infraread issue 10 | Germany
03 Oct 2017
German Motorway PPPs: full speed ahead for private investment
Public private partnerships (PPPs) in the German trunk road sector have undergone a fundamental change in recent years. Since the first batch of pilot projects reached financial close between 2007 and 2009, PPPs have become an established way of procuring and financing trunk roads in Germany. Further PPP projects are currently being tendered or are at the planning stage. This pipeline of new generation projects aims to attract even more private investment into the road sector. This article provides an overview of PPP projects in the German federal trunk road sector and opportunities for private investors.
Evolution of PPP projects in the German trunk road sector
In many countries, PPPs have contributed significantly to the provision of public infrastructure in recent decades. In comparison, PPPs in Germany have gained in importance only in recent years, due in part to the fact that the fundamental concept of PPPs has been (and still is) the subject of ongoing social and political debate.
PPP projects in Germany are encountered in various fields of activity at local, federal state and federal government levels. Compared to the total quantity of PPPs in Germany, the number of projects in the trunk road sector has so far been relatively low1 and primarily focused on sections of federal motorways (Bundesautobahnen).
In line with general PPP principles, PPP projects in the German trunk road sector seek to provide, amongst other objectives, "whole life" solutions which aim to increase the efficiency and quality of the relevant service, ensure an appropriate allocation of risk between the private sector partner and the public sector and promote innovation. In practice, the design of PPP projects has undergone an evolutionary development process in recent years. Projects in the German trunk road sector which have already been implemented or which are currently being tendered cover design, construction (road upgrading), routine and heavy maintenance as well as operational elements, and usually run for a period of 30 years. Compared to conventional construction projects, the "whole life" approach of PPP projects results in an increased focus on long-term operational and maintenance aspects during in the design phase of the construction works. PPP projects also impose certain financing obligations on the private sector partner. However, structural differences exist between individual projects in the payment mechanisms and, on a related point, in the allocation of traffic volume risk.
F-model
The first PPP-type projects in the trunk road sector were the under-crossings of the Warnow river and the Trave river which were completed in 2003 and 2005 respectively. These are classic toll models which allow the concessionaire to charge a toll to users of the respective crossings (the "F-model"). The toll rate is subject to the approval of the relevant public authority. Hence, the concessionaire bears the traffic risk.
The first batch of federal motorway PPP projects
The next generation of PPP projects (the so-called "first batch") comprised four pilot projects. These pilot projects were structured on the basis of a road upgrading model with traffic volume risk (the Ausbaumodell or "A-model").
The payment mechanism for the A-model provided for the concessionaire to receive remuneration from the public authority based on traffic volumes calculated using the actual heavy goods vehicle (HGV) toll revenue attributable to the relevant section of motorway. A distance-based HGV toll was introduced by the German legislator in 2005. Unlike the F-model, the concessionaire under the A-model received its remuneration from the public authority and did not directly charge a toll itself. However, due to its dependence on the actual toll revenues received, the concessionaire's remuneration was still subject to volatile traffic volumes, changing toll rates and the composition of toll classes. In addition, where maintenance measures exceeded certain defined limits, the concessionaire's remuneration was reduced by so-called "traffic impairment costs" (Verkehrsbeeinträchtigungskosten) calculated in accordance with the underlying project agreement.
The second batch of projects
The so-called "second batch" of projects consists of nine federal motorway PPP projects, of which six projects are currently at the implementation phase. Other than for the first project in this batch (the A8 (Ulm – Augsburg)), these projects have been based on a new availability model concept (the Verfügbarkeitsmodell or "V-model"). The V-model approach is based on a modified and quality-focused approach and no longer exposes the contractor to traffic volume risks. Instead, the contractor's remuneration is based on the availability of the relevant section of road and the quality of the contractual services provided.
The funding and remuneration scheme for the current V-model includes the following core elements:
- the financing by the contractor of part of the construction costs;
- progress-based milestone payments by the public authority during the construction phase;
- the long-term financing by the contractor of the project funding requirement which is not covered by the milestone payments;
- remuneration paid at regular intervals by the public authority during the contract period consisting of two components:
– following completion of the construction works, for the duration of the remaining contract period a remuneration component to be paid monthly for the long-term financing, and
– for the duration of the contract period, a remuneration component to be paid monthly for operational services, maintenance and other services;
- a deduction mechanism for restricted availability (e.g. fewer lanes or speed restrictions) of the relevant section of road, as well as breaches of other obligations.2 Within certain limits, scheduled maintenance works may be exempt from deductions.
