RAIC Discussion Paper Series, Number 120 Bidding for Private Concessions The Use of World Bank Guarantees Project Finance and Guarantees Department Resource Mobilization and Cofmancing Vice Presidency January 1998 1z1 The World Bank CFS/RMC DISCUSSION PAPERS 101 - Privatization in Tunisia, Jamal Saghir, 1993. 102 - Export Credits: Review and Prospects, Waman S. Tambe, Ning S. Zhu, 1993. 103 - Argentina' Privatization Program, Myrna Alexander, Carlos Corti, 1993. 104 - Eastern European Experience with Small-Scale Privatization: A Collaborative Study with the Central European University Privatization Project, 1994. 105 - Japans Main Bank System and the Role of the Banking System in TSEs, Satoshi Sunumura, 1994. 106 - Selling State Companies to Strategic Investors: Trade Sale Privatizations in Poland, Hungary, the Czech Republic, and the Slovak Republic, Volumes ] and 2, Susan L. Rutledge, 1995. 107 - Japanese National Railways Privatization Study II: Institutionalizing Major Policy Change and Examining Economic Implications, Koichiro Fukui, Kiyoshi Nakamura, Tsutomu Ozaki, Hiroshi Sakmaki, Fumitoshi Mizutani, 1994. 108 - Management Contracts: A Review of International Experience, Hafeez Shaikh, Maziar Minovi, 1995. 109 - Commercial Real Estate Market Development in Russia, April L. Harding, 1995. 110 - Exploiting New Market Opportunities in Telecommunications: Lessons for Developing Countries, Veronique Bishop, Ashoka Mody, Mark Schankerman, 1995. 111 - Best Methods of Railway Restructuring and Privatization, Ron Kopicki, Louis S. Thompson, 1995. 112 - Employee Stock Ownership Plans (ESOPs), Objectives, Design Options and International Experience, Jeffrey R. Gates, Jamal Saghir, 1995. 113 - Advanced Infrastructurefor TimeManagement, The Competitive Edge in EastAsia, Ashoka Mody, William Reinfeld, 1995. 114 - Small Scale Privatization in Kazakhstan, Aldo Baietti, 1995. 115 - Airport Infrastructure: The Emerging Role of the Private Sector, Recent Experiences Based on Ten Case Studies, Ellis J. Juan, 1995. 116 - Methods ofLoan Guarantee Valuation andAccounting, Ashoka Mody, Dilip Patro, 1995. 117 - Private Financing of Toll Roads, Gregory Fishbein, Suman Babbar, 1996. 1 18 - Financing Pakistans Hub Power Project: A Review ofExperience for Future Projects, Michael Gerrard, 1997. 119 - Power Project Finance: Experience in Developing Countries, Suman Babbar, John Schuster, 1998. JOINT DISCUSSION PAPERS Privatization in the Republics of the Former Soviet Union: Framework and Initial Results, Soo J. Im, Robert Jalali, Jamal Saghir; PSD Group, Legal Department and PSD and Privatization Group, CFS - Joint Staff Discussion Paper, 1993. MobilizingPrivate Capitalfor the Power Sector: Experience in Asia andLatin America, David Baughman, Matthew Buresch; Joint World Bank-USAID Discussion Paper, 1994. OTHER CFS PUBLICATIONS Japanese National Railways Privatization Study, World Bank Discussion Paper, Number 172, 1992. Nippon Telephone and Telegraph Privatization Study, World Bank Discussion Paper, Number 179, 1993. Beyond Syndicated Loans, World Bank Technical Paper, Number 163, 1992. CFS Link, Quarterly Newsletter. RMC Information Center, phone: 202-473-7594, fax: 202-477-3045 Copyright © 1998 The World Bank 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured and printed in the United States of America The findings, interpretations, and conclusions expressed herein are entirely those of the authors and should not be attributed in any manner to CFS, the World Bank, or to members of the Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication, and accepts no responsibility whatsoever for any consequence of their use. The paper and any part thereof may not be cited or quoted without the author's expressed written consent. RMC DISCUSSION PAPER SERIES I 20 Bidding for Private Concessions The Use of World Bank Guarantees Contents Acknowledgments v Foreword vi Abstract vii Executive Summary 1 A Summary of Experience with Bidding for Concessions 2 Bidding Process 2 Risk Sharing between the Public and Private Sectors and the Role of International Institutions 3 General Considerations 5 Key Objectives in Concession-Based Projects 5 Suggested Overall Approach 6 Other Approaches 7 Preparation for the Competitive Process 8 Assembly of the Project Team 8 Legal and Regulatory Framework 9 Economic Analysis 10 Review of Financial Viability 10 Framework for Private Sector Participation 16 Prequalification Process 18 Main Bidding Process 20 Evaluation and Negotiation 24 Evaluation 24 Negotiations and Conclusions of the Concession Agreement 27 Integration of Agreements 28 Costs and Timetable 29 Bidding Costs 29 Timetable for the Government 30 Cost of Advisory Services 31 The Use of World Bank Guarantees 32 The Bank's Guarantee Mechanisms 32 Guarantees and the Bidding Process 32 U' The Use of the Guarantee 32 Testing the Market 33 Figures Figure 1 Two infrastructure sectors in Western Europe, Eastern Europe, Latin America, and Asia 2 Figure 2 Government and private sector objectives 5 Figure 3 Preparation for the competitive process 8 Figure 4 Examples of team structure 10 Figure 5 Tender documentation 22 Figure 6 Evaluation criteria 24 Figure 7 Factors resulting in different economic costs and benefits 25 Figure 8 Government specifies different risk coverage levels 34 Tables Table 1 Qualifications of team members 9 Table 2 Prequalification criteria 20 Table 3 Technical definition: input versus output specifications 21 Table 4 Timetable for the government 30 Table 5 Cost of advisory services 31 Table 6 Tenderers propose level of risk coverage 34 Table 7 Tenderers submit bids for options 2 and 3 35 iv Acknowledgments T his study was sponsored by the World Bank's Project Finance and Guarantees Department (PFG) and produced in collaboration with West Merchant Bank Limited of the United Kingdom (part of the Westdeutsche Landesbank Group). The report was prepared under the direction of Suman Babbar, David Baughman, and Ramzi Al-Bader and benefited from the contribution and comments of several PFG and Bank staff Alejandro Mirkow assisted in docu- ment processing and production. The report was edited by Katrina Van Duyn and laid out by Garrett Cruce, both with the American Writing Division of Communications Development Incorporated. v Foreword W ith the move toward private provision of public services, governments are increasingly using competitive bid- ding to award infrastructure concessions to private sponsors. Financing these projects, however, has often been difficult for countries with a less than investment grade credit rating and with limited access to the cap- ital markets. Furthermore, preparing and launching a competitive bid for the award of a private infrastructure concession is a complex and resource-intensive undertaking, the outcome of which affects not only the project, which is the subject of the concession, but the credibility of the government in relation to projects that it is planning to implement in the future. It is important that, throughout this process, the government and its implementing agency be supported by a qual- ified team of financial, technical, and legal advisers. To assist in this effort, the Bank has worked closely with governments and public entities to structure bidding and pro- ject documents. It has also provided technical support to governments in the areas of preparation, negotiation, and award of private concessions for high-priority infrastructure projects. Within this context, governments have also asked the Bank to provide loan guarantees in the bidding process to facilitate viable financing proposals on the best possible terms. Recognizing the increased participation of the World Bank in this area, West Merchant Bank Limited was appointed by the World Bank's Project Finance and Guarantees Department to produce a report that provides general guidance on how govemments may award a competitively bid private concession. Hiroo Fukui Nina Shapiro Vice President Director Resource Mobilization and Cofinancing Project Finance and Guarantees Department vi Abstract he report identifies the critical issues that are involved in the tendering and evaluation stages of bidding for pri- T vate concessions. It draws on a survey of bidding experience in eight water and toll road projects in seven coun- tries (China, Hungary, Mexico, Peru, Thailand, Turkey, and the United Kingdom). Although the information available from this survey was not comprehensive enough to establish any strong overall generic trends, either by indus- try sector or geographical region, it was observed that where the process of selecting of the concessionaire appears to have been handled more informally, it was difficult for the host government to be satisfied that it had achieved an optimum level of risk transfer from the public to the private sector. The report also proposes an approach by which a World Bank guarantee can be effectively integrated in the bidding process with the aim of providing the optimal level of credit enhancement necessary to attract responsive and competi- tive bids. For partial risk guarantees this necessitates the government making up-front decisions about the risk and obli- gations it is willing to assume and then reaching agreement with the Bank on the extent of risk coverage under its guarantee. This process may proceed in a structured manner, in which the guarantee terms are presented in the bid documents, or the bidders may be asked to propose the use of the guarantee and the scope of risk coverage. VI Executive Summary T he broad findings and recommendations of the covering the commercial, financial, and technical report are summarized below: aspects of the project. * In producing the technical specifications, the gov- * To maximize competitive interest from well-qualified ernment needs to consider carefully the tradeoff bidders, the government should adopt a strategy aimed between issuing an output-based performance spec- at minimizing the costs to bidders of preparing their ification, which will give bidders scope for innovation proposals and restricting the number of bidders in in design and risk taking, and a more detailed input- the final tender round to no more than three or four. based specification that, while having the advantage Governments should also ensure that the tender pro- of reducing bidders' costs, will have the effect of trans- cess is undertaken swiftly and efficiently. ferring more risk to the government. * Governments should take a number of steps before * The government should consider testing the market the tendering process begins: (a) establish a dedi- through the bidding processinthose areas where there cated project team made up of experienced individ- is uncertainty about the private sector's appetite for uals in the areas of engineering, financing, market assuming different levels of risk. This can be achieved analysis, revenue forecasting, and legal matters; (b) by inviting tenders on a manageable number of alter- make progress toward the establishment of an appro- natives, specifying different levels of risk transfer. priate legal and regulatory framework for the opera- * In order to attract responsive bids that focus on the tion of private concessions; (c) establish a clear government's key objectives, the evaluation criteria definition of what is required from the private sec- need to be spelled out transparently in the tender tor; (d) launch an expert review of the financial via- documents. bility of the project, to evaluate its suitability forprivate * If the need for any World Bank guarantee is identi- finance; (e) decide on how any financing gap revealed fied in the review of the project's financial viability, by the financial review will be filled;. and (f) develop detailed information on the terms of the guarantee a firm plan for the bidding process, including the should be provided in the tender document. If there timetable, number of stages, and the objectives to is any uncertainty about whether or the extent to which be achieved at each stage. such a guarantee is required to ensure that the pro- * The government needs to ensure that the tender doc- ject can be financed by the private sector, the gov- uments to which bidders are asked to respond con- ermnent could test the market by inviting bids based tain a clear set of requirements and specifications on different types and levels of risk protection. 1 A Summary of Experience with Bidding for Concessions T his section examines experience in selected con- project in Thailand. The pros and cons of formal and infor- cession-based projects in two infrastructure sec- mal approaches to bidding are discussed in later sections. tors, toll roads (including estuarial crossings) and While an informal process may result in a project reaching water, in Western Europe, Eastern Europe, Latin America, signature and financial close more quickly, this type of and Asia (figure 1). approach, which generally involves little or no true com- Together, the projects cover a spectrum of countries, petition among different private sector groups, makes it vir- financing and commercial environments, project sizes, and tually impossible for the government to be fully confident contract structures. (The relevant features of these projects, that it has obtained the best possible price (or tariff) and to the extent that such information is in the public domain achieved its other objectives. and not of a commercially confidential nature, have been The Second Severn Crossing project in the United briefly summarized in the appendix. However, consider- Kingdom used an explicit two-stage bidding process, and ing that the sample size of the projects investigated was the approach adopted by the government had many fea- restricted to a relatively small number and that the avail- tures of transparency and clarity in bidding requirements able project information was limited as described above, and evaluation that are discussed in later sections. Since there were insufficient data to make it possible to establish the Second Severn Crossing project was tendered, the any overall generic trends (by industry sector or geograph- government has formally adopted a policy known as the ical region) either in relation to the bidding or the financ- Private Finance Initiative, under which a framework has ing processes for these projects. This is especially so with been developed for private sector involvement in projects regard to what was expected by the government in relation in fields ranging from transport and infrastructure to health to these projects ex ante and how this compared with what was achieved ex post the bidding process and final selec- FIGURE I tion. Among the eight projects examined, a few broad obser- Two infrastructure sectors in Western Europe, vation can be made. Eastern Europe, Latin America, and Asia vations can be made. Water Roads and bridges Bidding Process | Da Chang Don Muang Toll Highway Bidding Process China Thailand Formal competitive bidding carried out with a varying degree of thoroughness appears to have been a feature of projects Turkey Hungary cited for Hungary and the United Kingdom, and possibly for some in Mexico, but appears not to have occurred in Daldowie and Invemess/ Fort William [Second Severn Crossing China and Turkey, where it is possible that more informal United Kngdom United Kingdom approaches might have been used. The details of the con- cessions in these countries evolved in a long negotiation Lima Toll highways process with one party. Information is not available on the Peru Mexico 2 care and information technology, which were previously however, projects diverge considerably in this area, with done in the public sector. This usually takes the form of a projects in the developing country environments sometimes concession. Guidance has been provided by the govern- taking considerably longer largely as a result of delays in ment to various departments and agencies, including among policy implementation. An estimate of the time that should other things, how the bidding process should be handled be allowed for when planning for a competitive bid situa- and the considerations that should apply to achieving opti- tion for such an infrastructure project is provided below. mal risk transfer to the private sector and obtaining value for money for the public sector. A number of features of Risk Sharing between the Public the Second Severn Crossing tender process have been incor- and Private Sectors and the Role porated into this guidance. Over the years the U.K. gov- of International Institutions