The French PPP market has delivered a slew of big-ticket financings this year, including two, Tours-Bordeaux and Bretagne-Pays de la Loire, in high-speed rail, a new national defence headquarters, Balard, and a road, the A63, that managed to include traffic risk and an upfront payment from sponsors. The country’s programme if anything accelerated after the 2008 crisis, on the back of generous sovereign support, an experienced bank market, and a small number of strong domestic mega-sponsors.

The latest bout of uncertainty in credit markets could be much less forgiving. It centres on the ability of sovereign governments to honour their obligations, and many European banks have been particularly hard hit. Can the mainstays of French PPP lending – the CDC and EIB – maintain their commitments to the sector, or can new instruments, including project bonds and dailly securitisations, replace them?

Project Finance gathered six market participants in London to discuss current issues in French PPP. The six are:

Tom Nelthorpe, editor, Project Finance

Agnes Mazurek, vice-president, European structured finance, Bank of Tokyo-Mitsubishi-UFJ

Pierre Denis Coux, director, mega-projects, Réseau Ferré de France

Thomas Blott, staff writer, Project Finance

Jean-Francis Dusch, managing director, head of project finance, Compagnie Benjamin de Rothschild

Stephane Duhr, director, Barclays Infrastructure Funds

Olivier Jaunet, managing director, infrastructure EMEA, Credit Agricole CIB

Francois Bergere, director, Mission d’appui aux PPP

Project Finance (PF): Why do you think the French PPP market has been so strong over the last 18 months?

Francois Bergere, MAPPP (FB): We worked out a comprehensive and stable legal framework seven and a half years ago, and this has only been adjusted once in 2008 to enlarge it and clarify some aspects. The government made infrastructure the focus of the economic stimulus package plan that was adopted two and a half years ago, in early 2009, and provided the tools to make sure that those big projects that were to be launched as PPPs would come to fruition, in particular the state guarantee.

PF: How did France manage to incorporate PPP into the stimulus at the right time?

FB: In 2004/2005, when the PPP taskforce was set up, we initially started, and I think in retrospect it was a good thing, with limited-size projects mostly undertaken by local governments as procuring authorities. It took us some time to push those big ticket projects at the national level, for instance in December 2006 we had to change the law regarding rail projects so that they could effectively be entrusted to private partners. In 2008/2009 we were effectively ready to bring those big national projects to the market.

Olivier Jaunet, Credit Agricole CIB (OJ): French banks have been active since the start of the project finance industry, and they continued through the crisis to support key projects because they are committed to the real economy. Another reason is that a number of French banks have deep regional roots, with subsidiaries or entities all over France, like we have with our Caisses Régionales, for example. But since the middle of the year we are probably seeing a critical change with the liquidity crisis, and with Basel III’s accelerated implementation. Foreign banks came to France, many of them, such as the Spanish, considering that the French leading sponsors were a very good risk. We have seen also banks coming from parts of the world, like Japan, where liquidity is cheap and available.

Pierre Denis Coux, RFF (PDC): The state incentive came in 2004 but you have to take account of the duration and the difficulties with each project. When the first PPP was signed, it was a Eu6 million project signed by a local authority. In our model, especially in the railway system, the projects are very big and the duration of the studies are long. We launched Nîmes-Montpellier in March 2007, and that process is still under way. The state decided to launch all these rail projects in 2004, a state committee approved them on 14 October 2005 and it took at least 5 years to be ready, and so the first project signed only in 2010.

Jean-Francis Dusch, CBR (JFD): Most of the mega projects were launched before the sub-prime crisis, during what I call the golden age of project finance, especially for motorways in France. Then along comes sub-prime. There was suddenly a certain lack of liquidity, pricing rocketed, which was also an issue for the French authorities because the costs of projects would increase and with them public spending. But what is interesting is that Tours-Bordeaux and Brittany-Pays de la Loire, or the Balard defence headquarters, another jumbo deal, or even the A63 all closed in 2011 and represent almost Eu7 or 8 billion of debt raised in pretty adverse market conditions. Perhaps there was a little bit of sunshine in the first and second quarter of 2011 in the loan market, but these projects could have failed to close. In some respect this is where the PPP certainly worked, in the sense that both the state, the consortiums and the lenders made efforts to make the deal close and create a real public-private partnership.

