What Is a BOT?

BOT allows governments to tap private resources by giving private entities a number of years in which they can build and operate a facility.

BOTs are often expensive because of the high number of parties involved. In thefinancing world, it is common to conduct transactions on a one-to-one basis – there is a borrower and a bank, a financier. In BOTs, the number of players is much higher. They include:

government

: the ultimate client. It is the government that wants to build theinfrastructure but does not have the money;

•utility

: This might be the power distribution company that is the operating armof the government. It may not have the resources or the know-how andtherefore goes into the market place and looks for a private party to helpdevelop the infrastructure;

•sponsor

: Normally foreign players that operate under different rules havedifferent mindsets;

•lenders

: It is the lenders that provide typically three quarters of the financingof projects. If the government, sponsors, utilities or whoever ignore thepresence of the lenders and their concerns, there is a high chance the projectwill fail;

• fuel suppliers

: The suppliers to power transactions;

•turn-key contractors

: It is quite typical to have a separate company other thanthe sponsors to carry out the construction work; and

• project company

: an independent operator that runs the project (in some cases).

The relationship between these players must be governed somehow and that isnormally the government’s task through complicated contractual arrangements. Thekey to the success of a BOT project is the deep understanding by all parties of threematters:

•the risks involved;

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allocating the risk between the participants; and

•how cash flow is generated.

BOT Risks

A true BOT is a project finance transaction in which there is no safety net; thegovernment is not going to bale out the project, or guarantee whether or not theoperation is successful. The equity risk is always there. Sponsors have the upsidepotential, but they also risk losing all their money. Financial risks must be sharedbetween the lenders and the sponsors.Other project risks will be left with the sponsors, who are most concerned aboutthe prospects for an interruption of cash flow. This could be caused, for example,by:

political interference;

•

technical problems; or

•

political violence.They are going to look at all these possibilities. If there is any category risk that theyare uncomfortable with, somebody else – most likely the government – will have topay, possibly in the form of a higher tariff or a higher interest rate on loans.There are various risk categories and their allocations that are to be considered bysponsors (see Figure 17.2):

•

political risk

: This might take the form of political interference by thegovernments. Or perhaps this will be the risk of nonperformance bygovernment’s executing agencies or utility. The government typically is goingto take political risk, although not always 100 percent of it. There areinstances where the sponsors take political risk, but that varies from project toproject and from country to country;

•

project specific risk

: An example is preconstruction risks. Building a powerstation in Asia is not an easy task. For power stations, large pieces of equipment have to be brought to places that often have no roads or have poortraffic conditions. Project risks are left with the sponsors;

Figure 17.2: BOT Risk Allocation

construction risk

: Sometimes there are technology problems that need to belooked at carefully. Sponsors usually do not want to take any constructionrisk, although they do not always get their way on this. They will aim for thebest contractor possible and execute an agreement under which thecontractor undertakes to build the infrastructure in a given period of time at afixed price. If the contractor fails, it is going to pay; and

•

operational risk

: Once all the hurdles are passed, and the infrastructureproject is built, it still has to be run and make money. The sponsor often laysdown that the operator will produce a certain performance from thecompleted unit, or else it will be liable to pay.

Risk Mitigation

Anyone who has worked in this sector will find that most of the time is spent trying toconvince sponsors, lenders, and contractors that the risk is either not there or if it isthere, can be mitigated.Everybody is paranoid about risk because once you put a turbine in a middle of adesert, it might be yours, but if the project does not work you cannot take the turbineback with you and then sell it.It is important not only to identify the risks but also to mitigate them amongparticipants. Risk mitigation is a key to the success of BOT. A BOT only “flies” if therisk structure and related allocation is sufficiently robust to survive a combination of pessimistic scenarios affecting various key players.

Contracts

The first form of mitigation is to have a clear and tight contractual structure thatleaves no holes that can cause problems later. This is difficult given the complexity of these projects.

Financial measures

Lenders typically require that cash flow streams are sufficiently large and that thereare enough cushions for any hiccups in the implementation of a project. Things can gowrong in emerging markets, so this must be anticipated and provided for.

Other forms of mitigation

Sometimes sponsors agree to take more risk than they might usually do, dependingon the project. There is also insurance, which will not cover everything and is highlyexpensive.

Risk Allocation

Risks borne by the government

In the case of a power type BOT, once a group of investors decides to invest a billiondollars in physical assets for a country, such as a power transmission line, thatinvestment is there for good – it cannot be taken away. So the investors are in the handsof the government. If the government decides to do something, for example, not to runthe power station, how is the sponsor group – the investor group – going to get itsmoney back?