emnment has refined its guidance to the departments implementing the many different types of projects that now Among the sample of projects, the U.K. projects, such as come within the scope of the Private Finance Initiative. the Second Severn Crossing, have the most clearly defined Consequently, where these steps have been well applied, a risk-sharing arrangements between the public and the pri- significantly greater level of effectiveness has been achieved vate sectors. (Private sector here includes investors, lenders, in the bidding process. Scottish Private Finance Initiative contractors, and the users of the service.) Also, in view of Water projects are expected to follow these processes. the relatively well-developed legal and financial environ- The bidding process adopted for the M1-M15 Motorway ment, a large number of risks relating to construction (includ- project in Hungary was similar to that adopted for the ing ground conditions), long-term maintenance, and Second Severn Crossing in that it involved the release of operation could be passed to the private sector. The ratio- extensive tender documents for bidders, including a draft nale for why it is possible to achieve a more systematic risk concession agreement. The tender documents displayed transfer in countries with such a legal and financial envi- somewhat less clarity, however, than those for the Second ronment is discussed in later sections. Severn on some of the government's requirements and eval- In the M1-M15 toll road project in Hungary, some of uation criteria. It is interesting to note that the financial these risks were also passed to the private sector. However, adviserto the Hungarian Governmentwas Morgan Grenfell, at the time of the bidding competition, there was consid- a British merchant bank. I erable concern among international lenders and investors Based on the information available, the other competi- about the economic and political risk, and therefore the tively bid projects were not perceived to have achieved com- involvement of the European Bank for Reconstruction parable standards. It is likely that the governments in the and Development (EBRD) in the financing package was countries where these projects are located had not suffi- seen as essential. Although in the bidding document the ciently addressed all the critical issues in relation to bid- government suggested that the EBRD's involvement would ding and evaluation, including the establishment of an be limited to the provision of a loan of about US$75 mil- appropriate concession framework before embarking on lion, the financing that was eventually put together after the process. As discussed in later sections, a number of the selection of the winning bidder needed much more critical issues need to be addressed at the appropriate time extensive EBRD participation. One possible reason could by the host government to facilitate a smooth, competitive be that there was a greater shortfall in the availability of bidding process that promotes the achievement of gov- private sector finance than had been anticipated at the eminent objectives. Arguably, one of the reasons for the outset. As far as is known, the EBRD did not participate lack of success thus far in the water project in Lima, Peru, in the evaluation of bids. relates to insufficient attention to these issues at the outset. It is conceivable that had the government done its analy- Accurate information on the elapsed time from the date sis more thoroughly in advance and indicated in the tender the respective governments began work on a project to the documents the availability of a more realistic level of EBRD date of contract award is not available; broadly speaking, financing (as opposed to making this known after the selec- 3 tion of the preferred bidder), it would have been able to obtain, ermnent at the time the private sector was approached under competitive pressure, a better overall price from the (and possibly by the bidders in the early stages of the private sector. The preferred bidder has no incentive to make tender), about domestic political risk and economic meaningful adjustments to its offer when additional support and credit-standing issues. is offered after it has been selected. This point is relevant to * Private sector concerns, unanticipated by the gov- the discussion on the inclusion of World Bank guarantees in ernment at the time the private sector was bid documents. approached (and possibly by the bidders in the early The risk transfer to the private sector in the other pro- stages of the tender), about specific commercial jects examined, especially to international lenders and risks being transferred-for example, consumer investors, does not appear to have been achieved to a com- risks in a water supply project-which may be intrin- parable degree, as summarized in the appendix. There sically unacceptable to the private sector in certain may be many reasons for this, including: locations. * Inappropriate attention given by the government to * Absence of an appropriate legal and regulatory frame- the critical issues relevant to the bidding process, as work for limited recourse financings in the country. outlined in later sections, and thereby a suboptimal * Private sector concerns, unanticipated by the gov- handling of this process. 4 General Considerations T he development of a concession-based project tion of the key objectives of both the public and private sec- in any infrastructure sector will be a substantial tor participants in such a project (figure 2). undertaking in any geographical region. This is The key objectives of the host government are likely to often not sufficiently understood by governments and as include: a result, the challenges involved are underestimated. The aim of such a project is to involve the private sector more * Minimizing government expenditure and contin- directly in providing a public service, with the public gent support for key infrastructure. sector functioning in a facilitating role and, if appropri- - Ensuring that the lowest possible cost of service pro- ate, also as an ombudsman conveying the interest of users vision can be achieved through competition and the of the service. harnessing of private sector efficiencies while at the same time achieving an optirnal level of risk transfer Key Objectives in Concession-Based to the private sector. Projects * Providing for transparency in the competition. - Ensuring timely project completion and operation. An assessment of critical issues in projects involving bid- - Maximizing the wider economic and financial bene- ding for concessions must be based on a proper apprecia- fits of the project. FIGURE 2 Govemment and private sector objectives Government objectives Environmental Selection of Early concession Optimization of financial Minimum government criteria best group award and social objectives support Concession award process F~~~~~~ overnmentintemational Recognition of high Transparent, fair, Clear project scope institutional support for Minimum legal costs bidding costs comprehensive process and definitions noncommercial isks and delays if not viable Private sector objectives 5 These objectives will need to be reconciled among them- already in place, this aspect of the preparatory work selves and with the concerns of the private sector, which will not be necessary. include: * Clear definition of the government's requirements of the private sector with respect to the project, and a * Clarity in project definition. The project, including realistic commercial framework for private sector par- its interface with other infrastructure and with var- ticipation. ious third parties, must be clearly defined, although * Review of the financial viability of the project, a balance needs to be struck with the desirability of including an expert assessment of the basis for and encouraging private sector innovation in the com- extent to which private sector finance can be petition. This issue is discussed in more detail in later obtained. sections. * Decisions on filling any funding gap revealed by the * Adequacy of available information. Sufficient infor- review of financial viability. mation of adequate quality needs to be made avail- * Decisions about the bidding process itself, such as able so that realistic, comprehensive expressions of the number of stages involved, the extent of negoti- interest can be made and final bids submitted. ations after bid submission, and so on. * Realism of bid stru cture. The bidding procedure needs to be lear and unambiguous, have a realistic timetable It cannot be emphasized too strongly that thorough and provide opportunities for questions and feed- preparation is fundamental to ensuring that the bidding back of bidders' views. process can proceed smoothly and that the government * Transparency in evaluation. The process of selecting can achieve its other objectives. A well-prepared project the concessionaire should be transparent, smooth, will attract a wider and more competitive response from and fair, and the basis for awarding the concession the private sector, as potential bidders are more likely to must be defined comprehensively at the outset. be convinced that they will be better able to control the * Minimizing bidding costs. The bidding process should costs of bidding for the concession. To the extent that this mrxinimize the high costs of preparing a final bid. approach is not followed, the later stages of the bidding * Clarification ofexternalsupport. Any external measures process are likely to be characterized by delays, confu- required to make the project financeable (such as sion, and an inability to optimize the key objectives of both support from the government or international insti- sides. tutions) should be clarified before the biding pro- This suggested approach, which clearly requires that cess begins and be perceived as practical. the government make firm policy decisions on key issues * Efficient resolution of legal and regulatory issues. relating to the project in advance of the bidding process, Arrangements need to be made to ensure that the need not exclude the possibility of private sector inno- costs and delays of resolving any legal and regulatory vation in design, engineering, and commercial risk tak- issues are minimized. ing where it has the freedom to propose its own solutions. For instance, in areas where the government is uncertain Suggested Overall Approach which approach will yield the optimum competitive response, it could consider testing the market by invit- To achieve the government's objectives and to maximize ing bidders to bid on a range of different specified alter- interest from potential bidders, thorough preparation is natives. These could include, for instance, prices that required. This includes: bidders may charge for assuming different specified lev- els of technical, financial, or regulatory risk, and inno- * Establishment of an appropriate legal and regula- vative technical solutions that bidders may be able to tory framework for the project in advance of the bid- propose relating to project design, construction, or main- ding competition. If an appropriate framework is tenance, while still meeting defined minimum perfor- 6 mance criteria. Issues treated in this way need to be few * Creation of confusion in the minds of bidders regard- in order to keep the tendering and evaluation processes ing the government's requirements and its approach manageable. to evaluation. * Receipt of widely differing bids that are very diffi- Other Approaches cult to compare and evaluate. * Considerable delays in effective project implemen- If approaches different to the one described above are tation. adopted, such as those that maybe described as open-ended * Higher bidding costs for the private sector as well as (major policy decisions and clarifications are not made in (eventually) higher costs for the government. advance of bidding), a number of drawbacks are likely to - Inability to achieve either public sector or private sec- be encountered: tor objectives. 7 Preparation for the Competitive Process T he key issues that need to be addressed in the prepa- * Specialists in forecasting revenues (depending on the ration phase are: project-for example, traffic economists for a trans- portation project). - Legal advisers. * Assembly of the government's project team. * Personnel concerned with overall policy issues. * Legal and regulatory framework. * Economic analysis of the project. Consideration needs to be given to whether there are * Assessment of financial viability, including the extent available resources with relevant expertise in-house or to which private finance can be obtained and the whether outside specialists need to be appointed. Unless nature of government or other support required, if the sponsoring department has substantial experience with any. awarding concessions to the private sector, as well as * Framework for private sector participation. resources that are able to devote a substantial part of their • Nature of the prequalification process. time to what will be an intensive and demanding process, * Preparation of final tender documents. it is generally advisable to appoint outside consultants to provide technical, revenue, financial, and legal advice. These are discussed in turn and showed graphically in figure 3, with an indication of the sequence in which they FIGURE 3 are taken. Preparation for the competitive process Assembly of the Project Team team It is essential that the government put together, at an early frLewolk stage, a multidisciplinary project management team with EcnoI Steps leading to invitation to tender nomic ~~~time representation from the different areas of expertise that analysis have a critical bearing on the project. The team would, in Finanda most instances, be led by a senior official from the spon- Aabilt/ soring government department or ministry. The team should Framework also include: of * Technical and engineering personnel with expertise clualficatonj in the design, construction, and operational aspects tende of the project. documentJ * Financial advisers. Invite * Specialists in procurement. tenders 8 It is critical that the official appointed as team leader be ject; or by selecting a local adviser who meets all the other capable and credible both internally, in harnessing the work selection criteria. The external advisers can be appointed either of his team and in securing key policy decisions, and exter- individually under separate contracts, or under one arrange- nally, in beitng able to negotiate with senior private sector ment with a lead adviser-for example, appointment of the figures. financial adviser, with other advisers reporting to him and It is beneficial from the government's point of view that their inputs coordinated by him. Examples of team structure external advisers have the knowledge and experience of are illustrated in figures 4a and 4b. providing effective and practical advice on similar conces- An example of the arrangement illustrated in figure 4b is sion-based projects and in dealing with both the public the appointment of West Merchant Bank in 1993 as a lead and private sectors. Up-to-date expertise in the relevant adviser to the U.K. Government for a potential toll road pro- industry sector and local knowledge are other criteria on ject in Scotland, known as the Fastlink. The bank provided which a selection can be made. financial advice and was responsible for coordinating the activ- The relative importance of the selection criteria referred ities of engineering consultants, traffic and revenue forecast- to above varies, depending on the nature of the advice ing specialists, an environmental consultant, and a property and, potentially, the nature of the project. The relative impor- consultant. The main advantages of this approach are that, tance of various selection criteria in the appointment of first, the lead adviser can remove much of the administrative the financial, technical, legal, and revenue adviser is depicted burden of managing the advisory team from the government in table 1. team's shoulders, second, the lead adviser can bring a degree In many cases, whether the adviser is a foreign entity or of focus to the advisory team, such that unnecessary work a local one is immaterial to its selection. The possession of and duplication of effort can be more easily avoided; and third, local knowledge, which is often viewed as particularly impor- the lead adviser can help the government avoid having to deal tant for the legal adviser and the consultant providing advice with conflicting advice from different members of the team. on revenue forecasts, is an attribute that may be held by The main disadvantage of this structure is that the government local firms or international firms with a local operation. It loses a certain amount of control over the advisory team. is important, however, that the advisers be able to com- municate effectively in a language with which the govern- Legal and Regulatory Framework ment officials and internal advisers are comfortable. This may make local participation in the adviser's team essential. Before the private sector is approached, an appropriate Language skills and other elements of local expertise can legal and regulatory framework must be in place. This be obtained in a number of ways: for example, by appoint- should enable the government to award, enter into, and ing an international firm with a well-established local pres- regulate concessions and enable the private sector to carry ence and requiring that it ensure that key team members will out all the tasks that may be required to effectively man- have appropriate language skills and other local expertise; by age the project. In considering the nature of the required selecting an international firm that has formed a joint ven- legal and regulatory framework, the following issues ture with a competent local firm for the purpose of the pro- (among others) need to be addressed: TABLE I Qualifications of team members Concession Sector State of the Public and private Local experience experience art expertise sector experience knowledge Financial 1 3 2 3 4 Technical 2 1 2 4 3 Legal 1 4 2 3 1 Revenue forecasts 3 1 3 4 2 Note: Skills are ranked from least relevant (I ) to most relevant (4). 