Agnes Mazurek, BTMU (AM): The past 18 months have been successful, but until that point it was more of a challenge to attract international funders’ interest to the French market, as projects were perceived as taking time to materialise and there is no standardised contractual framework, unlike in the UK where you have SoPC 4, which means you are starting over again for each transaction. It’s good that the MAPPP has started to provide guidelines, but more standardisation of the contractual framework would be useful.

Stephane Duhr, Barclays Infrastructure Funds (SD): When thinking about lead times, the process needs to be split between the public side’s thinking, and then the competitive dialogue with the private side. The evolution of PPP is that the competitive dialogue is shorter and shorter; where once we had three years of dialogue, RFF now manages to have competitive dialogues of 12 to 18 months for projects that are substantially bigger than even a large hospital. The worst situation we face is when a project is cancelled and if it has been in the pipeline for 5 years.

FB: These lead times are not that long actually when you compare them with traditionally procured projects of the same size. Spending 2 to 3 years in preparing and putting to the market projects like Tours-Bordeaux or Brittany doesn’t seem that long. That’s why we’re thankful again to local authorities for contributing to the take-off of the market during the early years.

PF: What influences have there been from the Anglo-Saxon model on French PPP?

SD: There was no official reference in France to SoPC 3 or SoPC 4, but in practice during competitive dialogue it has always been useful to have this reference framework even though in France we always like to make things different. We have a completely different legal framework, based on civil law and so on. That’s why we’ve had long discussions with authorities about termination clauses and the state’s use of references to the Conseil d’Etat, the highest public administrative court in France. But Japanese, German, Spanish banks use UK PFI as an important reference.

AM: Termination provisions are always the subject of careful consideration by credit authorities. It would help if procuring authorities had a consistent approach to those clauses, while what we witness from one project agreement to another is practices ranging from full compensation to reference to case law which by definition makes the amount of compensation difficult to predict. Such diversity of approaches is difficult to explain internally.

FB: One source of inspiration was the PFI, but the end result is quite different because as a civil law country, we need to set in stone the rules through law or ordinance. There are peculiarities to the French system that do not or did not exist in the English model, in particular the cession dailly, which has been instrumental in driving down debt pricing. We were also early adopters of the competitive dialogue.

JFD: Before the subprime crisis there were strong French banks or foreign banks with an established branch in France that knew how to do French PPP deals and provided the necessary level of liquidity whilst being familiar with an accepting the specifics of the French legal framework. But when additional liquidity was needed as jumbo projects reached the loan market just as the market turned, there was a need to question and challenge the usual suspects. If you were advising the state you would need to send messages such as, “You may need to do this perhaps to accommodate banks or international financial investors.” Which would be rather challenging because some might consider that since the model in place had worked so far, why change it?

OJ: We have a written law but we also have jurisprudence based on the case law of the Conseil d’Etat. And the case law for concessions, let alone PPPs, is very limited; Since finance has evolved since most of this case law has been written lawyers have to understand how a Conseil d’Etat decision from the 1920s could be applied to a project in the 21st century, for example in the case of swaps which have to be closed before a contract has been through the claim period and when a third party can still challenge the project.

PDC: But the success of the PPP in France is also the result of all the case laws you mentioned, because it gives some stability compared to other countries. You can’t find in the case laws any specifics on caps or figures, and the Conseil d’Etat doesn’t like to create precise rules, but it provides a reference that we can use to explain these activities to contractors and even to the equity providers. In the case of force majeure, we had a big issue around this question because the Conseil d’Etat never says clearly what would be the indemnity, but we can explain very simply that the Conseil d’Etat will fix an indemnity that would be fair.

OJ: There is some case law for issues like PPP contract cancellation or force majeure or fait du prince, but typically it does not deal with swaps, which makes swaps, as usual, a difficult and complex topic. Banks can understand these risks and take a commercial view on ad hoc solutions, but if you think of potential bond financings in the future, bond investors or rating agencies might not have the ability to take a view. And they might be more binary in a process where things are not clear.

PDC: I agree with that but it’s possible that for some specific topics like the swaps, you can include precise clauses in the contract rather than wait for case laws.

