I. Starting point
Germany with regard to project financing is very much like a developing country. This form of the assessment of large-scale projects on the basis of future profit potentials of the investment to be financed is from a German perspective the domain for the extraction of raw materials in developing countries, exotic foreign infrastructures or worldwide telecommunication projects. Therefore, German law firms, advisors and banks are mainly focussed on foreign project financings.
The dividing lines between the various forms of financing are fluid. The more important and significant the project to be financed is in comparison to the size of the company, the more the risks of the project are in the foreground, even without considering project financing. Frequently however with German infrastructure projects there exist (concealed or open) reverting rights (Full Recourse Financing) so that the characteristics of project financing are not being fully realised. As far as the press discusses German project financing, it is mainly concerned with funds and tax-orientated models. Quoted advantages are here particularly the reduction of time taken for construction, the lowering of building costs as well as the general advantages of outside construction management.
Local financings are based regularly on very favourable public sector loans or guarantees. A changed market situation and increased tougher legal requirements have forced the employment of new forms of financing. Thus the international project-financing model can be viewed as part of the future market in Germany.
II. Framework conditions
1. Project financing and privatisation
In the sector of local government the financing of local infrastructure measures by project financing often means a privatisation of previously original municipal areas of responsibility. Here one has to take the restrictions into account, which result from the German constitutional law. Large areas are from the view of the public law "belong exclusively to and are held in reserve" for the sovereign, so that they are the sole and final responsibility of the municipal monopolies. Thus in accordance with current thinking waste management particularly, i.e. wastewater purification and refuse incineration belongs into this category. This public law problem however does not occur in the areas of traffic, public utility and telecommunications.
There is an urgent need for investment for example in the refuse incineration sector. In Germany housing estates currently account for about 30 million tons refuse. About two thirds go straight to one of the 350 disposal sites. About one third is incinerated. The clinker is partly stored, partly used. In 2020 at the latest no refuse should be going to such disposal sites. After the year 2005 only pre-treated refuse can be permitted to be deposited. This results from the technical instructions regarding refuse from housing estates ("TASi"), which has already been passed as a regulation in 1993. As currently the about 60 operating refuse incineration plants or refuse heating power stations have an annual capacity of normally up to 400,000 tons, the requirements for investment and financing are obvious.
In addition to refuse incineration, Germany has an important investment need for the redevelopment and the extension of the sewage water disposal plants, the extension and maintenance of the traffic infrastructure, the revitalisation and recycling of industrial sectors, the creation of high-quality housing estates as well as the provision of further public facilities and urban development projects.
Particularly in Germany the European electricity market is under a strong pressure to liberalise. The loss of regional monopolies and with that the right to distribute electricity in the framework of the new energy law enables new providers entry into the market. This makes the future construction of merchant power plants i.e. power plants without fixed energy purchase contracts by energy suppliers possible.
For the market of possible project financing it is, however, decisive how far the community can operate in a private industry. This does not remain without influence on the ability and willingness of the community to make use of project financing. In the "Gelsengrün"-verdict of the Superior Court of Appeal in Hamm as of September 23, 1997 the town of Gelsenkirchen was forbidden to compete with private garden developers. The private industrial activity of the municipal garden developer could not be justified by as a public purpose. However, in the "car recycling"-verdict of the Superior Court of Appeal in Düsseldorf as of October 28, 1999 municipal activities in the (until then municipally controlled) area of refuse disposal was viewed as permitted in principle, when no public purpose makes the economical activity necessary and when private companies can fulfil this purpose even better and more economical. In the meantime a constitutional complaint has been lodged against this decision from 1999 at the Federal Constitutional Court. Time will tell whether the fundamental possibility for cost effective local credits and the legal insolvency protection of a community limits its economical freedom constitutionally.
2. Project financing versus public sector loans
Traditionally Germany communities finance themselves by public sector loans and municipal companies by municipal secured loans. The conditions granted thereby are very cost-effective. This has on one hand to do with the supposed or genuine insolvency strength on the part of the community and on the other hand with the regulations of the German banking law. A municipal security for a municipal company is mostly granted against a security commission, which currently in Germany is about 0,2 to 0,5% p.a.
These conventional financing structures are not (anymore) proper if public sector loan conditions are not available because of private share owners, legal limitations by the European Community, if the budgetary funds do not permit a conventional financing or if the municipal project does not have an urgent public purpose and therefore the citizen should not be burdened with the uncertain success prospects of the project. In these cases the possibility of project financing will be increasingly examined in Germany to be able to appraise the investment project.
