Value for Capital: Concepts for Loan Guarantees in Financial PPP Transactions

Abstract

Loan guarantees are a powerful economic tool for highly rated governments, but they also pose significant potential downside risk and cost to taxpayers. Excessive or misdirected loan guarantees can leave taxpayers either on the hook for projects with little economic value or simply paying for windfall profits. Can these risks be avoided in a systematic manner? This article outlines a two-part approach for controlling and assessing government guarantees for senior project finance loans. The first part is designed to mitigate the risks of politicization and poor credit judgment by limiting guarantees to projects that can also raise senior debt from qualified private-sector lenders to form a “financial public–private partnership” or financial PPP. But financial PPP will not ensure that the public sector is receiving sufficient value for the cost of its capital investment. For that, a separate analysis is required in a framework that is analogous to the well-known “Value for Money” tests for PPP transactions. The second part of the approach is focused on developing the framework for such a “Value for Capital” analysis. The Value for Capital framework includes components that are important for both policy objectives and economic efficiency, such as “additionality,” project output, possible externalities and multiplier effects, and the effect of the proposed guarantee on national debt capacity. Most generally, the article makes the case that a Value for Capital framework should also seek to connect to public discussion and debate wherever possible.

TOPICS: Legal and regulatory issues for structured finance, information providers/credit ratings