Guidance 1E. R. Yescombe (2007)
Public-Private Partnerships
Principles of Policy and Finance

A chapter of this book provides a summary of what project finance is and why it is often used for PPPs

Guidance 2World Bank - PPIAF (ver. 03/2009)
Toolkit for Public-Private Partnerships in Roads and Highways
This website contains graphical and numerical financial models based on a highway PPP project which illustrate the trade-offs inherent in alternative funding structures with model simulations

Guidance 3E. R. Yescombe (2007)
Public-Private Partnerships
Principles of Policy and Finance

A chapter of this book provides a comprehensive introduction on how bidders and their lenders structure the financing of a PPP

Guidance 4EPEC (2010)
Capital Markets in PPP Financing
Where Were We and Where Are We Going?

Provides background information on the role of capital markets in PPP financing and sets out the reasons why the capital markets have largely withdrawn from it

Guidance 5PPIAF & PriceWaterhouseCoopers (2006)
Hybrid PPPs
Levering EU Funds and Private Capital

Presents an analysis of a small sample of “hybrid” PPPs with mixed success regarding financial closure where EU grants are involved

Guidance 6EPEC (2006)
State Guarantees in PPPs
A Guide to Better Evaluation, Design, Implementation and Management

This paper provides elements for evaluating State guarantees role in national PPP programmes and guidance on how best to implement and manage them

Guidance 7O. Matsukawa (2007)
Review of Risk Mitigation Instruments for Infrastructure Financing and Recent Trends and Developments
This book summarises the characteristics of the major types of risk mitigation instruments

Guidance 8European Investment Bank (2009)
Issues Paper on Facilitating Additional TEN-T Investment
Identifies potential measures for consideration by EU and national policy makers that could deepen and diversify access to sources of finance as well as financial instruments capable of facilitating additional investment in the development of the TEN-T Infrastructure

Project Finance


This Annex introduces some basic concepts of project finance and shows how they relate to the financing structure of PPP projects. It is not meant to cover all the issues relevant to PPP financing structures, which are many complex and often project-specific. Authorities should rely on the expertise of financial and legal advisers to understand the relevant trade-offs in project finance issues.

PPP projects are generally financed using project finance arrangements. In project finance, lenders and investors rely either exclusively (“non-recourse” financing) or mainly (“limited recourse” financing) on the cash flow generated by the project to repay their loans and earn a return on their investments. This is in contrast to corporate lending where lenders rely on the strength of the borrower’s balance sheet for their loans.

It is important to stress that the project finance structure should be designed to optimise the costs of finance for the project. It should also underpin the allocation of risks between the public and private sectors as agreed in the PPP contract. In particular, the project financing should ensure that financial and other risks are well managed within and between the PPP Company shareholders, sponsors and its financiers. This should give comfort to the Authority that the PPP Company, and particularly its funders, are both incentivised and empowered to deal in a timely manner with problems that may occur in the project. Indeed, to a very large extent, the project finance structure should ensure that the interests of the main lenders to the project are aligned with those of the Authority – that is, that both need the project to succeed in order to meet their objectives. Where this is the case, the Authority can be confident that the lenders will take on much of the burden of assuring the ongoing performance of the project. This is a key element of the transfer of risk from the public to the private sector in PPPs.

Principles of project finance

In a project finance transaction a PPP Company would usually be set up by the sponsors solely for the purpose of implementing the PPP project. It will act as borrower under the underlying financing agreements and will be a party to a number of other project-related agreements. Guidance 1

The top-tier funding provided by lenders or capital market investors, usually referred to as “senior debt”, typically forms the largest but not the sole source of funding for the PPP Company. The rest of the required financing will be provided by the sponsors in the form of equity or junior debt. Grants, often in effect a form of public sector unremunerated equity, may also contribute to the financing package.

Since senior lenders do not have access to sponsors’ financial resources in project-financed transactions, they need to ensure that the project will produce sufficient cash flow to service the debt. They also need to ensure that the legal structuring of the project is such that senior lenders have priority over more junior creditors in access to this cash. In limited recourse financings, lenders will seek additional credit support from the sponsors and/or third parties to hedge against downside scenarios and the risk of the project’s failing to generate sufficient cash flow. Finally, lenders will wish to ensure that where a project suffers shortfalls in cash as a result of poor performance by one or more of the PPP Company’s subcontractors, these shortfalls flow through to the subcontractor, leaving the ability of the PPP Company to service the debt unimpaired.