9 * The power of the government to grant concessions Poland the implementation of the tendering process for the to private sector entities in the relevant sector and, toll road program had to wait until enabling legislation for if necessary, to regulate the concessionaire's activ- the functioning of road concessions could be passed in 1994, ities. including the creation of the Agency for Motorway * The nature and degree of regulation of the conces- Construction and Operation and other bodies. sionaire's activities that may be appropriate and whether this is best achieved by legislation or through Economic Analysis the terms of the concession agreement. * The power of the concessionaire to undertake the Before the private sector is approached, the government should obligations imposed upon it by the concession. undertake a thorough economic analysis of the project and * The possibility that existing legislation inhibits or pre- verify that it is justified on economic grounds. This has the vents the concessionaire from maximizing the value following advantages: it confirms the long-term rationale for of the concession. the project, it can serve to focus and confirm support for the * The acceptability of the legal and judicial system to project from different areas of the government, and it pro- international companies and financiers. vides the project with credibility in the eyes of potential pri- * The existence of laws enabling financiers to take vate sector bidders, international banks, and institutions. acceptable security. Preferably, a report on the economic analysis should be made available to all those interested in bidding for the concession. The absence of an appropriate legal and regulatory frame- work, if not addressed early enough, can cause consider- Review of Financial Viability able impediments to the efficiency and success of the bidding process. For example, in the Second Severn Crossing pro- Early in the preparation phase the government's financial ject in the United Kingdom, the government had to take adviser should review the financial viability of the project. additional risk as the concession contract agreed with the This will involve the following main steps as appropriate: successful tenderer could not be made effective until it was confirmed by the legislature, which of course could * Review of project assumptions, risks, and financing introduce changes or even delay or deny its approval. In options. FIGURE 4 - Financial analysis. Examples of team structure * Consideration of ways of enhancing project revenues, if appropriate. * Consideration of potential government actions to sup- Policymakers Policymakers (govemment ministers) (government ministers) port project funding. * Investigation into any support that might be available Project director Project Idirector in relation to political and economic risks which are Project director Project director (senior officer) (senior officer) perceived by banks and financial institutions to be I l unacceptable. Project manager Project manager (procurement specialist) (procurement specialist) Before the review of financial viability, a decision should be made on the scope and definition of the project (for Technical Financial consultant example, for a tolled bridge: its location and whether the consultant (lead consultant) project includes the provision of access roads); or at the I l l very least, the options should be narrowed down to no more Technical Legal Revenue than two or three whose viability can then be examined. consultant advisor forecasts 10 Review of project assumptions, risks, and financing - Existing patterns and level of demand for travel on options the proposed road. - Growth in demand for road transportation in the The financial adviser, in conjunction with the rest of the relevant area as a result of economic growth, increases project team, will first need to understand the technical and in the rate of car ownership in the country, and changes economic assumptions on which the project's financial in the cost of road transport relative to other modes. viability is to be assessed, examine the risks associated * Factors that would attract motorists to the proposed with these assumptions, and assess financing options that road rather than to other existing road links, if any, may be available against this background. for example, time savings, and road quality. * Changing development patterns, particularly the loca- Technical assumptions. Depending on the type of project, tion of commerce, industry, and residential facilities. the technical assumptions that need to be considered include, - The effect of provision or upgrading of competing as appropriate: forms of transport for both passenger and freight traf- fic, for example, rail links. * Capital cost estimates and the extent of their firmness. * The extent to which any new journeys will be made * The construction program, including a timetable (that is, generated traffic). and its interaction with the costs; * The proportion of foreign traffic, if any, and the poten- * The degree of risk associated with design and con- tial for collecting tolls in foreign currency struction and the implication for costs estimates and * The potential for charging differential tolls to freight the timetable, for example, ground condition risks and passenger traffic and to domestic and foreign and design risks. traffic. * Operating costs, including maintenance and staff * The resistance of motorists to paying tolls at differ- costs, and the risks associated with these. ent levels. * Any requirement on the part of the government for Although the technical assumptions are developed by tolls to be regulated to ensure that the road will appeal the technical advisers, the financial adviser's understand- to a sufficiently wide number of users. ing of these issues is often critical in raising the right ques- tions on which such assumptions must be formulated to For a water project, factors affecting revenue projections make the project financeable. are likely to include: Support infrastructure. If app]icable, the requirement for * Demand, based on existing population estimates, providing or upgrading any supporting infrastructure for ignoring existing constraints on service provision. example, approach roads for a tolled road or bridge pro- * Potential changes in demand as a result of the intro- ject-the indicative costs, and the timetable for comple- duction of water metering, changes in consumer tion of these will need to be examined. lifestyle (for example, as aresultofeconomicgrowth), industrial requirements, and improvements in indus- Revenue projections. Of critical importance is the avail- trial water recycling. ability of up-to-date revenue projections. For a tolled road * The rate at which consumers are likely to switch project, for example, the financial adviser, in conjunction from existing supplies (for example, wells or existing with the project team, needs to examine the assumptions distribution networks), to the service provided by the made in any traffic study conducted. Such an assessment concession. would take into account a whole series of factors that would * The demand from areas that hitherto had no access have a bearing on the revenue projections. Byway of exam- to water supply infrastructure, and the rate of increase ple, for a tolled road these would include: in this demand. 11 * The effect on revenues of the reduction of consumer Foreign export credit agencies. This type of funding can fraud and the introduction of efficient debt collec- be advantageous in that it is often at a fixed rate of tion. interest and of a longer maturity than bank debt. * The effect on demand of the cost to the consumer However, in general it is tied to the supply of goods of connection to the service, the tariff, and different and services from the country whose export credit degrees of tariff regulation. agency provides or facilitates the finance. It is there- fore unlikely that projects such as tolled roads, which The uncertainties associated with the various factors affect- usually have little imported content, can make much ing the revenue projections need to be thoroughly investi- use of it. gated and, where possible, an estimate made of the probability Domestic bank debt. This can prove to be a very flex- associated with each of them. A statistical analysis can then ible source of financing for a project. Its availability be undertaken to establish the robustness of the revenue pro- depends on the depth of the local market and the jections and the comparative impact of each factor. appetite of local lenders for limited recourse project finance. In addition, its usefulness will depend on Financing options. Since a key component of the review whether the maturities available match the needs of of financial viability is identification and analysis of the the project. requirements of lenders and investors, a comprehensive Foreign bank debt. Many international lenders have understanding of the following will be required: an appetite for well-structured project financings in infrastructure. The availability of this type of finance * The potential types of investors and lenders and other could depend on, among other things, the view taken financial sources. by international banks of the country risk (particu- * The particular requirements of each potential source larly the foreign currency risk) and its usefulness will of finance, in relation to such projects in general and depend largely on the term for which such banks are the specific project in particular, taking account of prepared to lend. the technical, economic, and financial aspects of the * The bond markets. This type of financing has been project as well as the wider country, political, and eco- used to serve a limited number of large projects, par- nomic environment risks. ticularly in the power sector. Although less common i Thescopeforvariationintheserequirements,depend- for other types of infrastructure, it was used suc- ing on the project scope, risks, and potential for upside cessfully for the M1-M15 Motorway project in benefits and other types of ancillary revenues, if any. Hungary, where domestic bond issues, partly guar- anteed by the EBRD, formed a significant element Potential sources of finance for a concession could of the funding package. It has also been used more include: recently in the United Kingdom for four transporta- tion projects, which are concessions implemented * Developmentfinance institutions, such as the IFC, the under the terms of the U.K. Government's Private World Bank, the EBRD, and the IDB. Each of these Finance Initiative. The appetite of international has its particular requirements. For example, the investors for a project-related bond depends on their EBRD and the IDB's lending activities are restricted perception of the country risk, the specific project to Central and Eastern Europe and Latin America, risks, and the likely liquidity of the paper. The poten- respectively The World Bank requires a government tial for a domestic issue depends on these factors as counterguarantee in its partial risk and partial credit well as the depth and diversity of the domestic finan- guarantees to projects, whereas the IFC lends or cial markets. invests without reliance on any government coun- * Commercialinterest investors. These investors contribute terguarantees; to the equity of a project either because they have a 12 direct commercial interest in its success (for example, financing and support options particularly relevant to com- the contractorresponsible for construction orthe com- plex financing situations. The model will need to allow a pany responsible for long-term operation.) or because full examination of: their long-term business interests may be indirectly affected by it. An example of this is the investment - The project's overall financial return, based on sev- made by National Express, a bus company, in the eral scenarios of capital costs, revenue forecasts, and Channel Tunnel Rail Link project in the United duration of the concession. Kingdom. While investment by companies with an indi- * The likely returns required by investors and lenders rect commercial interest is not common, at least at relative to the risks identified. the preconstruction stage, investment by companies * The size of the private sector contribution to project who have a direct contractual interest generally pro- financing based on the direct cash flows of operat- vides the main part of the equity portion of funding ing the project, in turn based on different corporate, for concession-based infrastructure projects, at least financial, and commercial structures. until the initial construction has been completed. • Institutional investors. The availability of long-term The assessment will provide the government with an institutional investment for concession-based pro- expert analysis of the likely maximum contribution of pri- jects at the preconstruction stage depends largely on vate sector financiers to the total investment needs of the the depth and diversity of the domestic financial mar- project. It will therefore define the funding gap, if any, that kets. Recently, however, specialist infrastructure funds must be covered from other sources. The financial model have been established that are prepared to invest can then be used to investigate the options available to the internationally in concession-based projects, if spe- government to complete the financing scheme. cific requirements are met. If the project lends itself to being financeable merely by * Venture capital. This is sometimes considered a poten- adjusting the toll or tariff rate to a level that is adequate to tial source of finance for infrastructure projects, but meet the projected funding and operating costs and pro- its use is limited as the investors require a high rate vide a return to investors, the financial analysis will be able of return and a high degree of confidence in an exit to provide the government with an assessment of the type route for their investment after a relatively short of financing structure that will lead to the lowest possible period, for example, five years. toll or tariff rate. It is important that price elasticity of a Publicshare issues. These have been successfully under- demand be taken into account when examining the effect taken for some large, high-profile projects in well- of pricing differences on project revenues. developed markets, for example, the Hub Power The model can also be used to analyze the potential Company's project in Pakistan and the Channel that might exist for any sharing by the government in the Tunnel in France and the United Kingdom. A public upside of the project, that is, profit in excess of that pro- issue is also planned for the United Kingdom's jected by the base case. Such profit sharing mechanisms Channel Tunnel Rail Link. For most projects, how- have formed part of a number of concessions, including ever, a public issue is only a realistic prospect once some Private Finance Initiative projects in the United construction is complete. Kingdom, for instance, the recent private prison conces- sions. However, while governments sometimes seek such Financial analysis mechanisms in order to generate revenue for the public sec- tor and prevent the private sector from making excep- The financial adviser will need to construct a project-spe- tional returns, it can be argued that the greater the restrictions cific financial model, utilizing the information derived from imposed on the concessionaire's legitimate upside poten- the various assumptions described above. The model should tial, the greater will be the return it requires under base- be designed to take account of the wide range of potential case conditions. 