Complexity and Documentation: that is where the risk is hidden.
My first private infrastructure experience – Interlink Roads and the M5 Motorway back in 1990 – was bid on a Lotus 123 model with less than 250 lines all on the only available spreadsheet page. I have just reviewed a toll road model which contained 32 sheets and bulked up to 29 MB – taking several minutes to run. Project documentation has also ballooned. The total documentation for the M5 project was less than the size of a typical project deed for a modern project. Importantly, the stakes are now higher. Most modern tollways consume billions of dollars, a factor of 5 to ten times the M5 project size.
The impact of this explosion in complexity and volume is that it is impossible for a normal Investment Manager in a Superannuation fund to ever be completely aware of all the details of a project. She must rely on advice from lawyers, investment bankers, engineers, planners and lenders to make an investment recommendation. Importantly, the documentation which is assembled under the pressure of bidding and financing frequently has gaps, errors and traps which only emerge over the daily grind of building, owning and operating the facility provided.
It is not only the financial model and documentation which brings complexity. Financial structures incorporating securitised leveraged leases, preference shares, licences, assignments of cash flows and several companies and trusts add an additional layer of risk around the future changes in law. Such changes may undermine carefully balanced transfers bring the complexity score to previously untold levels.
The size of the current crop of PPP projects also brings its own complications. Debt financing in the billions of dollars places demands on the finance system which can only be met by teams of banks, bondholders and export credit lenders. If the Global Financial Crisis taught us anything, it was that counterparty risk is paramount. So before signing up to the PPP arrangement, don’t forget to undertake detailed due diligence on the sixteen international banks and the 13 bond holders.
Over time refinance risk throws up the spectre of recasting swaps, introducing foreign currency swaps to accommodate international lenders and closing a finance deal all around the world at the one time. Added to this is the need to achieve the margins assumed in the financial model, which will have been set in the initial financial model as equivalent to the lowest margins ever achieved in a PPP as part of the bid winning strategy. All this assumes, of course, that the current level of extreme liquidity in the finance markets continues for long enough for the refinance to be completed.
And this is all before even laying the foundation stone.