Nathan Dodd Partner, Mayer Brown JSM +65 6327 0235 [email protected] David Harrison Partner, Mayer Brown JSM +84 8 3513 0310 [email protected] Ben Thompson Partner, Mayer Brown JSM +65 6327 0247 [email protected]
1 The Belt and Road Initiative
The Maritime Silk Road, an important part of the Belt and Road initiative, has its starting point in Southeast Asia. China is therefore aiming to deepen its co-operation with Southeast Asia in various areas and particularly in infrastructure.
Southeast Asia is a patchwork of economies and the independent power sectors in each country are at very different stages and these markets are progressing at varying speeds.
At one end of the spectrum we have Myanmar, which has only recently emerged from decades of military rule, and with a large and urgent need for power project development. However, with a heavily subsidised state off-taker the newly formed Electric Power Generation Enterprise (EPGE)1 which has yet to develop an established track record of payments from which investors might draw comfort, investment sentiment remains cautious.
In our view, government backing of EPGE's payment obligations will be essential in attracting financing for any significant projects (and certainly those requiring project financing) at this early stage in the development of the independent power sector.
However, there is on-going discussion in Myanmar as to whether the government, and in particular the Ministry of Finance (MoF), is willing to provide government guarantees with respect to power projects. To-date there is no firm policy in place, although the MoF itself has stated that it is unwilling to provide such guarantees.
Despite the lack of a clear policy, the Myingyan independent power project does provide cause for optimism. This is Myanmar's first internationally competitively tendered power project and Mayer Brown is advising the lenders on this project.
On Myingyan, the undertakings to be provided by the Ministry of Electricity and Energy in support of EPGE's payment obligations under the power purchase agreement have been key in mobilizing political risk cover from both the Asian Development Bank and MIGA.
1 Recently set up as a successor to the previous state off-taker, Myanmar Electric Power Enterprise. Mayer Brown
The project has been successful in attracting international commercial bank lending, but it was essential to ensure that these commercial banks are suitably covered in this frontier market. Absent such cover, the Myanmar power market is likely to be viewed as too risky. Given that Myingyan is likely to be the "pathfinder" for other, and indeed larger and more complex, power projects to come to market in Myanmar, the hope is that such government support will be replicated on other projects for the foreseeable future.
At the other end of the spectrum we have Thailand. Under military rule since the coup in 2014, Thailand nevertheless benefits from an off-taker Electricity Generating Authority of Thailand (EGAT) which, to the best of our knowledge, has never defaulted even during the strains brought about by the Asian financial crisis.
As such, investors and lenders are comfortable without Thai government guarantees, even for cross-border power projects developed in neighboring countries, such as Laos, due to EGAT being the ultimate off-taker of the power. Power projects in Laos intended for domestic supply to Electricite Du Laos are, however, likely to continue to require Laos government support in the near term.
Moreover, the advantages are not necessarily only onesided in favor of investors and lenders; governments can also benefit. Ultimately, government guarantees should result in independent power producers charging lower tariffs government guarantees should result in a lower risk premium charged by the project company and lower margins and longer tenors offered by the lenders (given the higher credit rating attached to the loan).
For internationally tendered power projects a government guarantee should also attract a wider range of bidders, increasing competition. However, not everyone agrees that guarantees necessarily represent a win-win for everyone involved.
Guarantees are not a panacea for all ills and they are not universally popular. Critics point to a number of issues. For example, are projects with guarantees as thoroughly analyzed and well-structured as they might be without the comfort of a guarantee? The redistribution of risk pursuant to such arrangements can arguably dilute the incentives on the private sector to adequately manage risks that they could otherwise feasibly get comfortable with, through increased due diligence and project monitoring, for example.
Deep Pool of Liquidity Combined with Guarantees
Against the backdrop of this varying regional landscape there is a deep pool of commercial bank liquidity, waiting to be deployed to assist the region in meeting its rapidly expanding power needs. Bankers regularly tell us that there is no shortage of debt to deploy--rather that there is a shortage of good projects to lend to. Ultimately, lenders are looking for properly structured projects and this means power projects that are not overly exposed to offtake payment risk.
In many cases, government guarantees, in some shape or form, appear to be an obvious way for governments to encourage private investment in the power sectors of their respective countries. A sovereign obligation back-stopping the payment obligations of the off-taker in a difficult jurisdiction should encourage private investment.