Since the launch of the first V-model project (the A9 (Lederhose – Thuringia/Bavaria state border)), the V-model has been continuously refined, not only to reflect experience gained from the implementation of previous projects, but also with a view to addressing market requirements. This has also been the case in relation to the contractor's financing arrangements. In the course of the second batch of projects, the V-model has thus been adjusted to introduce project bond financing structures.
The way forward
In 2015, the German Federal Ministry of Transport and Digital Infrastructure announced, in conjunction with the German Federal Ministry of Finance, a "new generation" of eleven PPP projects in the federal trunk road sector3. Two of these projects (the A10/A24 (Neuruppin – Pankow) and the A3 (Biebelried – Fürth/Erlangen)) are currently being tendered and it is envisaged that there will be a continuous deal flow of two to three projects per year. The new generation projects have been included in the German Plan for Federal Traffic Routes 2030 (Bundesverkehrswegeplan 2030)4 which was approved by the German Federal Government and accompanied by three legislative acts in December 2016.5
The new generation projects aim to, among other objectives, further promote a framework for investment opportunities for private sector investors.
Opportunities for private investors in the primary market
One option for private investors is to invest equity in the contractor. Customary funding structures often allow sponsors to defer their equity contributions until completion of the construction works. For example, in the recent A7 I (Hamburg – Bordesholm) and A6 (Wiesloch/Rauenberg – Weinsberg) motorway PPP projects, the Dutch institutional investor DIF was part of the successful bidding consortium alongside Hochtief, and was a shareholder in the contractor. However, against the background of a typical leverage of between 90 and 92.5 per cent for these types of project, the equity ticket tends to be fairly limited compared to the overall size of the project.
A second option for private investors is to participate in the financing of the contractor (i.e. private debt). Even though the involvement of private investors in the financing of a PPP project is not mandatory, the PPP concept opens this up as a possibility and also allows – alongside the traditional credit financing by institutional investors – the issuance of project bonds.
The specific structure of the private financing arrangements need to reflect the structure of the remuneration for the construction and maintenance works as set out in the project agreement between the public authority and the contractor. Accordingly, the package of private debt regularly includes certain short-term and long-term instruments (credit facilities and/or project bonds) to bridge the funding gap created by the need for the contractor to finance the project costs (construction; maintenance; services; debt-service; taxes; etc.) before it receives payment from the public authority and/or before the sponsors make their equity contributions, and to provide the required financial headroom.
The PPP projects in the second batch which have, to date, reached financial close were financed by way of the following packages:6
In addition, financing of the A6 (Wiesloch/Rauenberg – Weinsberg) project (which reached financial close in December 2016) included a project bond as well as debt instruments. The debt instruments were provided by the European Investment Bank (EIB) and other banks (DZ BANK, L-Bank and MUFG), and the project bond was purchased by KfW IPEX. Ashurst LLP advised KfW IPEX and the syndicate of lenders (other than EIB) on this transaction.7 The overall project cost totalled approximately EUR 1.3 billion, of which approximately EUR 600 million was purely construction costs.8
Project bonds
So far, only the financing of the A7 I (Hamburg – Bordesholm) and the A6 (Wiesloch/Rauenberg – Weinsberg) projects have included project bonds in the financing structure. The fact that their use has not been more widespread may be because the documentation and administration for a bond is more complex and expensive than that required for a loan. However, the appetite for such structures tends to increase as market experience increases. In addition, the implementation of Solvency II, with the introduction of the concept of "Qualified Infrastructure", has further encouraged institutional investors to invest in German PPP projects.
The inclusion of project bonds in a financing package generally increases the numbers of potential private investors, mainly on account of the following:
- from a German regulatory perspective, investing in a project bond does not require a German or EU banking licence, which is an important difference compared to providing a loan. As a result, issuing a project bond opens up investment opportunities for non-banks (such as insurance companies, pension funds and other financial intermediaries).
- In addition, if a project bond is included in the financing package, it will generally also be possible for the EIB to provide certain subordinated credit enhancement instruments to improve the rating of the (senior) project bonds and thus to make an investment in the bonds even more attractive.9 Such a structure was, for example, chosen for the initial financing of the A7 I (Hamburg – Bordesholm) project.10 It should be noted, however, that banks as well as other private investors may be keen to invest in a project bond. Consequently, while the A7 I (Hamburg – Bordesholm) project bond was purchased by banks as well as other institutional investors, the A6 (Wiesloch/Rauenberg – Weinsberg) bond was only purchased by a bank.
While, in theory, the options for private investors to invest in project bonds are broad-ranging, it should be noted that there may be certain de facto constraints on potential investors. For example, it is sometimes the case that significant financiers are only prepared to invest in a project if all the other investors with outstanding commitments in the financing package achieve certain minimum rating criteria (so-called "co-funders risk") and/or if certain categories of investors are excluded from participating. Such criteria obviously limit access for private investors to invest in projects.