Minimum off-take agreements

When a big power station is built, the government undertakes that under allcircumstances it will buy a percentage of the capacity of the power station at a fixedprice. This will be a heavily negotiated point because it ensures that the investors willhave enough money to repay their lenders and their shareholders.

The tariff

This is also negotiated heavily and is usually a painful exercise. It often happens thatthe government will have to undertake to perform the contractual undertakings of anyunderperforming government entity, according to its contract.

Foreign exchange risk

Who will guarantee that there would be enough dollars to take out of the country torepay the debt? The answer is the government, which must make available sufficientamounts of hard currency.

Stable legal framework

BOTs are complicated negotiating exercises that result in the signing of dozens of documents that set the rules for the implementation of the project. The government hasthe power to alter the rules of the game at any point, as it has the sovereign right tochange laws.If it does so five years after a project has begun construction, the sponsor cannotdo anything about it.So typically governments must provide strong assurances that there will not be any change in the rules of the game for the

duration of the project.That is an essential point. If there is no such undertaking, the chances of the projectnot going forward are high.

Government Commitments

A typical contractual structure of a private power project includes a number of agreements.

Implementation/concession agreement

This is an umbrella contract that keeps the whole thing together. The governmenthas to formally declare its commitment to the infrastructure development project. If the government is not behind it in writing, it will be difficult to get investors to come toany country to finance projects.

Political risk

A typical commitment is to guarantee that there will be no change of law.

Government interference

When building a transmission line, a power station, or a telephone network, it has tobe clear to private investors that for ten, 20 years, or whatever, that it is going to betheir project and the government is not going to interfere. There have to be writtenobligations from the government to this effect. Also, private developers have bigdifficulties in coping with bureaucracy. The government has to undertake to help themwhere it has the power to do so.

Other guarantees

In the case of a fuel supplier that is a state-owned entity – such as a state-owned oilcompany that is near bankruptcy – the government will have to back the entity withguarantees that may even survive privatization. Certain events may occur that should notresult in the government penalizing the sponsors. If a government opts for BOT rather thana BOO structure, then it will have to deal with the issue of termination – what is going tohappen at the end of 15 or 20 years? And there is also the issue of how to transfer thefacility. The government wants to protect itself to ensure that on transference, something –say a power station – that is in operational condition is well-maintained.

Conclusion

BOTs are extremely powerful mechanisms. A government can raise a large amount of money if it plans the deal right. But BOTs are not an easy option. Based on the Bank’sexperience of BOTs, there are several factors that can be identified as contributing to acountry’s success:

sound policy and regulatory framework

:

There should be a BOT Law, somesort of foreign investment law that sets the general rules of the game,otherwise it will make investors’ life more difficult and will reduce thelikelihood of projects succeeding;

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strong government support

: The government is the client, therefore it is in itsinterest to facilitate the process. The problem cannot simply be handed to theprivate sector. BOTs are a partnership between the private sector and thepublic sector. As in any partnership if one of the two partners does not play hisor her part, it is not going to work. Instead, the amount of work is probablygoing to rise exponentially. The two parties have to be side by side, workingtogether to ensure success. It takes years, in which either the governmentdevelops a good relationship or the project will not go ahead;

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clarity

: The project formulation and documentation have to be as clear aspossible. Some countries opt for standard documents given to all the partiesinvolved in power projects. In some cases this strategy works, but at othertimes it causes governments headaches because every project is different. Aperfect standard document has to be adopted for every single project.Whatever the case, the documents have to be clear and transparent;

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real priority projects

: There is no point in chasing projects that are not apriority, because they are going to have a high chance of falling apart. It wouldbe wasting resources and investors’ time;

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transparency

: It is fundamental that the selection process of sponsors becarried out in a transparent manner;

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responsible sponsors

: Governments should deal with responsible sponsors.Responsible does not simply mean lots of money. It means people who knowwhat they are doing and have a long-term commitment to a country;

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profitable

: Projects that might barely break-even should not be attempted,because nobody is going to finance them. Sustainability is an element of profitability. Projects cannot be based on heavy subsidies because one day thegovernment may not be able to sustain the hidden costs; and

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fair deal for all parties

: This is the most important of all. If the private sectorinvestors are taking advantage of the government, the deal is going to gounder. If the government takes advantage somehow of the private sector, thedeal again is going to fall through. It must be a win-win situation.

The Bank’s Private Sector Group

The Bank has a group that specializes in private sector infrastructure financing,including BOTs, called the Private Sector Group, which can be approacheddirectly or through the public sector side.

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