Given their contingent nature, guarantees can also put significant strain on state budgets, in some cases leaving governments unable to meet their commitments. This potential exposure can in turn lead to governments (through their ministries of finance, for example) taking on a much more involved role in the relevant state off-taker's investment plans, which may not necessarily be the most conducive approach to developing the country's power sector.
Further, do guarantees even work as a deterrent against breach by the off-taker?
In Pakistan and Bangladesh where investors draw comfort from well-drafted sovereign guarantees and robust project documentation there have been issues with late payments, with a number of independent power projects in Pakistan electing not to invoke their sovereign guarantees simply to recover overdue bills.
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Hai Thao Nguyen Counsel, Mayer Brown JSM +84 8 3513 0318 [email protected]
Rohan Bilimoria Senior Associate, Mayer Brown JSM +65 6327 0248 [email protected]
Orsolya Szotyory-Grove Senior Associate, Mayer Brown JSM +84 8 3513 0355 [email protected]
Norah Mugambi Associate, Mayer Brown JSM +65 6327 0637 [email protected]
3 The Belt and Road Initiative
However, on the ill-fated Dabhol project in India the guarantees from both the government of Maharashtra and the central government were called upon, and successfully arbitrated by the project company, and it was only the intervening bankruptcy of the main sponsor, Enron, that meant that India ultimately escaped the dubious distinction of having to pay out under those guarantees. Given the possible drawbacks, we are seeing some governments begin to retreat from the provision of guarantees.
Indonesia and Vietnam
INDONESIA The Asian financial crisis in 1997 led to a devaluation of the Indonesian rupiah against the US dollar. The power purchase agreement tariffs for larger independent power projects in Indonesia were US dollar linked. Soaring costs in rupiah terms badly affected the government's ability to pay international infrastructure investors and resulted in cancelled contracts with inadequate compensation.
Between 1997 and 2003, the IMF provided around US$25bn in loans to help Indonesia rescue its banking system and rehabilitate its economy, but the debt came with strings attached, including with respect to the provision of government guarantees.
As such, the Indonesian government has moved away from providing sovereign on-demand guarantees from the Ministry of Finance with respect to the offtake obligations of state electricity utility PLN. However, PLN is heavily subsidised and foreign investors and lenders have been wary of investing without any form of credit support.
Instead of government guarantees, Indonesia has developed two types of government support schemes to be made available to qualifying independent power projects, namely (i) the Indonesian Infrastructure Guarantee Fund (IIGF) and (ii) the Business Viability Guarantee Letter (BVGL).
The IIGF programme was set up in 2009 with the backing of the World Bank/MoF to insure the private sector's risk by providing a guarantee to qualifying applicants undertaking projects procured under Indonesia's PPP scheme. In order to qualify, project companies have to make an application, and any project benefiting from the guarantee, which is
entered into directly with the IIGF, must (in theory) achieve financial close within 12 months (or 48 months for geothermal projects) from the date the guarantee is issued. Projects will be screened before being declared eligible, in an effort to manage quality and feasibility.
Although still in the early stages, the IIGF is a welcome development. However, the IIGF remains relatively thinly capitalized, and therefore is presently only able to offer guarantees over a limited portion of the investment.
The BVGL, introduced in 2011, is a letter available to independent power projects under the Fast Track II program (including the recent Sarulla geothermal and Asahan hydropower projects). The letter effectively states that if PLN were to breach its obligations under the PPA, the MoF would put PLN in funds to enable it to fulfil its payment obligations. It is not a sovereign guarantee that provides direct recourse to the MoF, but is more in the nature of an undertaking of financial support.
The Indonesian government continues, however, to gradually retreat from providing financial support to power projects (notwithstanding that the IMF debt was repaid in 2006, which should in theory make it easier for the government to provide guarantees). The high-profile Java 7 power project (2,000MW coal-fired) went to tender with no guarantee provided and the Java 1 (1,600MW gas-fired) power project is also currently out to tender with no guarantee to be provided.
These are the most prominent test cases of this approach and are being closely watched by the investment community. While these projects are likely to attract bidders, interest would be significantly greater if government guarantees were provided so for Indonesia the question is not so much whether there is a need for guarantees but whether they would still be preferable (given the advantages outlined above).
in its economy. On a typical independent power project, the off-taker would be Electricity of Vietnam (EVN), a stateowned enterprise (SOE); the feedstock supplier would be Vinacomin or PetroVietnam, both of which are SOEs; the converting bank would be a majority state-owned bank; and the land would be leased from the local government.