Private vs. public financing
Private sector investment in PPP projects in the German road sector is not essential: the alternative would be for the public authority to finance the relevant project from the public sector debt. This could even prove to be cheaper than procuring investment from private financiers, because the public authority could raise debt on the capital markets on more attractive terms than private investors would be able to. The German Federal Government has, nevertheless, decided to open up the German trunk road sector to private debt investors. The advantage it sees from doing so is that the more stringent risk assessments carried out by private debt investors, as well as their incentive to reduce costs, may help to avoid unprofitable public investments, so that higher funding costs are compensated by a lower risk for taxpayers of a credit default due to an unprofitable project.11
Attractive investment opportunities
The decision of the German Federal Government to open up PPP projects in the German road sector to private finance creates attractive investment opportunities, especially in the current environment of low interest rates. Despite some reservations and vigorous debates, PPP projects in the German road sector are strongly supported by the German Federal Government, as the new generation of projects and their inclusion in the German Plan for Federal Traffic Routes 2030 (Bundesverkehrswegeplan 2030) demonstrates. The current German Minister for Transport, Alexander Dobrindt, made clear his view that concerns about economic efficiency are outweighed by the positive effects of involving the private sector, on the basis that, without private investment, certain projects might not come to fruition at all.12
Opportunities for private investors in the secondary market
Further opportunities for private investors may also arise in the secondary market, with possible refinancings of existing projects. PPP projects in the German federal trunk road sector permit or, in certain cases, actually require a refinancing to be undertaken; e.g. where more favourable financing conditions have evolved in the market during the contract term. In June 2016, the refinancing of the A8 (Ulm – Augsburg) project reached financial close. According to the Federal Transport Infrastructure Plan 2030 (Bundesverkehrswegeplan 2030), refinancings of further projects (the A5 (Malsch – Offenburg), the A8 (Augsburg – Munich), the A1 (Bremen – Hamburg), the A4 (Hörsel Hills bypass), the A9 (Lederhose – Thuringia/Bavaria state border)) are also envisaged.
So, all in all, there are busy times ahead for those wishing to invest in the German trunk road sector.
1. Scientific advisory board of the German Ministry of Finance, expert opinion on opportunities and risks of PPP projects ("Chancen und Risiken Öffentlich-Privater Partnerschaften"), www.bundesfinanzministerium.de (2/2016).
2. Scientific advisory board of the German Ministry of Finance, expert opinion on on opportunities and risks of PPP projects ("Chancen und Risiken Öffentlich-Privater Partnerschaften"), www.bundesfinanzministerium.de (2/2016).
3. German Federal Ministry of Transport and Digital Infrastructure, information brochure "Public-Private Partnerships in the Federal Trunk Road Sector – the New Generation", www.bmvi.de (July 2015).
4. German Plan for Federal Traffic Routes 2030 (Bundesverkehrswegeplan 2030), www.bmvi.de (3 August 2016).
5. Sixth Act Amending the Act on Trunk Road Expansion (Sechstes Gesetz zur Änderung des Fernstraßenausbaugesetzes); Third Act Amending the Act on Federal Railways Expansion (Drittes Gesetz zur Änderung des Bundesschienenwegeausbaugesetzes); Act on the Expansion of the Federal Waterways and Amendment of the Federal Waterways Acts (Gesetz über den Ausbau der Bundeswasserstraßen und zur Änderung des Bundeswasserstraßengesetzes).
6. Sources: VIFG, "Traffic infrastructure financing and the requirements for tomorrow's road construction" ("Verkehrsinfrastrukturfinanzierung - Anforderungen an den Straßenbau von morgen"), www.bast.de (January 2017); InfraDeals (https://www.infra-deals.com).
7. "Ashurst advises bank consortium on project planning and financing of new section of A6 motorway", www.ashurst.com (13 December 2016).
8. KfW IPEX-Bank, "KfW IPEX-Bank and EIB finance new section of A6 motorway in Baden-Württemberg", www.kfw-ipex-bank.de (13 December 2016).
9. European Investment Bank, "An outline guide to Project Bonds Credit Enhancement and the Project Bond Initiative", www.eib.org (21 December 2012).
10. European Investment Bank, "A7 extension: first financing operation in Germany with EU project bonds", www.eib.org (27 August 2014).
11. Scientific advisory board of the German Ministry of Finance, expert opinion on "Opportunities and risks of PPP projects" ("Chancen und Risiken Öffentlich-Privater Partnerschaften"), www.bundesfinanzministerium.de (2/2016).
12. Article in Merkur, "Private investors may invest in road constructions" ("Privat-Investoren dürfen Straßen bauen"), www.merkur.de (26 May 2015).
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