13 Project revenue enhancement rather than from the project itself. Similarly, the Hong Kong government was able to exploit property development gain Options for enhancing project revenues could include to finance part of the cost of the Hong Kong metro system. exploitation of ancillary activities, exploitation of prop- erty-related benefits, and packaging the project with other Packaging the project with other, higher-return projects. higher-return projects. Packaging the project with another associated high-return project from which revenue could be earned, but which Exploitation of ancillary activities. Activities ancillary to, would not necessitate any significant additional capital for instance, a road project are potential sources of income. expenditure to the concessionaire, would be another way Examples of such activities are service stations containing of enhancing overall project revenues. After identifying shops, restaurants, filling stations, motels, and advertising. the second project, the key issue will be whether it is a log- However, experience of such activities, at least for road pro- ical fit with the likely skills of groups bidding for the first jects, shows that they are not significant revenue enhancers project. If the fit is not optimal, it may be better to ten- although it may nonetheless be appropriate to give the der the two projects separately to optimize the total ben- concessionaire the opportunity to exploit them in order to efits to the government. An example might be the enhance the upside potential of the project. Unless the bid- packaging of the operation and tolling of an existing road ders for the concession can satisfy themselves as to the orbridge requiring refurbishment with a concession involv- certainty of such revenues in advance they are likely to dis- ing the design, construction, and operation of a new road count their value significantly when pricing their bids. or bridge. An example of this is the concession for the Bidders for the M1-M15 Motorway project in Hungary Second Severn Crossing in the United Kingdom. This pos- were offered the opportunity of exploiting filling station sibility is likely to have a more limited applicability in some revenues, although this is unlikely to have had a significant developing countries, where the value of projects avail- effect on the project's overall financial viability. able for packaging might not be sufficiently certain for them to have a significant effect on the financial viability Exploitation of property-related gains. The potential for of the concession. property development gain in connection with a project's implementation can be significant, depending on the cir- Government actions and support cumstances of the project. Significant new transport infras- tructure projects, for example, have a positive effect on It is not possible to finance the project on a fully private the value of neighboring land and provide opportunities for sector basis, even after taking full account of revenue- development profits to be made. In some instances, it may enhancing possibilities. It will be necessary to explore ways be possible to offset such gains against the cost of the pro- in which the government could support the project to make ject and thereby enhance its viability. Where potential gains it financeable. The primary concern for many governments are identified, a thorough investigation of their potential will be to minimize direct, up-front contributions to the cost value and how they can be captured for the benefit of the of construction, although the extent to which this type of project will need to be undertaken. In many cases it may support can be avoided will depend on the economics of only be possible to capture the gain where the government the project and the results of the review of financial via- already owns the land in question. The proposed Corridor bility. Depending on the type of project, mechanisms that Sur toll road in Panama is an example of a project where could be considered include: government-owned land with potential development value will be made available to the concessionaire in order to Governmentparticipation in revenue risks. In certain types improve the financial viability of the project, although in of projects, for example, a new toll road, potential bidders this case the development gain stems largely from the change are likely to attach a high degree of uncertainty to the traf- in land use (from an airport to residential or other uses) fic forecasts produced by the government or its advisers 14 and will therefore adopt a conservative forecast for their until the initial level of demand has stabilized. This is espe- base-case financial projections. This will result in a reduc- cially the case for transport projects. An alternative to the tion in the amount of finance a private sector bidder can government making cash available to the project up-front provide. The government, however, may be more willing would be to make cash subsidies to the project during, say, to treat the forecasts as relatively certain, and consequently the first five years, either on a lump-sum basis or on the could afford to agree to provide some revenue protection basis of, for example, units of throughput. These could be if the traffic falls below certain levels. in the form of nonrefundable grants or subordinated debt. Government participation in geotechnical risks. If existing Cash contributions during the construction period. The low- geotechnical surveys are inadequate for a definitive risk est-priority type of direct government support tends to be assessment by bidders or if there are serious geotechnical provision of cash contributions to the construction costs. risks that cannot be insured, prices bid for a concession These could be in the form of nonreturnable grants or sub- can be adversely affected in a way that could reduce the ordinated debt or equity. project's financeability. If these circumstances arise, con- sideration could be given to the government assuming some Support in relation to economic and political risks of these risks, focusing particularly on risks that it would be unreasonable for the private sector to bear. In this case Infrastructure projects in countries with a difficult politi- the government would contribute to the construction costs cal or economic environment will raise particular issues of if additional costs arose as a result of unexpected ground a trailblazing nature in relation to financeabiity, especially conditions. where the earnings of the project would be generated sig- nificantly in domestic currency, while the finance may be Contributions ofassociated infrastructure. The government largely foreign currency. These are primarily currency con- can reduce the capital costs of project and enhance revenue vertibility in relation to the debt service and returns on by, for example, contributing associated infrastructure works investment, the risk currency devaluation, and the financ- for no or little charge (although this would imply an up- ing of any government obligations to the project in a situ- front contribution to construction costs), or by including ation of budgetary constraints. existing infrastructure in the concession-say, in the case Unless these issues are addressed at an early stage, pri- of a new toll road project, a section of existing road, on vate sector interest in the project will be considerably which additional toll revenues could be collected. If the reduced. Even if the government is prepared to carry the existing road was previously untoll, the approach is more above risks, the project still may not attract sufficient finance likely to work if upgrades are first carried out on the road if the political risk of the country is not acceptable to inter- to make it more acceptable for users to pay tolls on it. national banks and investors. Backup of government obli- gations by international institutions is likely to be the most Favorable tax regime. The granting of special income tax feasible way of resolving this issue. Failure to deal adequately holidays to the concessionaire (over and above those that with this issue has meant that a number of major non-for- may already be available) during the early years of opera- eign exchange-earning projects have not been realized in tion and the refunding of any tax on construction and non-OECD countries. operating costs could have a significant effect on financial In the first place it is necessary to establish the level viability, although the government would have to weigh of support that government authorities are required to the effect of this against the revenue forgone. provide, taking account of all the circumstances of the project. Next, the'required form and amount of external Subsidies during the operating period . In many new infras- support by international and bilateral institutions, such tructure projects the achievement of a positive cash flow as the World Bank, and development finance institu- in the early years can be difficult and will continue to be so tions to back up these obligations must be assessed. The 15 support mechanisms can vary depending on the precise designing the bidding process will, depending on the pro- risks, perceptions of financiers, and the flexibility of the ject, include the following: international institutions. The common thread is that the support be focused, that it be the minimum neces- * The nature of the bidding process. sary to achieve the objectives, and that it not dilute the * The definition of the project in technical terms. bearing of key financial risks by the private sector project * Identification and undertaking of detailed work to promoters. enable the government to provide revenue forecast In addition, if it is shown to be necessary for the gov- information-for example, traffic forecasts for a road ernment to make an up-front contribution to the con- project-and any other technical and geological data struction costs, it may be that an international institution likely to be of importance to bidders. like the World Bank or regional institutions like the Asian * Confirmation of a detailed timetable, including, Development Bank or EBRD (none of whom would nor- depending on the project, a timetable for items such mally lend directly to the project without a government as any planning procedures, land acquisitions, and guarantee) would be prepared to finance this on conces- legislation. sional terms. Such institutions are only likely to do this if they determine that the government has relatively severe Nature of the bidding process. Experience suggests that it resource constraints. is preferable that the bidding process be undertaken in a Upon completing the review of financial viability, the manner that holds the expensive full-bidding stage to a lim- government's financial adviser should be able to provide ited number of bidders. The benefits include the following: recommendations to the project team and the government on the project scope, the financing of the project by the * A fewer number of bidders improves the chances for private sector, the form and amount of any government or any single bidder to win the concession, and as such, international institutional support necessary, and the opti- bidders would be more willing to incur the high cost mal corporate, financial, and commercial structures. The of bid preparation. recommendations should be practical, recognizing the par- * Maximizing the commitment and enthusiasm of the ticular environment, but should also aim to be innovative relatively few shortlisted final bidders. and imaginative and take full account of international expe- * Saving time at the final bidding stage by confining rience in similar situations. discussion to fewer prospective concessionaires. * Allowing early consideration of any innovative alter- Framework for Private Sector natives presented. Participation With such a small number of bidders, it is important Simultaneously with the review of financial viability, and to minimize the possibility of any bidder withdrawing, as before the bidding process can begin, it will be necessary this would have the effect of undermining the competi- to define the framework for the bidding process, resolve tion. Careful evaluation of prequalification candidates, key policy issues, and if necessary, secure external support proper structuring of the bidding process in a way that from international funding institutions. recognizes the legitimate concerns of bidders, and care- ful implementation of the bidding process are needed to Definition of bidding framework ensure that bidders do not withdraw at any stage. In addi- tion, consideration can be given to the usefulness and The bidding framework needs to be designed so as to desirability of requiring bidders to submit bonds at dif- extract from bidders the most competitive proposals that ferent stages of the tender in order to protect the gov- are technically compliant as well as financially feasible. ernment from the additional costs it may incur as a result The issues to be resolved and tasks to be undertaken in of a bidder or the concessionaire withdrawing. The bond- 16 ing requirements for projects vary greatly with the par- depend on a number of project-specific circumstances, ticular circumstances and therefore it is not possible to including terms of the concession agreement relat- provide any generally applicable guidelines about such ing to maintenance. bonds and their relative magnitudes. However, in very broad terms, based on actual experience of such pro- Technical definition. A key issue for early decision will jects, for a project of substantive size the bonds listed bethenature andextenttowhichtheprojectwillbe defined below may be considered, depending on the circumstances in technical terms and the nature and detail of the specifi- of the project and the degree of risk protection perceived cation. A balance will need to be struck between a detailed by the government as necessary: physical specification that could save bidding time and costs and make evaluation easier, and performance specifications * Conforming bid bond-issued by or on behalf of short- that would allow bidders the flexibility to produce their own listed tenderers within, say, one to two months of issu- cost-effective solutions and that has the effect of transfer- ing tender documents (to allow time for tenderers to ring design risk to the private sector. assess the documents and make suggestions for changes), undertaking that the tenderer will submit Revenueforecasts. Given the critical importance of fore- a bona fide fully conforming bid. Indicative amount: casts for the underlying demand for an infrastructure .01-.02 percent of capital costs. project (for example traffic forecasts for a toll road) and * Tender bond-issued by or on behalf of the tenderer the limited bidding period, experience shows it is highly at the time of tender submission, guaranteeing that desirable that bidders be provided with full demand (and the tenderer will not withdraw or seek to vary any preferably revenue) forecasts together with the assump- conforming or additional alternative tender, but will tions underlying them and a detailed description of the negotiate in good faith with the government up to methodology used to produce them. Although the con- signature of the concession. It will supersede the con- cessionaire and its financiers will need to undertake their forming bid bond. Indicative amount: 2.5-3 percent own investigation of demand and