Project Finance, a mechanism to promote decent Human Settlements

- By Philip Webster
19th October 2018
Sandton, South Africa.
Relevant legal issues for the Department of Human Settlements to consider when proposing and/or drafting legislation which inter alia aims to facilitate the raising of finance and/or causing finance to be raised for public-private partnerships (see *1 below) or for private sector initiatives in the public sector in circumstances in which due to lack of available funding, none of the three spheres of government (i.e. national, provincial, local) are able or willing to fund and/or cause to be funded the human settlement project in question.

1/ The writer is of the view, that in the circumstance such as that described above, there is only one form of financial mechanism available. This form of finance is commonly referred to as ‘Project Finance’.

2/ ‘Project Finance’ is not a legal term of art. Project finance may be described as the provision of finance under agreed terms in which both the borrower and lender accept the security given to the lender by the borrower for the finance shall be limited to the assets and/or revenue arising from and/or attributable to the project in question. Consequently, the project sponsor, whether it be a person, incorporated entity or public entity does not leverage the balance sheet assets/revenue owned by the project sponsor (e.g. the personal and/or corporate balance sheet) for the purposes of providing security to the lender. The project sponsor will invariably set up what is commonly called a “special purpose vehicle” (‘SPV’) to own and perhaps manage the project in question and this SPV shall be treated separately from the personal and/or corporate balance sheet assets and/or revenue of the project sponsor. Thus assets and/or revenue attributable to the project being financed would invariably be ‘ring –fenced’ and treated separately (i.e.’ off-balance sheet’) from the other personal and/or corporate assets/revenue of the project sponsor. Only the SPV would provide security to the lender in respect of the finance granted under the relevant project finance transaction.

3/ Project Finance in its purest form is often referred to as “off-balance sheet” or “non-recourse project finance” and in its less pure form is sometimes referred to as “ limited recourse project finance”.

4/ Project finance in either of the forms referred to above is relevant for the financing of human settlements since it provides a means, at least in principle, to finance projects without necessarily relying on guarantees (in the legal sense) from any of the three spheres of government.

5/ When one considers that the 2017/2018 human settlements budget reduced funding for this sector by 10 billion ZAR (see speech of Minister Namaindiya Mfeketo : Re Human settlements Department Budget of 10th May 2018 in which the honourable ministers is reported as stating ”….As we present the budget you will observe that the Human Settlements budget has suffered a massive cut in the order of ten billion rand over the 2018/2019MTEF”) the need for funding mechanisms other than government grants , loans or equity investment is of paramount importance.

6/ However, stating the obvious is not sufficient. A solution should be proposed.

7/ The need for public- private sector and private sector investment in the public sector is stated explicitly and implicitly In the current draft white paper discussion document (hereinafter referred to as the “Draft White Paper”) issued by the Department of Human Settlements Department (‘DHS’). This is considered as a primary source of reference given that it is intended that on approval of the White Paper on Human Settlements and the Human Settlement Act, a notice for repealing the Housing Act 107 of 1997 in its entirety including the 1994 White Paper on Housing, shall be issued.

8/ Explicit examples are given. In paragraph 43.7.2 it is stated the DHS will actively promote ”private- public partnerships in the renovation and conversion of derelict buildings to residential and mixed uses”; in paragraph 41.5 is states “Public-private partnership Led rental initiatives shall be adopted” and in paragraph 41.6 the paper further states “Private Sector Led rental initiatives shall be adopted” and paragraph 56.1.5 is entitled “Utilise Public – Private Partnership” and refers to the need to attract investors and developers to produce more affordable housing stock by developing mechanisms and adopting various means to reduce the cost of one unit”; and paragraph 57 states “ mechanisms to ensure the availability of affordable housing finance for the gap market shall be developed” and notes that “ according to the Financial Sector Code the banking sector is expected to contribute at least R24bn through the provision of housing finance and that “this will require lenders to originate loans of approximately R60bn by 2020”.

9/ Implicit examples are given in that the need to ensure the availability of funding is frequently stated without limiting such funding to grants. Eg under paragraph 35.3 companies in mining towns may need to respond to housing requirement of workers as a condition of obtaining a mining permit ;under paragraph 97.2 entitled “Ensure the availability of funding and efficient expenditure” the DHS is expected to “mobilise funds”, as well as manage and administer funds for human settlement programmes etc.; and in paragraph 99.9 under the section entitled “The Role of Local Government/Municipalities “: municipalities are to “Ensure the availability of funding for various for various aspects of human settlements development”.

