions, including:

• An increase in bank margins, from 100-150 to 250-300 basis points
• Shorter loan repayment periods, these generally not being in excess of five to seven years
• The emergence of soft mini perms: once bank loans mature (after five to seven years) if they are not refinanced, all or part of the cash flow earmarked for shareholders has to be used to pay off the loan
• Diminished enthusiasm on the part of the arrangers, who are no longer able to obtain a firm commitment for 100% of the sums required, and the emergence of pool funding mechanisms including market flex (whereby the financial conditions can be adjusted in the months after contract signature), or the adoption of club deals in which each bank invests under the same conditions as the others and all take smaller positions.

To overcome the problems posed by a beleaguered banking system, public sector solutions have been mustered to drive down liquidity and risk-related costs.

Public sector action is first geared towards driving down liquidity costs. Therefore, loans are available from the Caisse des Dépôts and may account for up to 25% of borrowings at much more attractive rates than those offered by the commercial banks: margins of around 100 basis points as opposed to bank margins of between 200 and 300 basis points.

The second target is to contain the risk factor:

• In France, DFBM contracts qualify under the ‘Dailly’ Act for assignment of receivables, which enables up to 80% of project debts to be safely assigned against the irrevocable guarantee of payments from the public contracting authority. This added security enables borrowers to enjoy lower bank margins
• A specific guarantee established for the Tours–Bordeaux DFBMO concession, the second largest railway concession in Europe after Eurotunnel. This interestbearing guarantee put up by the French State covers 80% of the debt, in other words €2.4 billion of a total €3 billion.

The future of long-term funding

The new financial context is detrimental to longterm project funding. PPPs date from the time when funds were in abundant supply but their scope of application is bound to be more restrictive in times of financial hardship.

First of all, the industrial benefits derived from private sector intervention need to be all the greater – the higher the cost of private sector funding compared to that of public-sector debt.

Secondly, the State needs to put public sector mechanisms in place to curb liquidity cost and bank risk escalation. In addition to moves to ensure cash availability and secure loans (‘Dailly’ assignments, loans from the Caisse des Dépôts), it is vital to broaden the investor base beyond the banks to include institutional investors (insurance companies, pension funds) and sovereign wealth funds.

This explains why the development of bond financing may prove a boon for financing or refinancing greenfield projects. These require credit-boosting mechanisms, since institutional investors do not have the financial engineering and debt servicing capacities required to analyse and bear project risks. This is the purpose of the European project bonds, which will include a proportion of junior debt underwritten by the EIB that may amount to as much as 80% of the senior debt.

RFF’s large-scale PPP projects were set up in a very inauspicious financial context. This fact alone speaks volumes about the robustness and flexibility of this type of financial engineering. But as funding possibilities become rarer, public sector policies should be geared towards reducing liquidity costs and ensuring proper risk allocation over the entire project life-cycle.

About the author

Alain Quinet is a graduate from the Institut d’Etudes Politiques in Paris (1983) and the Ecole Nationale d’Administration (1988). Alain was appointed Deputy Chief of Staff at the Prime Minister’s office in 2005. Subsequently, in 2007, Alain became Inspecteur Général des Finances and a Member of the RFF Board of Directors. From 2008 to 2010, he was Chief Financial Officer at the Caisse des Dépôts Group and President of CDC Infrastructure. Since December 2010, Alain has been Chief Operating Officer at RFF.