produce their own rev- of capital costs. enue projections eventually, the provision of full demand * Concession signature bond-issued by or on behalf of forecasting information by the government at the bid- the winning tenderer at the signing of the conces- ding stage will shorten the time and expense of bidders sion agreement to guarantee performance of the con- in undertaking basic work at a time when their exposure cessionaire until the agreement becomes effective. is the greatest. It may also encourage bidders to take a This bond will supersede the tender bond. Indicative more optimistic view of the revenue projections. If bid- amount: 5 percent of capital costs. ders are presented with scanty information, they are more * Performance bond-issued on commencement of the likely to treat it conservatively because they will be unable concession period to guarantee fulfillment of the con- to satisfy themselves as to the assumptions or methodol- cessionaire's obligations under the concession agree- ogy used without undertaking expensive original work, ment. It supersedes the concession signature bond. which will have the effect of increasing bidding costs. This This bond can be allowed to lapse when a reason- will be particularly important for a project in which there able amount of money has been spent on construc- are considerable uncertainties surrounding the potential tion, since by then the project itself could provide demand due to, say, a radically changing economic envi- the government with sufficient security against con- ronment and the lack of experience of other similar pro- cessionaire default. Indicative amount: 15 percent jects in the area. of capital costs. * Maintenance bond-applicable during the last years Timetable. The government should prepare a detailed of the concession to ensure that the project is handed critical path timetable for the project incorporating, if rel- over in the agreed condition. Indicative amount will evant, aspects such as the legal steps involved in land acqui- 17 sition and planning processes. The interest of bidders can Defining the scope of the concession agreement. As it is desir- be reduced considerably if they conclude that the neces- able for the concession agreement tobe released at the same sary measures have not been taken by the time the bidding time as the bidding documents, the legal advisers should process starts. begin drafting the concession agreement, in conjunction with the project team as soon as possible, in order to ensure Resolution of key policy issues that the completion of the draft agreement does not delay the issue date. It is desirable that key policy issues affecting the scope and nature of the potential concession agreement are resolved Securing support from intemational financing institutions before the prequalification process is complete. This is to ensure that bidders focus on the government's key objec- If external financing support is deemed to be a requirement tives, and that they do not drop out of the competition then such support can take a number of different forms: because of major surprises when such issues are eventually back-up of government obligations (discussed above), fund- resolved. Prequalification candidates should be advised of ing of government cash contributions to construction costs the decisions made, and they should be given the chance (discussed above), provision of debt finance direct to the to amend their submissions, if necessary. Apart from those project, and investment of equity directly in the project. issues decided in the context of the review of financial via- The mobilization and integration of this support is critical bility referred to above, depending upon the project, the in ensuring the financeability of the project. policy issues that need to be resolved at this stage include, as appropriate: Prequalification Process * The packaging of the project with other similar under- In general, for large projects the objective of the prequal- takings in order to enhance financial viability (as dis- ification process should be to reduce to about three the cussed above). number of interested bidders selected for the main bid- ) The nature of risk sharing between government and ding process. This stage in the bidding process needs there- the private sector. fore to be stringent so the government can distinguish * The nature of the government's role in participating adequately among candidates. Bidders need to be provided in or regulating the operations of the concession. with sufficient information on the project to enable them a The form and basis of any other government or exter- to undertake an adequately detailed assessment that will nal support for external risks required for the project. allow them to justify the commitment of substantial resources * The scope of the concession agreement. to making a comprehensive and competitive submission. The information provided to potential prequalifiers must The issues listed above, which all need to be resolved be sufficient to attract suitable bidding groups. Apart from before the prequalification process is completed, are dis- information on the design, scope, timetable, and back- cussed in more detailbelow. (There will, of course, be many ground to the project, the following will be particularly other policy issues to be resolved later in the process.) important to candidates, depending on their specific situation: Government role in participating in or regulating the con- cession. A number of mechanisms can be employed by the * Summary demand forecasts, with estimates of rev- government in the supervision and regulation of the con- enue and assumptions of demand elasticity. cession. These range from the government having a minor- * Progress on the various critical path actions relevant ity equity stake to a formal arms-length supervisory for the project. relationship. The general preference is for the government * Scope of the proposed concession, including an out- to undertake supervision on an arms-length basis. line of the concession agreement coveringthe keyissues. 18 * Outline of the selection and evaluation criteria to be Assessment of the financial capabilities of sponsors used. should include the following criterion: the combined net worth of the sponsors should, at a minimum, exceed the The assessment procedure should be designed to select sum of the level of equity plus the quantified value of any the candidates who have: guarantee-like undertakings, including bonds (which may be required from sponsors to make the project finance- * The financial, technical, and managerial capacity and able), by a margin that is comfortable enough to enable expertise to build, finance, and operate the type of them to undertake their original business commitments. project in question. This element in the assessment carries, arguably, greater * Experience of bidding successfully for similar pro- relative weight than, for instance, track record in mobiliz- jects and mobilizing project finance. ing project finance. In addition, other factors, such as the * Demonstrated commitment and competitive enthu- realism of the bidder's expected rate of return and how siasm to participate aggressively in the main bidding well it has demonstrated its understanding of some of the process. key commercial and financing issues likely to be encoun- - The knowledge and experience of conditions within tered on the project, will also carry a significant weight. the host country. This approach should allow a judgment to be made about how well a bidder has grasped the risk and business char- In addition to providing details of past technical per- acteristics of the project and reflected this in his or her formance, bidders should be asked to provide, as thinking about the likely financing structures. This has appropriate: implications for the bidder's capacity and appetite to per- sist with the demanding bidding and negotiation process * A description of their experience on the design, con- and to formulate and implement a credible and competi- struction, and operation of the type of project being tive financing structure. considered. A hypothetical example of how six candidates could * A description of the bidder's (a) proposed conmuer- have scored in a prequalification process for an infras- cial structure, if awarded the concession, and their tructure concession in a developed country environment understanding of the commercial issues; (b) likely is depicted in table 2. Two candidates prequalified rela- sources of financing; (c) proposed scale of financial tively easily, two were judged to be well below require- commitment and, if relevant, the level of the finan- ments, and the remaining two were on the border of cial commitments of consortium members; and (d) acceptability, with each offering a different mix of strengths likely level of financial returns sought. and limitations. It would only be possible to distinguish * Their approach toward managing any construction between these two bidders with confidence if the infor- contracts. mation they have provided is sufficiently comprehensive. * Their experience of competitive tendering for projects This will be determined partly by whether the information involving a design, construct, and operate concession. provided to them by the government is of adequate depth * Their experience of major construction and opera- and quality, and partly on whether the demands put on tional undertakings in the host country. them by the prequalification process are sufficiently rigorous. In evaluating bidders at this stage, relative weights may Prequalification processes conducted in some develop- be allotted to the various criteria listed above and, given ing countries may also result in similar outcomes. However, the nature of these criteria, careful judgments will often be for a country whose international creditworthiness is per- called for in assessing bidders' capabilities in a number of ceived to be marginal, the interest of suitably qualified inter- these areas, rather than there being any strict quantitative national bidders is likely to be severely limited. To make the criteria. project attractive to such bidders, it is important that key 19 TABLE 2 Prequalification criteria Candidates Criterion A B C D E F Capocity/expertise Finandal / / / X / / Technical / / / / / Managerial / / / X / (/) Experience Similar prpjects / / / X / / Bidding successfully / / X X / X Mobilizing finance / / / X .1 X Commitment/enthusiasm X / / / / X Knowledge of local conditions (/) / V / X X Prequalification ?/ v X ? X / High soore; (/) Moderate score; X Low score: ? Not available. areas of concern to the private sector be addressed at the operation of the concession, and the mechanism for early stages of project preparation. these. * Final decisions on risk sharing. Main Bidding Process * Common information provision, for example, the commissioning of a ground conditions survey by the Ideally, the main bidding documentation should be com- government and its inclusion in project costs. plete and clearly presented so that the amount of abortive * Final decisions on government support. work bybidders can be minimized. Bidders allow for uncer- * Anybonding or guarantee requirements. (Careful con- taintybyincreasingexpectedcosts andreducingbidvalues. sideration should be given to the appropriateness of these as their cost will reduce the value of the bid.) Critical issues * Treatment of qualified or variant bids. - Restriction, if any, on competing infrastructure. Before the main bidding process begins, certain critical * Agreements on external support. issues will need to have been resolved, including: * Potential reimbursement of abortive bidding costs. * Areas on which specified alternative bids will be required * Whether the concession period is fixed, or whether from bidders so as to test the market. bidders are free to propose the duration of the con- cession. (Each approach has pros and cons, depend- These issues involve complex considerations. A balance ing on the nature of the project, including the overall has to be struck between ensuring that the government's risk transfer structure that has been adopted.) commercial, economic, and social requirements are met, * If appropriate, the basis on which the concession and offering a structure that will attract the private sector. will revert back to the government or be transferred Imposing on bidders restrictions that are unreasonable, to another concessionaire. impractical, or costlywould minimize the private sector con- * Whether it is appropriate to impose liquidated dam- tribution or render the concession unattractive. ages relating to delays in completion of construction Given the level of detail required and the importance and commencement of operation. of maximizing the bid value, a minimum bid period of five * The degree of design freedom to be permitted, to six months is usually appropriate, depending on the com- * Whether it is appropriate to include in the conces- plexity of the project. During this period bidders' questions sion agreement any financial incentives relating to the and comments need to be answered with speed and on a 20 consistent and open basis, with any new information pro- Kingdom, where the concessionaire's revenue is to be in vided to one bidder being copied to all other bidders. the form of "shadow tolls" paid by the government. Bidders' conferences in which information is disseminated simultaneously may be considered appropriate. However, Bid documentation care needs to be taken to address any bidders' concerns in relation to the intellectual property aspects of their proposals. The documentation for submission of private sector con- Separate consultation meetings with each bidder can also cession proposals should include, as appropriate, the gov- be used to allow bidders to raise issues that they may not emient's requirements relating to the project and the wish to raise in the presence of third parties. Governments bidding process, detailed information on the project, and need to retain an open mind and be prepared to issue amend- dear bidding instructions. ments to the bidding documents where gaps and inconsis- tencies are identified by bidders or where issues that could Government requirements. The bidding documents must affect the financeability of the concession have been raised. include a clear definition and description of the govern- ment's contractual, financial, and technical requirements Considerations relating to the government's technical and how they will handle the bidding process up to con- requirements tract signature. Specifically, this should include: The government's technical requirements can be expressed * A detailed definition and description of the project. either in a very detailed manner, in the form of an input * A draft concession agreement that will include, as a specification, or more simply, in the form of the perfor- schedule, a technical performance specificatioi relat- mance requirements of the project, that is, an output spec- ing to both construction and operations, and drafts ification. The pros and cons of these two approaches are of any other key agreements to which the government summarized in table 3. will be a party, such as any direct agreement between As indicated in table 3, compared with an input speci- the government and potential lenders that gives the fication, an output specification allows for a greater trans- lenders the right to take over the concession in the fer of design responsibility to the private sector and provides event of concessionaire default. This should help to more scope for innovation and for efficient and cost-effec- reduce the post-bid negotiation period, as the gov- tive interface between design, construction, and opera- ermnent's position on all aspects of the concession tion. In order to ensure the effectiveness of such an approach, will be clear. It is important that these documents be the government needs to: balanced and realistic, rather than reflect an initial negotiating position. * Ensure that its technical team has the relevant expe- * Full details of the government's proposed support for rience to enable it to produce a specification that the project. will permit a like-for-like evaluation of bids, and against which the concessionaire's performance can be TABLE 3 monitored. Technical definition: Input versus output * Consider bidder consultation meetings during the specifications tender period to ensure that the technical solutions Specification Input Outut bidders