Even though responsibility for arranging the financing of a PPP rests with the private sector (the PPP Company is the borrower), it is important for the Authority’s officials and their advisers to understand the financing arrangements and their consequences, for the following reasons:

  • When the Authority evaluates a bidder’s proposal, it must be able to assess whether the proposed PPP contract is bankable and whether the proposed financing is deliverable in light of the market conditions and practices prevalent at the time. Awarding the PPP contract to a company that ends up being unable to finance the project is a waste of time and resources.

  • The allocation of risks in the PPP contract can affect the feasibility of different financing packages and the overall cost of the financing.

  • The financing can have an impact on the long-term robustness of the PPP arrangement. For example, the higher the debt-to-equity ratio, the more likely it is that in bad times the PPP Company will run the risk of a loan default, possibly terminating the project. Conversely, the more debt in a project, the more lenders are incentivised to ensure that project problems are addressed in order to protect their investment.

  • If the PPP includes State guarantees or public grants, the Authority will play a direct role in some part of the financing package.

  • The amounts and details of the financing can directly affect contingent obligations of the Authority (e.g. the payments the public sector would have to make if the PPP contract were terminated for various reasons).

  • The Authority’s financial advisers should have a thorough understanding of what will be needed to make the PPP project bankable, given market conditions and practices prevalent at the time. Carrying out market sounding exercises at different points during the project preparation stages will greatly assist in developing a good understanding of investor and lender attitudes. It will save a great deal of time if any credit enhancement is to be provided by the public sector. Guidance 2, 3

Financing structure

As outlined above, the financing of a PPP project consists principally of senior debt and equity (which may sometimes be in the form of junior shareholder loans). The financing structure may also include other forms of junior debt (such as “mezzanine” debt, which ranks between senior debt and pure equity) and in some cases grant funding.

PPP projects should seek to achieve optimum (as opposed to maximum) risk transfer between the public and private sector. But the allocation of risks among the private sector parties is also crucial. Financial structuring of the project relies on a careful assessment of construction, operating and revenue risks and seeks to achieve optimum risk allocation between the private partners to the transaction. In practice, this means limiting risks to senior lenders and allocating this to equity investors, subcontractors, guarantors and other parties through contractual arrangements of one kind or another.

As a general principle, the higher the gearing of a project, the more affordable it is likely to be to the public sector.[1] This is because senior debt is less expensive than other forms of financing (except grants). Other things being equal, project gearing (i.e. the level of debt senior lenders will provide relative to the level of equity) will be determined by the variability of a project’s cash flow. The greater the degree of riskiness in the cash flows, the greater the “cushion” lenders will need in the forecast of available cash flow beyond what will be needed for debt service. This is necessary to reassure lenders that the debt can be repaid even in a bad-case scenario. Lenders will specify their requirement in terms of forward-looking (i.e. predicted) “annual debt service cover ratio” (ADSCR)[2] above a specified minimum level. The value of required ADSCR will depend in large part on project risk, and therefore variability of cash flows.[3]

For a given gearing (or volume of debt in the project), the target ADSCR will determine the level of the service fee to be paid by the Authority. Alternatively, for a given level of service fee (perhaps the affordability limit), the target ADSCR will determine the project’s gearing. In other words, the lower a project’s gearing (the more equity relative to debt), the higher the cover ratio from a given service fee.

The Authority’s financial advisers need to understand lenders requirements in this regard. It will greatly facilitate financing if the project developed and taken to the market is structured in such a way that the cover ratios are compatible with lenders expectations for the particular sector and type of project. This will also facilitate achieving the best possible cost for the financing and will thus have direct implications for the public sector, which is usually the ultimate payer for a PPP.

One of the fundamental trade-offs in designing PPPs is therefore to strive for the right balance between risk allocation between the public and private sector, the risk allocation within the private sector consortium and the cost of funding for the PPP Company.


Senior debt enjoys priority in terms of repayment over all other forms of finance. Mezzanine debt is subordinated in terms of repayment to senior debt but ranks above equity both for distributions of free cash in the so-called “cash waterfall” (i.e. priority of each cash inflow and outflow in a project) and in the event of liquidation of the PPP Company. Since mezzanine debt’s repayment can be affected by poor performance of the PPP Company and bearing in mind the priority in repayment of senior debt, mezzanine debt typically commands higher returns than senior debt.

Debt to a PPP project is normally priced on the basis of the underlying cost of funds to the lender plus a fixed component (or “margin”) expressed as a number of basis points to cover default risk and the lender’s other costs (e.g. operating costs, the opportunity cost of capital allocations, profit).

