Financing Saudi PPPs: Is there an Appetite?

By all measures the number of proposed PPP projects being contemplated by Saudi ministries is impressive. Implementing these projects will require considerable resources from the government and financial investment from the debt providers and the private sector. The Saudi government is aware of the need to make a compelling argument to attract private sector investment (both domestic and international) and has articulated this in the National Transformation Plan as well as the Vision 2030.

The Saudi National Transformation Plan emphases the importance of strengthening partnerships with the private sector. The Saudi Government sees considerable benefit in partnerships with the private sector that could reduce the current funding gap for strategically important national infrastructure initiatives. Hence the considerable current government interest in alternative financing and public-private partnerships (PPPs). 

A further goal of the National Transformation Plan, which is widely supported by government ministries, is to create an attractive environment for both local and international investors and enhance their confidence in the economy. Achieving this goal is critically important for international investors (e.g. sponsors, banks, capital market investors, equity providers) and debt providers (e.g. commercial banks, national and international financial institutions, capital markets, hedging counterparties) who are considering investing in PPP projects and who are closely following the Saudi investment climate. The Saudi government needs to send very clear messages of commitment to potential private sector partners who might currently be sceptics, specifically when it relates to institutional capacity to launch PPP procurements and creating an enabling environment that will offer clear protections to investors and debt providers.

There is considerable speculation regarding the ambitious number of PPPs that are being proposed and whether there is enough international finance available (or investment appetite from investors) for all the projects that are being proposed.

To generate an appetite for investment the Saudi government understands that it will need to assuage investor concerns that investments will be protected and provide adequate guarantees offered for projects if the potentially enormous amount of investment finance that needs to be raised in a competitive investment market is to be successful. Regarding investment opportunities, the Saudi government is working on providing clarity regarding how open it will be to international investment and whether there would be any bias towards domestic investors. 

There is also much speculation on the role of the Saudi Sovereign Wealth Fund (Public Investment Fund) and whether it would be a PPP investor?

The current focus on alternative funding is taking place in a context of fluctuating market trends, volatility in oil and gas prices, and political and security concerns in the GCC region. This context has heightened perceptions of investment risk. The Saudi government is pragmatic about the needs to address these risk perceptions. If not, the uncertain evolution of these risks will most certainly determine the sources of private sector investment for the foreseeable future.

The World Bank identifies a number of financing mechanisms which are available for PPPs. They include: government funding; corporate or on-balance sheet finance; and project finance. The KSA is currently at a decision point on which of mechanism(s) it will consider and how deals will be structured.

As Saudi Arabia moves forward with PPPs the government realizes that it will have to decide to: fund some or all of the capital investment in individual projects and only look to the private sector to bring in expertise and efficiency; or encourage the private operator to finance some of the capital investment for the project through corporate financing; or seek project financing / limited recourse financing through a SPV (Special Project vehicle). Project specific decision could also include a combination of the three options when deals are structured. 

Whatever decisions are made; careful informed decisions will need to take place that consider bankability factors which include:

• Financial viability (does it make economic sense)
• Sustainability
• Risk identification, appropriate allocation, and possibility of mitigation
• The country investment risk profile

Questions on what is the best way to structure financial deals are being asked in Saudi Arabia by both the private and public sectors. There is also particular concern about what constitutes a reasonably sized project. During conversations over the last few weeks the number of proposed PPP projects that were discussed is astounding. Consequently, the financing needs of projects is also being discussed. Depending on the ministry and the complexity of the projects, the financing needs are in the range of US $ tens of millions to billions. This raises challenges that must to be addressed to test the appetite of investors.

Project size matters to investors and is driven by their willingness to assume risk. PPP projects that are too small (tens of millions of US dollars) are not always attractive to investors due to the transaction costs that often are the same for much larger projects. A strategy to overcome this (especially for service type projects) should be to consider bundling a number of projects into a larger project. On the other hand, some PPP projects might too large for an untested market due to considerations of risk that drives the willingness or unwillingness of financial institutions to invest so much in one project. As the government moves forward it would be important that it understands what investors will consider to be the ideal project size. While determining this, the following questions will need to be deliberated:

• Is there market appetite for the projects that are proposed?
• Will private sector partners be able to raise finance?
• Is there enough investment capacity in domestic banks?
• Is the enough interest in investment from international financial institutions considering the immaturity of the Saudi Market?

Investors are also waiting to see what position the government will take regarding the assumption of financial risk for projects that could fail. For projects that have high risk, the Saudi Government will need to manage the provision of government support through mechanisms that include government guarantees of grantor payment obligations or debt repayment.

The World Banks succinctly states the following:

“Governments seek a balance between i) the risks they incur when supporting infrastructure investment and ii) fiscal prudence. Striking this balance right will help the government make careful decisions about when to provide public-money support (guarantees) and manage the government liabilities that arise from such public-money support, while still being aggressive in encouraging infrastructure investment.” 

This succinct statement about achieving a balance underlies a reality that the Saudi government should heed and address through policy to attract investors that are hesitantly poised to invest in the many promising PPP opportunities that are surfacing. Additional clarity regarding policy intentions include the following:

• What path will the government choose to protect itself from the implications of calls on its guarantees?
• Who will pay for the cost of the guarantee?
• Will the treasury have sufficient funds to cover guarantees if a number of mega PPP projects failed simultaneously?

The question of sovereign or state guarantees (SGs) needs further clarification from the Saudi government.

The European PPP Expertise Center (EPEC) states the following on SGs:

“In PPPs, a risk should be borne by the party best placed to manage it, that is, the party that can best understand, control and minimise the cost of the risk. The private sector is generally in a better position than the public sector to handle and mitigate many of the typical PPP project risks (e.g. construction on time and on budget). There are however circumstances under which a “standard” risk allocation may not yield the full benefits of PPPs. This is where SGs may have a role to play.

SGs are a way for governments to incentivise the private sector (e.g. sponsors, banks, capital market investors, equity providers) to participate in PPP programmes or projects. SGs may take various forms and be aimed at an entire PPP market, specific programmes or simply individual projects.”

In addition, EPEC provides a very clear definition on SGs –

“SGs are defined as agreements under which a sovereign or assimilated entity (“Government”) agrees to bear some or all of the downside risks of a PPP project. An SG is a secondary obligation. It legally binds the Government to take on an obligation if a specified event occurs. An SG constitutes a contingent liability, for which there is uncertainty as to whether the Government may be required to make payments, and if so, how much and when it will be required to pay.

In practice, SGs are used when debt providers (e.g. commercial banks, national and international financial institutions, capital markets, hedging counterparties) are unwilling to lend to a PPP company as a result of concerns over credit risk and potential loan losses. SGs can also be used to benefit the equity investors in a PPP company when they require protection against the investment risks they bear.”

Policy clarity on SGs will most certainly incentivize the private sector and mitigate the concerns of debt providers about what would happen if events occur that jeopardize projects and result in potential loan losses.  

There is in general an appetite for investing in Saudi PPPs. It is up to the Saudi government to open the doors to interested parties by making compelling arguments for investment. In addition, clear policy statements regarding assumption of risk and the evolution of a clear pipeline of viable projects can only help.

Referenced Sources:

EPEC: State Guarantees in PPPs: A Guide to Better Evaluation, Design, Implementation and Management

World Bank – PPPIRC: Project Finance - Key Concepts