3. Balance sheet and tax parameter
As the project will be completed in the framework of a separate project company the German sponsor has no regular own balance sheet binding obligations. As the balance sheet statistical information cannot be worsened there is no danger that future corporate financial tests can no longer be achieved and so general credit worthiness could be decreased. Equal status frames (pari-passu clause, negative pledge) in third party loans can be kept to, even if an urgent surety of the project becomes necessary.
According to the previous opinion of the tax authorities obligations or reserves for commitments, which have to be fulfilled, depending on future earnings and profits, have only to be revealed when these earnings or profits have been made. In contrast the German Federal Tax Court has decided in its latest judgement (verdicts from December 17, 1998 and February 4, 1999), that for company payments, which have to be paid back under a not yet fulfilled condition, independent of whether the legal relationship has to be viewed as dissolved or postponed conditional liquidity assistance or a subsidy which is not required to be paid back, that there is an obligation to accumulate a reserve for this. According to the tax law modification act incorporated on December 22, 1999 a regulation was included, dealing with obligations, which only have to be fulfilled if future earnings and profits occur. Due to this rules obligations and reserves only then have to be calculated when the earnings or profits have been made.
4. The role of the KfW
The KfW (Federal Development Banking Institution) provided the German economy in 1999 with 41,7 (1998: 31,4) billion Euros. Of this 32,4 (1998: 24,7) billion were allotted to investment loans. Export and project financing increased from 6,7 billion Euros in 1998 to 9,3 billion Euros in 1999. The remaining 1,6 (1998: 1,4) billion Euros were allocated to the support of developing countries. A smaller contribution is anticipated for 2000. The combination of export and project financing is in accordance with practice, which by employing multi-sourcing makes the national export insurance coverage for project financing usable. In doing so the financing of an independent power project through the KfW often serves the increase in sales for German manufacturers of turbines. Here insurance by HERMES-cover, exporter’s guarantee and foreign sureties can take place. The HERMES-cover is regularly limited to a certain percentage of the total value.
III. German project finance structures
1. Operator models in the waste management sector.
Under an operator model the planning, construction, financing and operation of a municipal waste incinerator plant is carried out by one or more private investors. Depending on the starting situation the legal ownership (e.g. the hereditable building right) is transferred to the investor and eventually after 20 to 30 years transferred back (reversion regulation). The investor is both building contractor and supplier of finance at the same time. Forfeiting certain payments to a credit institute is often part of this financing. Important model ingredients in addition to the operator and sales contract are waste management contracts between the operator and the district corporate body as well as personnel transfer and/or personnel supply contracts.
The operator model enables the municipal side to use a private company to fulfil municipal duties. However the (waste management) responsibility of the community remains unaffected by the operator contract, the community cannot evade its municipal duties. A genuine privatisation of the task is denied to the community; only the undertaking of the task is transferred (private company as agent for the process). This means on the one hand that if the operator drops out the municipal side has (again) to become active itself. With the municipal side remains the legal responsibility, the civil rights liability and the criminal responsibility. On the other hand contributions and charges are fixed by the district corporate body by regulations and paid by private households, companies and other users to the corporate body. These payments are used for (1) the payments according to the operator contract, (2) the administration and control of the operator model and (3) maintenance as well as depreciation of remaining infra structure areas (especially cable networks).
2. Operator models in the traffic sector
The German law for the private financing of trunk roads permits the collection of tolls from the users for constructions at bottlenecks such as underpasses, bridges, border crossings and mountain passes. Therefore German operator models are of pressing importance in the present time. The model for re-financing by collecting a user fee is especially suitable when on the one hand a significant distance and time advantage exists and on the other hand there is no user compulsion, because other alternative roads can be used free of charge. As far as by the usage/cost-valuation of the federal traffic plan a classification under "urgent requirement" is not made, a financing by federal funds within the next twenty years is not realistic. If from the local point of view this schedule does not correspond with the urgency of traffic relief, private financing will be required.
a. Crossing of the Warnow River
At the end of 1999 the construction works started for the 800 m long sub-tunnel in Rostock between the districts of Schmarl and Oldendorf. Main part of the four-line tube will be six 120 m long elements of water-resistant concrete, each of which weighs about 22 000 tons. The tunnel should have an access height of more than 4 meters. The concrete elements have to be immersed so deep into the bed of Warnow, that a water clearance of eleven meters is required for the safe passage of shipping. For this purpose about 1,2 cubic metres of soil have to be dug out. The construction phase will create 1300 jobs. In the operating phase a further 100 jobs will be created.
The town only provides 7 million Euros for financing the production costs of 213 million Euros. These funds are provided for cycle paths and noise prevention measures, which were introduced into the project after inception. A French project development company, which is behind the project team, provides a company capital of 47 million Euros. 140 million Euros will be financed by a private bank, a regional bank and by the KfW. The European Union has provided the remaining 19 million Euros for the Warnow-crossing as "a project of joint interest" in the framework of supporting the trans European network.