As such, when Mayer Brown as Johnson Stokes & Master advised the Vietnamese government on a bankable structure for the development of Vietnam's two pathfinder independent power projects--Phu My 2.2 and Phu My 3--robust government guarantees were a key part of the structure developed.
Since the Phu My 2.2 and Phu My 3 power projects, government guarantees in Vietnam have covered all of the obligations of Vietnamese state counterparties under commercial agreements related to projects that are classified as BOT projects.
However, in September 2011, shortly after the Mong Duong 2 power project reached financial close, the Vietnamese government modified this policy by providing that the payment obligations of Vinacomin and PetroVietnam would be indirectly guaranteed in the BOT contract (instead of being explicitly addressed in the government guarantee) and, for coal projects, that government guarantees would not cover contractual obligations in relation to coal transportation.
Moreover, where the Vietnamese government had previously provided a full guarantee on the availability of foreign currency, in 2011 a guarantee cap of 30% on currency availability was introduced. It should be noted that the Nghi Son 2 power project, a BOT power project awarded to Kepco and Marubeni in 2013, will continue to enjoy a 100% currency availability guarantee from the Vietnamese government because the bid package for this project was developed before the policy was revised.
Vietnam is another key example of a power market in transition with respect to the level of government support deemed necessary. In contrast to other jurisdictions in the region, Vietnam's government continues to play a major role
These moves have been viewed by many in the market as a material step-down in protection, which in turn will impact investment. The reduction in the currency availability cap to 30% has in particular been singled out as a significant threat to the bankability of projects.
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However, there are reasons for hope. More recent legislation broadens the scope of projects for which foreign currency guarantees are available, giving the Vietnamese government increased flexibility in granting guarantees to respond to changing priorities in the development of Vietnam's infrastructure.
Looking to the Future for Southeast Asia
So what will we see in the region going forward? Clearly, once an off-taker develops good financials and a solid track record of payment, this may allow the scaling back, or complete removal, of government guarantees. Of less certainty is exactly when that can happen in a particular country without significant negative impacts on the bankability of projects.
Notwithstanding the scaling back in Vietnam, the scope of the government guarantee remains broader than the guarantees in a number of other jurisdictions, particularly given the coverage of most commercial obligations of SOE counterparties.
However, as Vietnam continues to privatize SOEs, the government's willingness to provide similar commitments on new projects may be further limited, and investors will need to weigh that up against the positives of investing in a stronger Vietnamese economy (propelled by the private sector).
Similarly, in Indonesia, it remains to be seen how comfortable the market can become in taking on PLN credit risk without government guarantees in place. PLN has of course been successful in accessing the capital markets without cover, but the risk of a large and expensive stranded asset in the event of a PLN default makes the power market a different prospect for lenders (only one independent power project has closed in Indonesia without a guarantee (the Banten 660MW coal-fired power project) and there were structural aspects to that financing that may not be replicable on the latest projects under tender).
The tender processes on Java 7 (which was finally awarded to China Shenhua Energy) and Java 1 have shown that while the number of bidders has not been significantly impacted, the make-up of the bidders has changed a decrease in Japanese investors and an increase in Chinese investors being indicative of both differing risk appetites and, perhaps, the challenges for Japanese investors in bringing on-board JBIC for non-guaranteed projects. The Belt and Road initiative has resulted in a steady increase in Chinese investments across Southeast Asia with a survey showing that 47% of Chinese corporations surveyed listed Southeast Asia as their top destination for investment over the next three years.
For Myanmar, we are hopeful that the government will recognize that the Myingyan project is a success that should be replicated, with the full suite of documentation being used as a precedent for future projects for a number of years.
Of course, the success (or not) of any attempts to move away from guarantees will only become fully evident in years to come. Questions also remain over whether the success of one or two unguaranteed projects would justify any wider move by governments to remove them from the sector entirely--many would argue not, given the likely impact on tariffs, as outlined above.
For now, there is plenty to keep governments, sponsors, lenders and their advisers engaged in a lively debate. u
5 The Belt and Road Initiative
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