Project Finance Initiative (PFI) is the public policy newly introduced in 2000120. The main purpose of this policy is to utilize funds and management know-how from the private sector to construct, maintain, and operate a public facility. Pushed by the financial deficit of the public sectors, 203 PFI projects have been executed or publicly announced (Appendix O)121.
The project scheme of PFI is not new: BOT (Build, Operate, and Transfer) or BTO (Build, Transfer and Operate), mainly. However, it has strong characteristics as an installment payment of the facility construction price through rents or operational fees paid by the public sector, so the main PFI products are governmental offices, housing for public employees, schools, and so forth. In these projects, the leasing price paid by the government to the developer is predetermined at the time of bidding, and the operational risks levied on the developer are limited.
In order to participate in the bidding process, some companies make up a consortium. For example, a construction company and a facility management company build a team for a governmental office PFI project. In order to enjoy stable operation, the government requires the credibility of the consortium members and the responsibility to operate the project until the maturing date. Concretely speaking, the successful consortium members are required to establish a SPV controlled by Japanese law to operate the project and they are not allowed to leave the consortium during the operational period.
120
“Low on the Promotion of Public Facility Supply by Utilizing the Private Funds” in 1999 and related “Basic Policy” determined by the prime minister in 2000
121
Furthermore, the original consortium members normally must own the majority of the SPC shares. In short, not only the offering construction and management prices but also the company’s credit and the skill are important factors to be selected in a PFI project.
5.4.2 Advantages of Investing in PFI
The largest attractiveness of PFI is the security of the money source. Both the periodical income stream and the property transfer price, including the inflation adjustments, are normally predetermined in the contract. Additionally, the payer is government, so the default risk is almost zero.
Second, the operational structure is also secured. The construction and the operation companies which are included in the consortium have a high credit generally. This is one important criterion for the consortium to be selected.
Third, the expected Equity IRR is said to be around 5%, although the real figures are not publicly announced. Since inflation risks are generally levied on the government, this IRR represents the real term. This level of return would not be bad if the low cash flow risks, the visible exit, and the isolation from inflation risks are taken into consideration.
Lastly, the PFI equity investment is a niche market. First, there is a potential desire to sell some PFI shares among original companies. In general, all SPC shares in PFI projects are held by original consortium members, which have interests in the PFI projects other than as investors, including construction, facility management, and others, so the SPC shares are gradually accumulated in these companies. Because their main purpose for participating in a PFI project is the business related to the PFI operation, not the investment return, they do not want to lay away money as an unutilized capital until the end of the project. In order to entice the third party investors to acquire SPC shares up to the level acceptable for the government, namely 50% generally, the original consortium members may try to enhance the equity yield. Second, currently there is no third party investor who wants to invest in SPC
equity in a PFI project. Financial institutions prefer to finance for a PFI project as a lender because of the secured money source and the higher interest rate resulting from the non-recourse loan. Also for private funds, the PFI project period has too long a horizon to invest in. While their expected operational period is normally set three to five years, many PFI projects last more that 15 years. In short, both financial institutions and private funds, the equity investment in a PFI project is not suitable for their investment policy. Maybe, only German open-ended funds can invest in such a long-term investment product with a secured yield, because they sometimes hold a property more than 30 years.
5.4.3 Disadvantages of Investing in PFI
However, the investment in a PFI project by German open-ended funds has a great disadvantage, too. The problem is that the SPC normally uses very high LTV, sometimes over 90% of the property value thanks to the secured cash flows. On the other hand, one great attractiveness of the Japanese market is that German funds do not need to use the debt finance by using the hedge gains. However, this advantage does not work in PFI projects. For German funds, how to balance the LTV limitation (below 50% of the total property value) and the currency risk exposure limitation (below 30% of the total fund value) is a crucial point to manage an international fund. Thus, such a high LTV of the SPC in a PFI projects may break the subtle balance.