JFD: I remember some time ago looking at the face of our legal adviser on a transaction when we asked them to write down on paper, for example, that force majeure should never be worse for the lenders than termination for concessionaire’s default. They probably thought that what we asked was crazy.

PF: So has the larger number of deals with traffic risk, whether in rail or roads, been a bank-driven or a state-driven phenomenon?

PDC: Well in France the railway sector is changing every day and we don’t know yet what will be the situation in 10 years given the open market we will have. So maybe the foreign banks were uncomfortable with the traffic risk but with SEA the traffic risk is under control because we assess that roughly two-thirds of the traffic is already known with the existing line.

JFD: With Tours- Bordeaux traffic risk was certainly an important credit feature to take on board but it was not the most important one as the structure provided significant credit enhancement through the state guarantee and the LGTT, the EIB traffic risk guarantee. But there were other significant credit challenges, including the duration of the construction period, the complexity of the infrastructure design, the interface issues with the French railway network and operator, among others.

FB: I’m not sure Tours-Bordeaux is a convincing example of the state’s ability to transfer traffic risk, given the presence of the EIB and the debt guarantees. I think that there will be more PPPs in the strictest sense of the word, maybe with availability payments, but with the private sector collecting tolls on behalf of the government but not assuming any traffic risk. This would combine the best of both worlds

AM: From a lender’s perspective, the Loire-Brittany transaction was a good template for risk allocation between the public sector and the private sector, with the former retaining traffic risk. This was reflected in the strong market response, with a 70% oversubscription, and strong international bank interest, because 10 out of the 12 banks were non-French.

FB: One reason French infrastructure markets continued to be very active through the crisis was the presence of the EIB, which supported BPL and SEA, and is expected to support CNM. We should also not forget that on those deals most, if not all of the dailly tranche was taken by public or multinational entities and not by commercial banks. Public authorities need to bear in mind that there could be constraints on the appetite of these lenders, and there has been a reduction in appetite especially at French banks, but also at some foreign lenders for dailly tranches. So it’s not only about pricing increases but also constraints with Basel III. Banks with project finance expertise think, “We can do better with our assets, we’d rather take a traffic risk that we can assess than use that capital to take a sovereign or local authority risk because probably other people could do that”.

FB: The big deals are all very capital intensive, and wouldn’t have been possible to close financially without some upfront public financing. All of these deals involve more than 50% public funding and another 40% comes from multilaterals or public development banks. So these are not chemically pure PPPs.

PF: What would the effect be of an increase in bank funding costs and withdrawal of public lenders?

AM: Although the universe of banks that are still happy to take on dailly has shrunk, appetite for dailly tranches remains, especially at the current margins. The issue is more around the scale of the projects. It’s likely that you’ll still have enough banks to fund Eu100 and Eu200 million projects with dailly tranches but for larger projects it’s likely to be more of an issue.

JFD: Nowadays banks have different credit risk acceptance criteria, they have an ability to deal or not with the forthcoming Basel III, the ability to offer long tenors can differ from one bank to another and so does their cost of funding. Some may think, “Yeah, actually why not do a nice traffic risk deal that I understand,” but others will be better equipped to fund a dailly tranche because they can handle it better from a balance sheet standpoint.

OJ: You should also look at who was active and who was supporting the projects 18 months or two years ago, and who is the most active today. There’s a risk there, because the practice is to have banks sign exclusively to one consortium, but then that consortium can discover that its banks are not as interested or not as healthy as they used to be.

JFD: I had someone ask me a very interesting question during the last crisis when there were fears that some banks would go bankrupt: “Imagine we closed a deal, and one of the banks during the drawing period collapses, what happens for the borrower?”

OJ: I think once the contract is signed that’s life, even if lenders are not joint and several, you have a counterparty risk on your funding partners to some extent. I think the availability of the financing will be more and more difficult to predict until the situation stabilises. It’s true that some pressure has been released on a number of tenders by grantors such as RFF, by asking for 40% or 50% of its needs to be committed. RFF has also asked bidders to release exclusivity as soon as the preferred bidder is chosen.