have in mind are likely to be acceptable. Most engineers have the expertise / X Straightforward evaluation of bids W/ X * Be prepared to issue amendments to output specifi- Straightforward monitoring of performance I X cations after consultations with bidders. Transfer of design risks to private sector X / Scope for private sector design innovation X / Scope for acceptable technical solutions / / This approach was successfully adopted in the M6 Design, Maximum scope for efficient and cost-efrective Build, Finance, and Operate road project in the United interface between design, construction, and operaton X / 21 * Details of any external support agreed for the * A coherent, well-developed commercial and organi- project. zational plan for operations of the concession com- pany. Information on the project. The information provided to * Financial projections and analysis demonstrating the bidders on the project should be as full as possible to avoid viability of the concession company's operations over the bidders incurring unnecessary time or expense, and to the life of the concession. enable them to meet the government's requirements. It * The assumptions underlying this analysis on all aspects should be made clear to bidders that, although this infor- of construction and operation. mation is provided in good faith, it is not warranted by the * Comprehensive, detailed financing proposals together government and will not form part of the contractual arrange- with evidence of the support of lending and invest- ments with the government. The information provided ing institutions. These should cover the full capital should include, as appropriate: costs of the project apart from any amount to be funded by the government or international financ- * Detailed, independentlyvalidated underlying demand ing institutions. forecasts and revenue projections, with assumptions - Evidence of adequate financial resources from the and methodology used. bidder, other investors, and lenders to cope with • Survey reports including any detailed soil and ground unforeseen circumstances. condition tests that may be relevant, or any detailed * Any bonds or guarantees required at the bidding stage. environmental assessment of the project site. 3 Legislation, existing and proposed, that will affect the Alternative bids. Within the context of the overall sug- project, including any applicable environmental reg- gested approach which, as stated above, could also require ulations or guidelines. bidders to bid on the basis of specified alternatives to test the market on certain issues, it is also feasible to allow ten- Bidding instructions and information. The bidding instruc- derers to put forward unspecified alternative proposals that tions and information should inform the bidder precisely do not comply with all the requirements of the tender doc- what it needs to do in order to submit a compliant tender uments. However, such alternatives should onlybe additional and what will happen to its bid once it has been submitted. to the fully conforming proposals that must also be submit- It should specify: ted so that the government can be reasonably sure of receiv- * The timetable that bidders must adhere to for bid FIGURE 5 submission. Tender documentation * The required form of tender. * Details of any bonds and guarantees required. * Details of what the bid should contain (see below). Legal form of tender * The precise criteria on which both compliant and vari- _ ant bids are to be evaluated. Technical proposals As a minimum, bids should contain the information operatonal shown in figure 5: plan Financial projections and * A signed form of tender in the specified format. assumptions * Technical proposals that clearly demonstrate the way Financial in that the bidder intends to meet the government's proposals specifications. Tender bond 22 ing a set of bids that it can evaluate on a like-for-like basis. * In the event that the government determines that a the Alternative bids could be based on variations in the alloca- proposal is not intellectual property, notification of the tion of risk specified in the bidding documents or variations bidder of this judgment and an opportunity given for in other tender requirements, for example, those relating to withdrawal of the proposal. If the bidder chooses not to technical performance. However, experience shows, espe- withdraw the proposal, the government should reserve daily with Private Finance Initiative projects in the United the right to invite other bidders to bid on the same basis. Kingdom, that such proposals should be made subject to the following: The above approach provides for: * Discussions of any proposed alternative bids in confi- * Increasing the scope for further innovation on the dence with the government during the period before part of bidders. the submission of final bids. * Confidentiality and protection of intellectual property * Acknowledgment by the government that the alter- * Elimination of the possibility of bidders spending a native proposal is acceptable in principle. large amount of time and expense on preparing fully * For alternative proposals judged acceptable, deter- developed alternative proposals that are subsequently mination by the governrnent as to whether the pro- determined not to be of interest to the government. posal can be considered intellectual property (this * Reconciliation of the objective of a fair and equi- is more likely to apply with alternative technical solu- table evaluation process with the need to provide flex- tions rather than with alternative allocation of risk). ibility to bidders to innovate. 23 Evaluation and Negotiation he issues and tasks involved in the evaluation and Finally, the different elements of the assessment are inte- selection of the concessionaire in the final bidding grated and a preferred bidder selected. T phase, and negotiation and conclusion of the con- cession agreement are discussed in this section. Assessment of value for money Evaluation The assessment of value for money could involve taking into account, for each bidder's proposal; the level of gov- Bidders' proposals are more likely to match the govern- ernment support, if any, required to complete the funding; ment's critical objectives if the evaluation criteria are pre- and the costs and benefits of each proposal. cise and transparent. Also, evaluation of tenders on a common basis can be handled more easily and rapidly. It Level ofgovernmentsupport. The type of government sup- is therefore recommended that considerable effort should port (if any) will have been defined in the bidding documents. be spent in developing firm, precise evaluation criteria The evaluationwill focus on the amount of support (whether (figure 6). Vague and general evaluation criteria result in a direct contribution to construction costs or contingency bidders inevitably spending considerable time and effort financing) required by each bidder. Clearly, this factor will on proposals that do not meet the government's critical be irrelevant if the financial viability review shows that gov- objectives. The extra time spent is reflected in their tender emrnent support is not necessary. In this case bidders would price, apd there will be criticism from the unsuccessful have been told that such support would not be available. bidders about high abortive bidding costs, as well as lack FIGURE 6 of transparency and fairness in the award process. Evaluation criteria The precise approach to evaluation will depend on the gov- ernment's objectives, the framework within which the can- didates have to bid (for example, for a tolled road project, whether they have complete freedom to vary tolls during the for money MaaeI concession period), and the level of detailed information avail- able on the potential socioeconomic impact of the project. If the necessary information is available, it is sensible to assess: Feasibility of * The value for money to the government of each pro- posal. Integrationof * Whether the bids are technically feasible and compli- different aspects Commercal ant with the specification. * Whether the bids arefinancially feasible and compli- \l n.n I ant with the government's financial requirements. 24 Costs and benefits. The first issue to consider is whether can be calculated, and that their value is affected by those there is any difference between compliant bids in terms of factors that the bidders have the freedom to propose. charges the concessionaire will seek to impose in return for For a road project, for example, the bids could differ in the services provided. Where the concession involves the pro- terms of the amount of road congestion relief each bid vision of services to a single government agency-for exam- produces in the area where the road is to be built. For such ple, a water treatment project, such as the Daldowie Sludge projects, the degree of congestion relief can be said to rep- Treatment project, or shadow tolled roads, such as those resent the net benefit of the proposal. The value of this ben- known as DBFO roads, both in the United Kingdom-it is efit is commonly used in the United Kingdom as one measure appropriate to assess the cost to the government of the charges of the economic viability of potential new roads. Provided made by the concessionaire over the concession period. the appropriate data are available, its value can be calcu- This can be done by calculating the net present value of the lated by expert traffic economists. initial charges proposed by each bidder-in other words the This is often done by ascribing values to the various ele- bidder is obliged to fix the charges for a prescribed period ments of congestion relief-such as time savings to motorists at the level proposed in its bid, and a common discount rate as a result of relieved congestion, savings in vehicle operat- is used to compare the proposed charges Where the con- ing costs as a result of reduced journey times, and a reduc- cessionaire is required to take demand risk, the calculation tion in the cost of dealing with accidents, which would reduce should be based on the government's own demand projec- in number as a result of congestion relief-and computing tions in order for a like-for-like comparison to be made a net present value of the aggregate of these individual ele- between different bidders, and should incorporate the bid- ments for the period of the concession. The value of the der's proposed escalation regime (if bidders have the free- individual elements will vary from bid to bid as each will dom to propose this) or the government's prescribed escalation depend on the proposal the bidder has made for some or all regime (where this is specified in the tender documents), of the factors it has been given the freedom to propose. For For concessions where there are multiple customers, such example, different time savings will result depending on the as toll roads or water supply concessions, but where the con- road capacity (which will affect traffic speed), the number cessionaire's tariff is regulated, it maybe appropriate, depend- and location of junctions (which will affect the volume and ing on the nature of the regulation, to undertake a comparative type of traffic using the road), and the proposed construc- assessment of bids based on the proposed charges of each tion period (which will affect the period over which the time bidder on a similar basis as described above. In a completely savings will accrue). To calculate a value for time savings, it unregulated environment, for example, where a toll road con- is necessary to be able to assign a unit "value of time" to cessionaire has the freedom to fix the tolls throughout the each category of traffic that is likely to use the road. concession period, it will not be necessary to take toll levels Congestion relief may not be a relevant benefit for all into account, as it may be safely assumed that any conces- tolled road projects, for example, interurban roads. Another sionaire will eventually adopt a revenue maximizing toll strat- egy regardless of its initially proposed toll charges. FIGURE 7 Factors resulting in different economic costs Apart from the charges to be levied by the concession- and benefits aire, other factors could give rise to differences in the costs and benefits of bids received (figure 7). It will be particu- W cs larly important to focus on these where the concessionaire Toll roads Water concessions charges are to be unregulated. v Road/bridge capacity v Rate of expansion v NumberAocation of of coverage If the tender process gives the bidders the freedom to junctions v Enhancement of propose any such factors, one approach would be to cal- v Open/closed tolling emergency water reserves culate the net present value of such costs and benefits for i How well environmental each bid. It is important that the costs and benefits that Also, construction period, concession period, and are taken into account are those for which an objective value risk taking approaches. 25 benefit that may differ between bids is the tax revenues to fying sufficiently stringent technical standards, providing be collected from the concessionaire, which will be inflows for penalty points to be given for noncompliance, and to the government. Such revenues, which will differ depend- adopting high standards in relation to the bidder's expe- ing on factors specified by bidders, such as the duration of rience. In these circumstances it could be argued that all the concession, the capacity of the road, and the construc- the proposals that meet the required technical standard tion period, may be readily calculated. should be treated alike; proposals that do not should be If some or all of these factors have been predefined for rejected. An alternative approach would be to undertake bidders in the tender documents, a simpler approach could a probabilistic and risk-weighted analysis that would be easily be adopted. For example, where the concession period applied to the relevant factors in each proposal. The result is the only variable, a comparison could be made of the toll would be a value for each factor, that would then be revenue not collected, measured from the end of each bid- applied as an adjustment to the price offered. This sec- der's concession period to some defined point in time. In ond approach is complex and should, in most circum- this case a maximum construction period would need to stances, be avoided. be specified to bidders, as it would not be possible to inte- grate the evaluation of different construction periods with Financial evaluation different concession periods. In circumstances where no government support is nec- It is essential to assess the credibility of the commercial essary and all aspects of the project are prescribed by the and financial aspects of the bidders' plans over the con- government except for the construction period, the best cession period. This needs to be undertaken with a strin- value for money could be said to be offered by the bidder gent and detailed review of the underlying assumptions in proposing the shortest construction period. each bid. The past track record of the sponsors, their finan- To the extent that detailed information on economic cial advisers, and the supporting financiers will be of con- benefits, such as the methodology and assumptions neces- siderable importance. The assessment of the credibility of sary to calculate congestion relief, is not available and can- a bidder's proposal will involve considering issues such as not be provided to bidders to ensure full transparency, the bidder's own capital structure, and the sources and then some of the more simple approaches that limit the bid- availability of funding. At one extreme, if the bidder is a der's degree of freedom would need to be used to make company of substance and is willing to provide guaran- proper value-for-money comparisons. tees for the repayment of debt, considerations of the finan- cial structure and availability of funds will fall away. Technical evaluation However, aspects to be considered in the absence of guar- antees will include: The technical aspects include, as appropriate: * The amount and nature of the subscription of equity. * Whether the bidder's technical and management pro- * The strength and credibility of expressions of financ- posals are likely to meet the requirements of the per- ing support from banks and institutions that accom- formance specification. pany the bid. * Technical and design risks of the proposals. * The requirements of lenders and other project partici- * The proposed construction costs, their timing, and pants, such as suppliers and operators, with whom the likelihood of their attainment. there is an arms-length contract. * The proposed operating and maintenance costs, and * The availability of standby equity and debt. the likelihood of their attainment. * In the absence of equity, the extent to which the com- mitment of other participants (in terms of bonds, Evaluation of technical aspects during the construc- guarantees, and other conditions) provide an ade- tion and operating period could be simplified by speci- quate substitute for equity. 