The 30 year concession contract between the Hanseatic town of Rostock and the project team assumes a capacity of 30 000 motor vehicles a day. This corresponds to about half of the traffic currently passing through the town centre. On the basis of an exit toll of 1,5 Euro per vehicle-unit (at the rates of 1995) this accumulates the necessary earnings per day of at least 80 000 Euros for the development, construction, financing and regular operating costs. The toll will only be collected for crossing the tunnel, not for using the access roads and junctions constructed in the framework of the overall project. The planned public local transport will be exempt from the toll. After the concession contract has expired the tunnel will be handed over to the town.
The opening is planned for March 2003. By scheduled completion the Warnow crossing would be the first realised German trunk road using the BOT-model.
b. Crossing of the Trave River
The construction of the Herrentunnel underneath the Trave at the Hanseatic town of Luebeck is understood by the term Trave crossing. The one kilometre long Herrentunnel ("herring tunnel") will replace the existing old bascule bridge, usable until the year 2003. The Federal Government had pledged 83 million Euros for the construction of a new movable bridge. Such a replacement seems to hold little attraction for the town, because of the frequent lifting extensive traffic delays would occur, which are not economically acceptable in this day and age. The plans suggest the construction of two about 9,60 meters strong cement tubes. Both will be able to take two lanes each. The overall stretch with approach ramps and toll lanes will be over two kilometres long. The construction is planned for 2001 and should last about four years.
Regarding the total costs of 164 million Euros the Federal Government takes over the costs for a new bascule bridge, the remainder will be privately financed. Two big German construction companies are behind the project consortium. The concession contract has a 30 years period of validity. The crossing charge will be between 0,50 and 0,60 Euros for passenger vehicles and between 5 and 6 Euros for heavy goods vehicles. The public local transport will be exempt from the tolls. Pedestrians and cyclists will be able to use busses free of charge. After the concession contract has expired the user rights for the tunnel will be handed over to the town.
When financing trunk road projects the question is regularly put as to whether traffic direction measures make sense and whether they are legal in order to increase toll earnings. According to current estimates the tailback costs on Germany’s motorways are 8 billion Euros per year. Currently the Federal Government invests 4,2 billion Euros annually into the construction of trunk roads. Finally it has been established that in Germany as anywhere else in the world an increased desire for mobility exists. To satisfy this desire can be a special motivating factor for project financing.
IV. Tasks for the advisor
The project consortium is the centre for complex contract arrangements at the basic structure of project financing. Similar to a cross-border-leasing arrangement a number of contract variants have to be taken into account. The planning phases (putting project ideas in a concrete form, project development and evaluation, project tender, issuing of offers and orders) have to be structured and include the involvement of credit institutes, law firms and engineer’s offices. Thereby types of foreign capital, periods of validity, repayment arrangements and financing costs have an indirect affect on the flexibility, security, availability and profitability of the project. By arranging share relations, degree of indebtedness, reverting and security rights as well as delivery and purchase obligations a risk structure is formed, which might vary from contract to contract and takes the German municipal interests more or less into account.
The main task of the sponsor’s financial advisor is to secure the advantageous distribution of chances and risks in regard to financial engineering. This applies equally to the risks of project construction as well as long-term purchase contracts. The following subdivisions can be found in German legal literature
- Construction risk, completion risk, concession and approval risk,
- Operational risk, supplier risk, market risk,
- Exchange rate, inflation, change in interest rates and re-financing risk,
- Abandon-risk (risk that the sponsor abandons the project) and
- Country risk, transfer risk, force-majeure risk, risk of legal acceptance.
The market creates the principles for a proper distribution of risks. But often they are also shaped by varied negotiating skills of the participants. The expert advisor will have to ensure that risks correspond not only with the relevant chances but also with knowledge of the subject at hand. Furthermore questions about insurability and other shifting opportunities play a decisive part. In the end however risk sharing means the taking over of project risk against a commercially appropriate remuneration payment.
It is in accordance with the normal German procedure to offer project financing as a finished bank product where the clauses of the contract are represented as the supposed market standard and the negotiation of single aspects is only accepted reluctantly. This is where the work of the financial advisor begins, who evens out information deficits of the sponsor and shows other arrangement options. It is the aim of the advice service to reach a transparent owner, capital and risk structure, which corresponds with the sponsor’s interests, and to counter the excessive security thinking on behalf of the banks. If such arrangements were possible, which are fair and tailored to the individual case, project financing in Germany will have excellent prospects for the future.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.