FB: We have reminded both public and private actors that there is absolutely no obligation in the current legislative framework to have fully underwritten final offers and it’s up to each and every procuring authority to decide whether or not they’d rather go for a 100% underwritten bid. But as RFF has done on CNM or other deals you can perfectly well decide that you only require, say, a 50% firm underwriting at the best and final offer stage, and then specify that unsuccessful bidders have to release their banks from any exclusivity agreement.

JFD: The fact the tender rules allowed for a bank funding competition is certainly what made Brittany-Pays de la Loire successful and ultimately worked for RFF and the state as Eiffage negotiated lower margins from the lenders, with this decrease in pricing being reflected in the rent and benefiting RFF. Another interesting situation is we worked on a recent deal where we had obtained credit approvals from our banks the initial offer, again at the final offer. In light of the bank crisis at the end of this summer, one can say that if we hadn’t had banks tied in with existing credit approved commitments, we may have been without banks during the finalisation and financial closing phases.

PDC: When we created the rule of 40% of commitments for SEA and then 50% for the Brittany-Loire project, we are not sure of the result, but in fact it worked very well. The only trouble we met on SEA was that the banks at the beginning of the deal were present and very strong and supported the SPV to the end, so the funding competition was not as efficient as we had hoped.

AM: Given current market conditions there is a risk that by asking bidders to submit best and final offer bids with fully committed funding the cost of the bid will be distorted, because if you want 100% financing the pricing will be set by the marginal lender. It may be more beneficial to set a threshold as RFF has done for recent projects. You could even question the relevance of committed funding at BAFO stage, here again compared to other jurisdictions where banks are not asked to go to credit until a preferred bidder is announced.

PF: Is it likely that a European project bond template could emerge from France?

JFD: France was not necessarily the most active in project bonds because it wasn’t necessarily needed back in the late nineties/ early 2000’s thanks to established and strong bank support. There were indeed a couple of examples of refinancing with project bonds but it was not a first choice, unlike in other countries where they were more frequently used and provided interesting cost savings though they are less flexible instruments than a bank loan. In the current context of increased pricings, shorter tenors and reduced liquidity, everybody’s thinking of it: the state is thinking of it, banks also for balance sheet reasons must be thinking of it: it is the flavour of the month. We certainly have institutional investors that have invested in equity funds that must be asking, “why not now be on the debt side with a senior position, a yield that is not that bad as compared to other opportunities in the market and more secured than dividends.” The question of whether the bond solution is the answer and long-term solution for the debt funding of French PPPs is going to be down to the leading French banks’ strategy towards project financing. They will have to assess how they can manage with their balance sheet, how they can adapt to the challenges such as Basel III and see whether they can be significant providers of long-term project-type bank loans at still attractive conditions. It all depends also on whether the current bank loan market adverse situation is a long term trend or a temporary one.

FB: My perception is that it’s probably long-term, not only in the French market but in the European market for that matter. There’s the EU project bond initiative, but how and when will they effectively come to the market? On the domestic front the treasury and MAPPP have formed a working group that for the last 18 months has looked at how we can make most out of an existing tool – the cession dailly. This assignment of receivables, free of project risk, would back the issuance of bonds to which institutional investors, mostly insurance companies, could subscribe. This would be an option for refinancing, and allow banks to unload these credits from their balance sheet. We are working with half a dozen of the main banks in Paris to test it on a real project come next year, but we will also have to make sure that there is appetite on the institutional investor side. A new decree was published on 31 October effectively creating a new asset class for insurance companies and mutuels, for up to 5% of their overall assets to be eligible.

OJ: The dailly securitisation concept originally took into account one of the usual requirements of the French state, of having rents fixed at signing of the contract, and was to have that bond issue at financial close and commercial close which would mean increased financing costs and, unless fully covered, investors’ exposure to construction risk. So it’s very interesting that Francois mentioned that the concept is evolving towards more bond refinancing of the project at completion. But this also needs to be followed, or preceded, by changes to the tender rules and maybe the contracts because that will lead to refinancing risk. Procuring authorities would need to accept that there would be financing in place for construction, for the project risk tranches during operations, but the dailly tranche financing would remain open for some time, and even the full construction period. The strength of that cession dailly acceptée, is that it’s completely autonomous from the project itself once the project is completed: If authorities are moving in that direction maybe the dailly can survive. Otherwise, bearing in mind that local authorities now have to consolidate the dailly rents and the assets in their balance sheet at completion, and given the increases in pricing we’ve seen on dailly tranches, why not have a sort of completion payment or whatever? Alternatively, some projects could be launched with some sort of refinancing risk on a partly amortising dailly portion, in order to reduce the initial maturity. If the refinancing risk was properly addressed in the PPP contract, that I think would support the current model continuing.