It is important to bear in mind that the underlying cost of funds is typically determined on the basis of floating interest rates (i.e. rates that fluctuate with market movements). These are normally based on interbank lending rates such as EURIBOR in the euro market or LIBOR in the sterling market. In contrast to these floating rate funds, the revenues received by the PPP Company do not generally change along with the interest rates. This mismatch is typically remedied by the use of an interest rate swap, through which the PPP Company ends up paying a fixed interest rate (this is referred to as the “hedging”). Responsibility for incorporating hedging instruments into the financing structure should be left to the PPP Company, as it is the PPP Company that has the right incentives to take appropriate action. However, the cost of these swaps is relevant to the public sector as they may result in costs in certain termination situations. For this reason, they should be analysed by the Authority’s financial adviser.

Debt for major PPP projects may be provided by either commercial banks, international financial institutions (such as the European Investment Bank) or directly from the capital markets. In this last case, project companies issue bonds that are taken up by financial institutions such as pension funds or insurance companies that are looking for long-term investments. Guidance 4

Financial advisers will be able to advise on the likely sources of funding for a given project. They would also be expected to make an assessment of the anticipated costs and benefits of funding options. This will include an assessment of the debt tenors (the length of time to maturity, or repayment, of debt) likely to be available from various sources. This is particularly important if long-term funding is not available for the project and where the public sector may be drawn into risks associated with the need to refinance short-term loans (so-called “mini-perm” structures). Guidance 4


Equity is usually provided by the project sponsors but may also be provided by the contractors who will build and operate the project as well as by financial institutions. A large part of the equity (often referred to as “quasi-equity”) may actually be in the form of shareholder subordinated debt, for tax and accounting benefits. Since equity holders bear primary risks under a PPP project, they will seek a higher return on the funding they provide.

Credit enhancement

Project finance transactions may feature various forms of credit enhancement. For example:

  • Credit support from sponsors and subcontractors: Senior lenders will often require sponsors to put in place certain credit-enhancement measures that take some of the risk away from those senior lenders (and in some cases, equity holders). These may take a variety of forms, including:

    • guarantees by the sponsors and third parties relating to the performance of the PPP Company’s[4] or other participants’[5] obligations under the project documentation;
    • financing facilities that provide temporary liquidity to deal with specific risks (e.g. a large depreciation of the local currency); and
    • insurance against certain project related risks (e.g. construction risks, loss of revenue, third party liability, environmental liability).
  • Public sector support: Public sector support instruments may also be deployed, for example:

    • direct funding support by way of public sector capital contributions. These may come from community, national, regional or specific funds. They may be designed to make a project bankable or affordable Guidance 5; and
    • contingent support or guarantees by the public sector to the PPP Company or other private sector participants for certain types of risks which cannot otherwise be effectively managed or mitigated by the PPP Company or other private sector participants (e.g. minimum revenue guarantee for a toll road). Guidance 6, 7
  • Loan Guarantee for TEN-Transport (LGTT): The LGTT is a unique credit enhancement instrument specific to TEN-T projects in which the private sector takes traffic risk. Guidance 8

Security structure and lenders' protection

As noted above, project finance lenders rely exclusively or mainly on project cash flows. The lenders’ security arrangements and protection mechanisms reflect this and consist mainly of:

  • secured interests over all the project assets (including and especially all contracts) to enable the lenders to take remedial actions if the PPP Company has failed;

  • controls over all cash inflows and outflows of the PPP Company. As noted above, loan contracts and other financing documents will establish the waterfall for allocating the PPP Company's cash inflows to the various cost items. This will ensure that senior debt service always has priority. In addition, it will define the circumstances in which senior lenders are able to prevent equity distributions (“lock up”). This will usually be defined by reference to financial ratios such as ADSCR;[6]

  • cash flow controls in the form of reserve accounts (e.g. debt service reserve account, maintenance reserve account).

[1]           In a typical PPP project, up to 70%–80% of financing would be procured in the form of senior debt while the share of equity would not normally exceed 20%–30%.

[2]           The ADSCR is defined as the ratio of free cash (i.e. cash left to the project after payment of operating and essential capital costs) available to meet annual interest and principal payments on the debt.

[3]            For example, if the payment mechanism is designed so that the PPP Company does not take demand risk, lenders might be satisfied with a projected annual debt service cover ratio (ADSCR) of 1.3x. But if a PPP Company bears substantial traffic risk, then lenders may insist on a minimum ADSCR as high as 2.0x. Lenders use detailed forward-looking financial models to estimate future cash flows and cover ratios.

[4]            For example, standby or guarantee letters of credit used to protect against the PPP Company’s failures to meet its payment and other obligations due by it under the project agreements.

[5]            For example, performance bonds callable in the event of the contractor’s failure to perform the terms of the construction contract. Parent company guarantees will also often be required from construction and other service subcontractors.

[6]            The LLCR is defined as the ratio of the net present value of cash flow available for debt service for the outstanding life of the debt to the outstanding debt amount.