26 * The realism of the bidder's revenueprojections as com- * An assessment of the risk that this may not be real- pared with the government's projections. ized because of problems with the financial, techni- * The soundness and feasibility of the financing pro- cal, and operational aspects. posals, that is, the extent to which they move into rel- * The adjustment of the value-for-money assessment atively uncharted territory, are complex, or are in light of this risk assessment. dependent on external factors. * The bidder'sproposed timetable for obtaining under- Provided proper preparation has taken place before written commitments. bid documents are issued, and compliant bids have been received, the selection process should be reasonably Some of this assessment will involve qualitative judg- straightforward on the basis of the criteria set out above. ments. The objective would be to define stringent standards The process should be conducted comprehensively and of acceptability and, possibly, penalties for not meeting with speed. Under appropriate circumstances it may be them. Using an adequately specified financial model, the possible to ask bidders to remove any exceptions and robustness of the financial structure can be tested by sen- departures from the government's requirements and to sitivity analysis to assess the ability of the bidder's projected reprice their bids on a fully compliant basis. In the event cash flows to withstand adverse variations in economic that this proves impossible to achieve, any residual dif- assumptions. The assessment can then be converted into ferences between the bids in terms of the risks being a yes-no judgment or into a weighting sufficient to remove assumed could be dealt with by making quantitative adjust- the risk of failure. ments to the value-for-money assessment that reflects the If the bidding and evaluation process is well handled with government's view of the value attached to the differences. appropriate built-in protections, including bonding, there is likely to be much greater consistency between the final Negotiation and Conclusion of the financing plan and the one initially submitted by the win- Concession Agreement ning tenderer as part of his bid. This was the case in some of the U.K. Private Financing Initiative projects. In other It will be necessary to remain alert to a number of issues situations discrepancies can arise, as, for example, occurred that can be resolved only during or after the negotiation in the case of the M1-M15 Motorway project in Hungary. phase of the final concession agreement. These may include ensuring that: Integration of evaluation * Private sector finance can be underwritten on terms It is necessary to integrate the different components of the contained in the preferred tender. evaluation methodology. As indicated above, two broad * Construction and equipment supply contracts have approaches can be adopted: making judgments between been negotiated that reflect the terms of the con- different aspects of bidders' proposals, either implicitly or cession agreement, and are executed at the same time. explicitly (through assigning weights); or developing quan- * The process of obtaining legal powers and ensur- titative criteria where practicable, and using hurdles or yard- ing other conditions precedent are satisfied in time. sticks for other criteria. The second approach has several - The government's timetable of actions and contri- advantages, although it is recognized that there will be areas butions is consistent with the proposed timetable where judgments need to be made. The government will, in for signing the concession agreement. the last analysis, need to be able to exercise judgment in the Underwritten offers of debt finance and shareholders' round. Depending on the project, the approach should entail: guarantees should be required at this stage only. This is to ensure that the financial markets are not flooded with * Quantitative assessment of the value for money using competing financial proposals for the same concession (espe- one or more of the methods described above. cially in developing country environments with a limited 27 availability of international finance), and to ensure that of the fact that it is not in the leading position and may abortive bidding costs are minimized by necessitating the object to committing the substantial resources that may be completion of financiers' due diligence and imposition of needed to participate fully in the final negotiations. commitment fees only after a preferred bidder has been identified. Integration of Agreements The obligation would be on the private sector consor- tium (and not the government or financial adviser) to raise If the approach described above has been effectively imple- the finance for the concession. However, the government mented, the final process of integration of the various con- will need to ensure that the finance promised in the bid- tractual agreements, and ensuring that the concession ding documents is confirmed. agreement becomes effective, should be straightforward. Depending on the circumstances of the project, gov- However, bidders sometimes seek, at the last moment, to ernments generally find it helpful to negotiate in parallel recover some of the ground they might have lost in earlier with, say, the first two of the top-ranking bidders. This has negotiations. Delays also occur frequently in the prepara- the advantage of preserving the government's abilityto exert tion of documentation-all of which needs to be coordi- competitive pressure on the bidders until all contractual nated up to the signing date of the concession; this is more details have been agreed, and of ensuring that if the lead- likely to happen in certain developing country environments ig bidder withdraws the second choice is more likely to or where there has been limited experience of such pro- step in to the leader's shoes quickly. In practice, however, jects. Pressure and momentum has to be maintained on the becauise of constraints on the government's resources, the bidders to prevent this, and, on the government's side, steps second bidder is often kept in reserve and negotiations with need to be taken to ensure that all tasks within its own it carried at a less intensive level than with the top-ranking province are anticipated well in advance and promptly bidder. In addition, the second bidder often becomes aware addressed. 28 Costs and Timetable T his section considers issues relating to costs incurred - They increase the pressure from bidders to limit the by bidders during the bidding process as well as bidders participating in the expensive bidding stages those incurred by the government in preparation, to the smallest feasible number. evaluation, and selection. It also comments broadly on the * Over the longer term, they erode enthusiasm in the timetable required for the government and its team for the market generally for concessions. preparation of bid documents, evaluation, and selection, Controlling bidding costs Bidding Costs The approach to the bidding process described in earlier One of the major deterrents to serious bidders for conces- sections-involving thorough preparation and a stringent sions for major infrastructure projects is the high cost of bid- prequalification stage, followed by a tender based on clearly ding. The costs include not only the costs associated with defined requirements and evaluation criteria-offers the the development of a design-and-build project (which are best prospect of enabling bidders to control their specula- greater than for a build-only project) but the extremely tive bidding costs while at the same time allowing the gov- high cost of developing the operational, commercial, and ernment to achieve optimum value for money. financial aspects of the bid. These costs include the costs of financial advisers, lawyers, consultants advising on demand Reimbursement of bidding costs and revenue aspects, and a range of other external third- party costs as well as greatly increased business development Another measure that has been considered by some gov- costs associated with the commercial issues. Bidding costs ernments as a way of overcoming the problems arising from in relation to some recent concession awards in an indus- high bidding costs is to reimburse a portion of the costs trial country environment have totaled around US$5 mil- incurred by unsuccessful bidders. For instance, some years lion. Arguably, there is considerable potential for this figure ago the Greek government agreed to reimburse bidding costs to be exceeded in developing countries, given the likely addi- of up to about US$2 million to unsuccessful bidders for the tional uncertainties and pioneering nature of the project concession to build a new airport, for which the initial cap- structures relative to what may have been achieved before. ital costs of the project were in excess of US$750 million. These high bidding costs have a number of effects: The purpose of holding a bidding competition is to max- imize the benefits to the government and the public using They affect significantly the willingness of bidders the service to be provided by the concessionaire. It has (especially those of smaller net worth) to participate therefore been argued that, quite apart from developing a in major bids. This effectively limits the government's process that minimizes bidding costs, there is a case for access to market competition and innovation and, these costs not be internalized by the bidders to the detri- arguably, affects adversely the value for money that ment of the competitive process. However, if a government the government can achieve. is to consider any reimbursement of bidding costs, several 29 issues arise concerning who will bear the cost of reim- tial benefit of a shorter bidding period resulting from bursement, the amount and conditions for repayment, and a detailed performance specification needs to be the timing of the payment. weighed carefully against the potential value-for- money benefits of a less detailed specification. Who bears the cost. Since, in theory at least, bidding costs * The level of interest of potential bidding groups and should be more than recouped from the benefits of the financiers and the need for an active campaign to gen- competition, it would seem appropriate that costs associ- erate their enthusiasm. ated with the bidding process should be incorporated into * The comprehensiveness of the bid documentation. the project. Therefore, it can be argued that the winning As indicated in earlier sections, initial time spent in bidder should bear the costs. The winning bidder will, of preparing a comprehensive bidding document, eval- course, pass these costs on to users through the tariff (or uation criteria, and draft concession agreement is back to the government in cases where the project's via- more than compensated by a shorter evaluation and bility depends on a government contribution). negotiation process. a The competitiveness of the bids received, and whether Amount. The amount of reimbursement paid to each they are compliant and unqualified. unsuccessful bidder should be sufficient to make a mate- * The complexity of the project from a technical, legal, rial impact on actual bidding costs, but should not exceed and financial perspective. them. * The sophistication and experience of the government, and in particular of the relevant department, with Circumstances ofpayment. The reimbursement of an indi- similar or comparable projects, as well as the com- vidual bidder's costs should be conditional on the bidder petence and experience of the project team. producing a compliant bid. With so many factors bearing on the government's Timing. The reimbursement of unsuccessful bidders should timetable, it is difficult to provide a meaningful estimate take place once the concession agreement has been signed. of the time that needs to be allowed. However, a possible timetable for a project of average complexity done in a Timetable for the Government developed country environment, where the approach described in this study is shown in table 4. The timetable for preparation, prequalification, bidding, Based on the timetable proposed in table 4, the con- evaluation, selection, and negotiation is influenced by a cession agreement and the contract award process could number of factors, including: be completed within about two years. This is roughly in * The extent and suitability of any preparatory work TABLE 4 already done before efforts formallybegin on the pro- Timetable for the government ject-for example, if a suitable legal and regulatory Weeks to Elapsed time framework already exists, provision for this does not Activity complete in weeks need to be made in the timetable. Review of financial visibility 16 16 * The speed with which decisions can be taken by the Government decisions on policy issues 8 20 Preparation for prequalification (up to government on the critical issues that affect the bid- release of invitation to the private sector) 1 6 22 ding process, from policy issues at the beginning to Submission of prequalification proposals 12 34 selection of the concessionaire at the end. Selection of bidding list 6 40 * The level of specification and design provided. The PreparBaion of bidding documents 26 42 Bidding period 26 68 more detailed the level of specification and design, Evaluation and selection of preferred bidder 20 88 the shorter the bidding period needs to be. (The poten- Final negotiations and tenders' due diligence 18 106 30 line with the time taken to complete certain of the United TABLE 5 Kingdom's larger Private Finance Initiative projects, for Cost of advisory services example, in the roads sector. Achieving completion of con- (millions of US dollars) tracts in this time scale assumes that the government's team Service Cost is able to handle certain tasks in parallel (in particular, the Financial advisers' fees 2.2 preparationof tender documents during the prequalifica- Technical advisers' fees (including demand forecasts) 2.0 preparation otedrdcmnsdrgtepeulfa- Legal fees 2.2 tion phase); that each stage in the process is handled on a prompt and priority basis; that the government's policy deci- sions on critical issues (which is often where the greatest country environment (assuming that the government has delays occur) are reached smoothly; and that no unusual appointed international advisers with the appropriate expe- difficulties arise. Where circumstances are more complex rience), the above costs can be expected to be appreciably than those assumed, which may be the case in some inex- higher. perienced developing countries, the timetable can be It may be possible for a government to enter into arrange- expected to expand considerably, ments with advisers whereby a portion of the adviser's remu- neration is in the form of a success fee payable at the time Cost of Advisory Services of the drawdown of finance and included in the winning bidder's final financing plan for the project. The winning bid- The cost to the government of using external advisers for der will, of course, be permitted to pass these costs on to a concession-based road or water infrastructure project will users through the tariff (or, effectively, back to the govern- depend on factors similar to those listed for the timetable. ment where the project's viability depends on a government Tlhe existence of specialized skills within the government, contribution). However, advisers will wish to protect them- such as legal skills, that could partly or fully obviate the need selves against the risk of such a success fee either being delayed for certain external advisory services will of course affect or not being paid at all, for reasons outside their control (such the government's costs. Experience indicates, however, that as, a government's either delaying or canceling the project governments rarely have the financial, legal, or technical for policy reasons). Depending on their assessment of the resources or expertise available in-house that are neces- project, they may seek to provide for such protection using, sary to cope with the demands of a concession award. among others, one or more of the following mechanisms: Because of the wide range of factors that can come into play, advisory costs will tend to vary greatly, making it dif- Building a contingency into the success fee. ficult to provide meaningful estimates in general terms. Seeking one or more advance partial payments of the However, estimates of the cost of advisory services (exclud- success fee payable upon milestone dates, in the event ing any direct out-of-pocket expenses) for a project of aver- that there are delays in the agreed project timetable age complexity done in an industrial country environment, for reasons outside their control. from bid preparation to contract award and financial clo- * Building a provision for indexation into the success sure, are provided in table 5. fee to offset the effect of delays. The estimates in table 5 do not take into account the * In the event that none of the above financial protec- costs for any significant technical preparation (for exam- tions is available, limiting the amount and quality of ple, ground conditions investigation). And as the estimated resources they make available to the project. This costs apply only to the cost of external advisers, they do should be avoided if at all possible. not include any costs that are internal to the government in terms of its own resources. Further, for a more complex Clearly, the greater the perceived risk in the project, the developed country project or for a project in a industrial higher will be the success fee required by the adviser. 