10/ Notwithstanding the above obligations to make available finance for the funding of human settlements, there are legislative constraints on the ability of the three spheres of government to borrow, lend and/or provide guarantees in respect thereof .

11/ Section 51 of the Municipal Finance Management Act No 56 of 2003 (MFMA) prohibits the national or provincial government from guaranteeing the debt of a municipality or entity except to the extent provided by Chapter 8 of the Public Finance Management Act No 1 of 1999 (PFMA).

12/ Chapter 8 of the PFMA lays out certain conditions in section 66 which provides for “Restrictions on borrowing, guarantees and other commitments” and Section 68 provides:
“Consequences of unauthorised transactions- if a person, otherwise than in accordance with section 66, lends money to an institution to which this Act applies or purports to issue on behalf of such an institution a guarantee, indemnity or security, or enters into any other transaction which purports to bind such an institution to any future financial commitment, the state and that institution is not bound by the lending contract or the guarantee, indemnity, security or other transaction”;
Section 70 outlines the terms upon which guarantees, indemnities and securities may be issued by a cabinet member.

13/ Most classical and typical funding arrangements involving the private sector will require or at least attempt to propose a lending arrangement under which there is a back-stop guarantee granted by one or other of the three spheres of government.

14/ This is fine, provided the relevant sphere of government is prepared to provide the guarantee and/or is able to under the above referred to provisions of the MFMA and PFMA.

15/ Unfortunately, the relevant conditions permitting a guarantee to be provided to the private sector lending institution are rarely satisfied.

16/ The writer is of the view that the mechanisms of non –recourse project finance and/or limited recourse project finance may provide, in certain circumstances, a mechanism, by which the DHS may provide a legislative basis for encouraging the private sector to more fully engage with the public-sector in projects in pursuance of the stated human settlement goals outlined in the draft white paper and in due course, once enacted, in the Human Settlement Act.

17/ A legislative framework ought to be introduce as part of the legislation which encourages the private sector to bid whether by why of public procurement or by way of unsolicited bids, provided the bid is deemed to made within a prescribed framework agreement as drawn up by the DHS.

18/ The prescribed DHS framework agreement would cover sectors within the area of “human settlements” as defined in the UN –Habitat definition(see* 2 below) ; provide for the embedded human rights referred to in sections 24 (environment’),25 (‘Property’),26 (‘access to Housing’), and 27 (‘access to health care, food, water and social security) of the South African Constitution (referred to in paragraph 6.6.6 of the Draft White Paper); and lenders/investors would be expected to provide funding on a project finance basis either without recourse to government guarantees from any of the three spheres of government (i.e. non-recourse project finance as far as the government is concerned) or in certain circumstances with recourse to only limited and capped recourse as may be prescribed (i.e. limited recourse project finance as far as the three spheres of government are concerned).

19/ Bidders of human settlement projects whether developers and/or investors (i.e. the “Project Sponsor”) would be expected to undertake and provide at the bidders cost a bankable feasibility study, subject to the above paragraph, which takes into account relevant law and legislation and meets national and international best practice norms for the successful execution of the project in question(s). Effectively the Project Sponsor would assume 100% or near that percentage of the risk of the human settlement project and would be expected to assume all and/or a substantial proportion of the costs of the human settlement project.

20/ Provided paragraphs 17/18/ and 19/ above and any other relevant conditions are satisfied the regulations might provide that the municipality in question and/ or other relevant sphere of government, would be obliged to accept a properly tendered bid (which may be unsolicited) unless the municipality and/or other relevant sphere of government in question is able to provide cogent and prescribed reasons within a prescribed period of time to the DHS as to why the bid ought not to be accepted. Such reasons might, inter alia, include the existence of an alternative bid better suited to the goals of Human Settlement under the terms of the Human Settlements Act (to be enacted).

