Commercialising public infrastructure

Sub-sovereign transactions as a transition scheme into commercialisation

The EBRD believes that public infrastructure, where the public sector at the national and/or municipal level invests in the improvement of assets, networks and associated services to allow for efficient running of the economy, can be done in a ‘commercialised’ manner.

Indeed, our track record from the mid-1990s through to the present shows just what can be accomplished using this approach.

Some 43 per cent of the EBRD’s infrastructure investment has been structured on a sub-sovereign basis with public sector clients on a commercialised basis. The non-sovereign nature of the EBRD’s business model stands in contrast to traditional sovereign IFI or bilateral lending in this area.

It is noteworthy that despite the added credit risk of non-sovereign investments, the non-performing loan ratio of the EBRD’s infrastructure portfolio stands at less than 4 per cent. This lending record has been achieved in challenging environments over a period that has seen multiple financial crises, and where only some of the countries where the EBRD works have investment grade ratings at the sovereign level.

Enhancing financial viability of the public infrastructure projects – Tariffs for full-cost recovery

Financial viability of infrastructure projects can be instilled by increasing revenues, or reducing costs, or both. 

Tariffs are the key element for revenues, thus a core drive for commercialisation of the utilities. The EBRD endeavours to turn the state sector utilities into commercially-minded financially viable enterprises. Therefore it incorporates policy dialogue for tariff reforms into the infrastructure projects, particularly while investing in revenue-earning assets.

Policy dialogue with the client enterprises – state or municipality owned - aims at fully cost recovery, which is challenging in reality for various reasons in the EBRD’s countries of operation 

Such policy dialogue, therefore is often supported by a combination of technical cooperation for review of tariff setting mechanism and optimal tariff formulation, conditionality in the lending agreement and sometimes capital grant from donors to lower the break-even point.

Inducing efficiency through technical cooperation

Commercialising public infrastructure means enhancing the efficiency of the way assets, once delivered, are managed.  This encompasses a focus on deriving the full economic benefits of the investments in infrastructure across the full life-cycle in line with expectations during the project development phase.

Under this approach, public sector managers are provided tools to control costs of operations, while improving revenue generation, and in so doing seek full cost recovery levels, while keeping within affordability constraints of users. 

The EBRD helps public sector clients develop and implement key tools using technical cooperation: from ‘Financial and Operational Improvement Programmes’ (FOPIPS) to improve services to users according to industry benchmarks, to regulatory tools based on performance-based contacting encapsulated within Public Service Contracts (PSCs, used typically in the municipal utility sector) or Public Service Obligations (PSOs, used for national services such as the rail sector).   

The Public Service Contract/Obligation (PSC/PSO) is a contractual arrangement between the service provider and the municipality (as owner) that clarifies the commitments, rights and obligations of all parties involved (state/city, company and users).

A well-crafted PSC/PSO includes clearly defined long-term performance targets specifying the operational, technical and financial performance indicators, and is signed between the public sector government as ‘owner’ and the operator as ‘service provider’. The EBRD is not a signatory to the PSC/PSO.

The EBRD uses the PSC/PSO approach with its national and municipal clients, including those outside the European Union (EU). In fact, some 50 per cent of all PSC/PSO-based projects have been implemented in non-EU countries, including the countries of Central Asia and the Caucasus. 

The duration of the PSC/PSO is set to match roughly the life of the asset being financed. The contract aims to create a stable and predictable operational framework for the company, operational independence, predictable procedures and management autonomy over revenue streams. It also strengthens accountability and incentives through well-defined performance targets.

Chief among the owner’s rights are approving business plans, investment programmes and tariff adjustments in a timely manner. The company’s rights and obligations include implementation of the business plan, as well as delivering, metering, billing and collecting payments/fares for services delivered. The company annually updates its business plan, investment programmes, tariff proposals and progress reports.

The major attributes of PSC/PSOs include:

  • “All-in” compensation for services delivered – all operations and management (O&M), depreciation of assets, any new capex programme planned over the lifetime of the PSC/PSO, and finance costs
  • A definition of the operational parameters and the performance targets to be met, including the quality of service
  • A definition of the tariff regime and arrangements for billing/ticketing and collection
  • The benchmarking of costs to deliver the operational plan, with inputs such as labour, energy, materials, depreciation and capital costs
  • The establishment of an indexation basis over the life of the PSC/PSO for variable costs (such as labour, consumer prices and energy costs)
  • A definition of the duration of the PSC/PSO, linked to the life of the asset to be finance
  • A defined payment formula
  • A description of the municipality’s obligations to provide quality service
  • Inclusion of standard contractual clauses pertaining to supervision, auditing, invoicing and payments, contractual amendments, force majeure, dispute resolution and termination
  • Technical appendices pertaining to the service and operations plan; equipment requirements; performance indicators; penalties for poor performance; tariff plan; and a formula for indexing compensation levels over time

The Project Support Agreement (PSA, sometimes denominated as a ‘Municipal Support Agreement’ when the object of improvement is a municipal utility) is a contractual agreement between the EBRD and the relevant municipality. This agreement includes a general commitment to support the project, the PSC/PSO and to facilitate key decisions (such as tariff adjustments).

The PSA includes:

  • an obligation to provide necessary financial backing for the public company or municipal utility company to cover all economically justified costs not included in the current level of tariffs or fares.
  • if the tariff/fare revenue does not cover the full costs of operations and the financial obligations of the company, and if the national / municipal government is unwilling (or unable for social or political reasons) to increase the tariff, the PSA commits the national / municipal government to cover the resulting financial revenue shortfall as per the PSC/PSO formula.
  • the PSA does not require the owner to finance costs that are not economically justified or that should be recovered through diligent collection of bills or fares. Hence, the PSA prevents the owner from paying for inefficiencies of the company not related to its real cost of operations.
  • Because PSC/PSOs are structured in a robust manner, with built-in performance standards reflected in Key Performance Indicators and supported by EBRD-funded technical cooperation during implementation, the PSA acts as a strong risk mitigator that helps lower the overall risk profile of the project.

In this way, the PSA is a robust credit-enhancement tool, as it lowers the risk profile of any given transaction.