31 The Use of World Bank Guarantees O ne purpose of the review of financial viabilityprior roll over short-term loans if this cannot be achieved in the to embarking on a tender process is to determine commercial markets at the appropriate time) relates pri- whether support from any international financing marnly to the difficulty of determining why a failure to refi- institution, such as the World Bank, is necessary to ensure nance in the domestic or international financial markets has that sufficient private sector finance can be raised for the occurred, and to determining the appropriate price to be project. The precise nature of the support required-for charged for different types and maturities of loans and guar- example, the types of risks to be covered and quantification antees made under these conditions. The partial credit guar- of the likely amounts involved-would also have been iden- antee would be a suitable mechanism where the reason for tified. It is important for the government to have discussed the failure to refinance as well as the pricing of the loans and agreed with the international financing institution the and guarantees can be reasonably determined on the basis extent, type, terms, and conditions of support that might be of the Bank's knowledge of the financing marketplace. The available in advance of the tender process. This will facili- Bank may consider it appropriate to appoint an indepen- tate a harmonized and integrated approach to the financing dent adviser to assist with this who is actively engaged in of the project and will avoid an inefficient and potentially the relevant financial market. unproductive situation where different types of dialogue are opened with the financing institution by different bidders. Guarantees and the Bidding Process It will also help focus the support of the international insti- tutions on those aspects of the project that are most critical. If a Bank guarantee is determined to be essential, clear information on this credit enhancement should be included The Bank's Guarantee Mechanisms in the tender documents. This information should cover: Partial risk guarantees are likely to be used for concessions * The types of guarantee mechanisms available. where the borrower is a private sector entity. In general, the * The applicable terms (total maturity, guarantee partial risk guarantee is the one likely to be needed for infras- amount, fees and charges, and maturity profile). tructure projects in countries that are on the margin of being * Conditions, if any. able to attract international financing. Further, longer debt * Clarity on precise risks covered. maturities can be achieved by addressing underlying politi- * Any information on how these mechanisms would cal, regulatory, or force majeure concerns of international work in conjunction with different financial instru- lenders and investors through such a guarantee. For such ments being used by bidders. countries the key issue is the availability of international finance rather than how the term of such finance can be extended. The Use of the Guarantee Offering a partial credit guarantee in a competitive bid- ding process for the award of a private concession (whereby The Bank needs to ensure that its guarantees are used where the Bank guarantees late-dated payments or undertakes to absolutely necessary and that they are used efficiently, that 32 is, that they are used to cover specific risks that the private ture, thereby making it more efficient. In such circumstances sector is genuinely unable to accept, rather than to provide the Bank may accept that it may be more efficient to max- blanket coverage. The different approaches that could be imize the use of its guarantee by assuming certain contin- adopted to achieve this objective are discussed in the fol- gent obligations to the project in order to reduce the level lowing paragraphs. of up-front government subsidy. In this case the bid eval- The Bank first needs to be satisfied that a project's eco- uation criteria should not penalize bidders for using the nomic justification, financial viability, and the financing guarantee. options deemed appropriate for it have been thoroughly investigated. Here, the Bank would rely on its own inter- Testing the Market nal analysis as well as the review carried out by the host gov- ernment and its team of technical and financial experts. It may be argued that the ex ante investigation of the need Such an assessment should reveal: of a guarantee is an inadequate indicator, especially for cer- tain countries in the middle range of creditworthiness, and * Whether there is a genuine need for financing sup- that in a competitive environment private sector financiers port from an intemational institution such as the Bank. and sponsors may be willing to assume greater risk than the * If so, what is the most efficient way in which such government's or the Bank's analysis suggested. The gov- support could be used. ernment and the Bank may therefore wish to test the mar- * What is the minimum risk coverage that would be ket to establish whether guarantees are being used in the needed to make the project financeable. most efficient way possible. This could be achieved by the government inviting bids on either of the following bases; Such confirmation of the need for the Bank support would provide assurance that the guarantee is not being * Tenderers are asked to specify the type and level of used for arbitrary or spurious reasons. Having identified risk protection they require from the Bank. the most efficient structure for doing so, the government * The government specifies, say, two or three different (and the Bank) needs to investigate the precise level of options for type and level of risk coverage, requiring risk coverage required. Should the Bank then agree to a bid on each. provide support, information on the type of support avail- able would need to be provided in the tender documents These approaches are discussed further below. Having with a suitable mechanism or cap to give bidders the incen- established the need to offer a guarantee, these approaches tive to rationalize the use of the guarantee. If it cannot be can help to determine the minimum extent of risk cover- induded in the tender documents, such information should age that a particular project requires, rather than whether be made available no later than, say, four to six weeks before a Bank guarantee is indeed needed, As a lender or guar- the tenders are to be submitted-otherwise tenderers will antor of last resort, the Bank may question the need and not be able to take it into account in their proposals. justification for a guarantee if bidders are willing to submit In certain cases it may be more cost-effective to have a parallel financing offers without a Bank guarantee, albeit financial structure whereby the government provides risk at less favorable terms. mitigation measures, such as participation in revenue or geotechnical risks, rather than, for instance, a structure Tenderers propose level of risk coverage whereby the government offers up-front subsidies (for exam- ple, grants for construction). The first structure may enable As tenderers could propose a range of different types of the project to support a larger overall level of debt financ- guarantees, this approach raises the issue of how bids that ing (resulting both from improved terms, such as longer require different levels of risk coverage can be evaluated on maturities, as well as from addressing those issues that a like-for-like basis. For example, tenderer A's offer with lenders are most concerned about) than the second struc- minimum risk coverage may require, say, protection against 33 the risk that the government will fail to perform its obligation evaluation approach would be the difficulty of developing to provide foreign exchange for debt service for 10 years on factors or premia that would adequately reflect the cost to a foreign currency loan of $100 million (table 6); tenderer the Bank (and to the government) of the different types of B's minimum risk cover offer may require protection against risks the Bank could cover through the partial risk guarantee. the same risk, but for a loan amount of only US$80 million for 10 years plus protection against, say, force majeure events The government specifies alternative risk relating to changes in law in the host'country that might coverage levels adversely affect debt servicing on the same loan amount. Clearly, a direct comparison of these two tenderers would be This approach would involve the government specifying, extremely difficult to achieve on an objective basis (table 6). say, two or three options for the type and level of risk cov- Whatever criteria are used to make the comparison, they erage, and requiring tenderers to bid on each of them. should be spelled out to tenderers in advance in the bid - Bidders would be informed that the government and the ding documents, such that bidders have the incentive to Bank would decide which of these options to adopt after minimize their use of the guarantee (and of the govern- bids had been received. This would make it clear to bid- ment's exposure to the Bank under its counter-guarantee) ders that they need to make a competitive bid for each and to focus their bids on the true objectives of the Bank option to be sure of remaining in contention for the con- as well as the government. One approach would involve the cession. An example of three options for which bids could government stating that bids will be evaluated in terms of be invited is shown in figure 8. As indicated, one of these those requiring the least amount of guarantee protection options could include, if realistic, a bid that does not require they require. Another evaluation approach is to focus not any guarantee at all. so much on the amount of the guarantee but on value-for- The evaluation would involve comparing the bids of dif- money considerations, for example, selecting the bid that ferent tenderers within each option. The bid providing the provides the optimal tradeoff between the cost of the guar- best value for each option would be identified. The gov- antee used and the tariff offered. This would involve spec- ernment and the Bank would then choose either the bid that ifying in the tender documents a series of premia or factors was the cheapest at the minimum level of risk coverage that could either be applied to compound the net present required or the bid that optimized value for money with effi- value of a bidder's tariff requirement (or whatever factor cient guarantee usage. The second choice would require is used to determine value for money) or be used as part the Bank and the government to carry out their own inter- of their financing cost assumptions in preparing their bids. nal analysis to determine the cost they might attach to pro- In effect, this is a method of applying a penalty (or a sur- viding the different levels of risk coverage and to compare charge) for incrementally higher levels (or different types) this with values received-in terms of, say, reduced net pre- of guarantee usage, which will offset the benefits of a lower sent value of tariff for each incrementally higher level of tariff a bidder may have achieved by an increased use of risk coverage. Thus, for instance, for the options indicated the guarantee. Each bidder would then be free to deter- mine its own optimum tradeoff. FIGURE 8 The main practical problem with this value-for-money Government specifies different risk coverage levels TABLE 6 TABLE 6 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~_____________J Bid wihout cover Tenderers propose level of risk coverage Option I - (ifrealistic) Tenderer Minimum risk coverage required A Foreign exchange convertibility cover for I 0 years on foreign Option 2 - -- ovemment defauk on tariff exchange loan of US$ 100 million. payment obligation covered B Foreign exchange convertibility cover same as A but for $US80 million plus protection against specified political force Option 3 As in option 2, plus foreign majeure events. Oxchange convertibility cover 34 TABLE 7 is lower than the least costly bid under Option 2. Thus, Tenderers submit bids for options 2 and 3 B's bid under Option 3 offers better value for money, even (Net present value of tariffs in millions of US dollars) though it requires a greater level of risk protection than Option 2 Option 3 this bids under Option 2. A 100 95 While the approach in which tenderers propose the risk B 105 98 coverage could be used if the government's and the Bank's evaluation methodology is based simply on the minimum level of guarantee requirement, the alternative approach, in which the government specifies different options for risk cov- in table 7 let us assume that tenderers A, B (net present value erage, lends itself more easily to evaluation based on value- of tariffs in milions of dollars), and C al fail to provide a for-money considerations. It has the advantage of simplicity, bid under Option 1, but submit the bids (net present value both for the tenderers, in that they bid for clearly specified of tariffs in millions of dollars) for Options 2 and 3. risk coverage options, and for the Bank, in that it elirminates * The most attractive offer on the basis of Option 2 is the need to provide detailed information to tenderers on that from tenderer A, while for Option 3 it is the bid the cost to the Bank or government of different risk cover- from tenderer B. As Option 3 requires the government age levels, (which would be required if tenderers were propos- and the Bank to provide greater risk coverage than Option ing the risk coverage). Furthermore, as the specified risk 2, let us assume that, according to the government's options could cover as broad a spectrum of possibilities as methodology, the incremental cost to it of providing this the Bank wished to test (within the limits of practicality), additional risk protection is valued at $5 million. Thus, theBankwouldhavetherebytestedtheprivate sector's need after allowing for this cost, tenderer B's bid on Option 3 for different levels of risk protection and the value the pri- has a total cost to the government of $95 million, which vate sector might attach to such protection. 35 The World Bank Headquarters 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. Telephone: (202) 477-1234 Fax: (202) 477-6391 Telex: MCI 64145 WORLDBANK MCI 248423 WORLDBANK Cable Address: INTBAFRAD WASHINGTONDC European Office 66, avenue d'I6na 75116 Paris, France Telephone: (1) 40.69.30.00 Facsimile: (1) 40.69.30.66 Telex: 640651 Tokyo Office 10th Floor Fukoku Seimei Bldg. 2-2-2 Uchisaiwai-cho Chiyoda-ku, Tokyo 100-0011, Japan Telephone: 813-3597-6650 Facsimile: 813-3597-6695