AM: The Dutch government has a staple bond offering for a pilot project – the N33 – with new project bonds put in place by their insurance companies, which is expected to close in mid-2012. There was never a deep investor base in Europe, and even in the UK market monolines supported greenfield financings.

SD: The common theme I think, more than the bond market, is the refinancing risk and both the authorities and the private sector partners have to start thinking about how to accommodate each other and how to take part in this refinancing. Maybe the bond market is an opportunity but maybe it’s simply continuing with banks lending, at least on small to mid-size projects. I think maturities of 25, 30, 35 years are probably not there and are not going to reappear, so maybe banks will stick to mid-term lending, as they do in Australia, for instance, and then somebody has to take the refinancing risk.

FB: The state could possibly take on the refinancing risk because one could argue that central government is already exposed to refinancing risk of a sort through its ongoing need to tap the capital markets. Things would be different for local governments so I don’t anticipate any significant change on the local project side, however.

OJ: We could look at the idea of the soft mini-perm where, you know, the grantor is happy because if refinancing does not occur on time there is no event of default, the project is not terminated, at least not by the lenders, and at the same time banks see a very strong probability of refinancing occurring within a certain timeframe. It’s maybe not ideal for Basel III, because banks still have to record a commitment for the longer maturity, but at least they can expect some rotation of their balance sheet. But that can only work if you have some room to accommodate some of the refinancing risk in the change to the margins for example even if it could eat the return for the sponsors in the end. And if you have fixed the rate on the probable profile on the fully amortised underlying debt, it’s only the fluctuation in the margin you have to think about, so it could be significant. On the contrary, on the dailly tranches the rent is fixed with a 1:1 coverage ratio, and the contract does not allow for any changes, so you are tied in with one financing amortising 25, 30 years. Hence you can only go to the authority and say, “Look, if I refinance we can reduce the rents, I can take maybe so much of it, I leave so much of it to you,” but the prospects for that are quite uncertain.

PF: Does the French market long-term need more than three, arguably four big sponsors?

AM: Yes, because there is an issue around barriers to entry. If you look at other developed markets like the Netherlands or the UK, a large number of deals were done with foreign contractors. This not the case in France.

PDC: If you have only one sponsor it’s impossible, if you have only two sponsors it’s rather difficult, if you have three sponsors competition is tough.

OJ: France has its own law, there are some permitting issues which are not always easy to deal with, you have some expropriation issues, it’s often good to have presence on the ground. I think that the French contractors have a strong competitive advantage when you think of roads and railways, but maybe on technology foreigners can compete, like we’ve seen with Autostrade winning Eco-Tax.

JFD: I think again it also depends on what type of project you’re talking of, but at the end of the day the leading French contractors also happen to be part of the leading contractors in the world and it’s an open market. For mid-size transactions, we have seen the likes of NGE and Fayat lead some landmark transactions, which shows that there is room for ambitious smaller players as well.

PDC: It’s also a question of equity, because when you are a major project you need for instance several hundred millions of Euros for SEA, and those kinds of sponsors are very rare.

JFD: But you also have the small projects and this is perhaps where local authorities have to think about the smaller local contractors that have the engineering talent and capabilities to complete projects but perhaps lack the financial strength or capabilities to bear development costs.

FB: At the central level we certainly hope for wider sponsor involvement in PPPs, and this can come from three different sources. The first is getting foreign contractors or foreign industrial sponsors to be maybe more bold and trying to access the French market. There is the precedent of Autostrade on Eco-tax, though we were disappointed that no Belgian or Dutch industrial sponsors showed up on the Canal Seine Nord. We had done road shows, I myself participated in a road show in Amsterdam trying to convince them to put a foothold or toehold in the French market. The second one is indeed the second tier of contracting players, and it’s good that they have been climbing up the ladder. And the third direction is to make sure that big operators as well get more involved as sponsors, and not just as sub-contractors.