21/ Section 113 of the MFMA deals in a perfunctory manner with unsolicited bids. The Housing Settlement Act could provide a means by which this section may be given greater weight by clearly defining the terms by which any such bid ought to be seriously considered with a view to encouraging the private sector to take upon itself the initiative to propose projects funded by way of project finance within a prescribed framework intended to encourage the establishment of sustainable and financially feasible projects which will contribute to human settlements as provided for under the Human Settlements Act.

22/ Project finance, if correctly structured requires the Project Sponsor to recover a satisfactory return on investment from the revenue streams of the project in question without reliance on guarantees other than contractual undertaking of end users offtakes of the project in question. Of course, in deprived areas ensuring a project is bankable may represent a challenge but the legislative basis for enabling the private sector to undertake this challenge and assume the risk in a financially sustainable manner should be available. Indeed, it may even be provided that for certain types of projects permitted in high return wealthy areas a corresponding value human settlement project must also be undertaken and/or caused to be undertaken by the same Project Sponsor or affiliate thereof in rural areas GAP income areas which under normal circumstances have difficulty attracting funding from the established banking sector.
23/ Such a non-recourse and/or limited recourse project finance funding initiative, promoted by the DHS might reasonably be pursued in collaboration with the recently launched Human Settlements Development Bank which has and/or will integrate the functions of the national Urban Reconstruction Housing Agency and the Rural Housing Loan Fund. Any prescribed framework for investment by the private sector would necessarily be obliged to take into account relevant legislative provisions underpinning the establishment of this bank. One could imagine a scenario under which any private sector initiative might require the entity in question to enter into a prescribed form of Joint venture with the bank and thereby form a special purpose vehicle (SPV) to undertake the proposed human settlement project in question with funding for the SPV being provided by the private sector on a non-recourse and/or limited recourse project finance basis.

24/ In addition proposed funding proposals should also take into account the provisions of The Housing Development Agency Act No 23 of 2008, unless the operations of this entity are to be in future pursued by the Human Settlements Development Bank.

25/ The writer is of the view that it is perfectly feasibly for the above proposals concerning project finance to be put into practice in respect of human settlement projects provided the Project Sponsor is also obliged to incorporate in any business plan the needs of poorer sections of the community.

26/ The writer was responsible for the drafting of documentation for projects of such a type. An example of such a project is the provision of water to inhabitants in Nelspruit. This project finance based public-private partnership with a UK group Bi-water is still going strong 15 years after its inauguration. In Nelspruit the more well off citizens subsides an agreed amount of free water for les well off citizens of the area.

27/ The writer was also responsible for the drafting of another similar project , again about 15 years ago in which the Project Sponsor , a subsidiary of the French group Vivendi, provided for the treatment of waste water such that it could be used for industrial purposes and thereby leaving more drinkable water available for the citizens of Durban .

28/ Both successful projects highlighted above may be analysed for the purposes of providing for framework legislation permitting private sector involvement in projects required for the establishment and / or refurbishment of housing, water, transport electricity, digital services and general social services required for decent human settlement.

29/ The writer has also been responsible for drafting lease and leaseback schemes involving local government and which enable funding to be raised for housing projects in low income areas, without the need for government guarantees or other forms of financial assistance.

30/ Of course, lease and leaseback funding arrangements require established and precise rules of legal land tenure .Thus legislation dealing with the issue of land title will require to be introduced in those area where registered title and/or proof of title against which funding transactions may be structured have yet to be established.

1* Public- Private Partnership (‘PPP’). May be described as follows:
A PPP is an agreement, which notwithstanding the reference to ‘partnership’ is not a legal partnership, between a public sector institution of the state and/or a state owned entity with a private sector entity or unincorporated body of person under which all the financial, technical and operational risk of a project (the “Risk”) ;or a substantial part of the Risk is transferred to the private sector via an incorporated Special Purpose Vehicle established for the project in question.
2* The Draft White Paper notes that in the UN ‘Habitat’ definition, Human Settlements are defined as “ the totality of human community-whether a city, town or a village- with all social, material, organisational, spiritual and cultural elements that sustain it. This means human settlements must be well-managed entities in which economic growth and social development are in balance with the carrying capacity of the natural systems on which they depend on their existence and result in sustainable development, wealth creation, poverty alleviation and equity.”

The writer would argue that this definition together with sections 24,25,26 and 27 of the South African Constitution include by implication digital networks (i.e. internet and telecommunications) given the importance of the digital and virtual communication networks in the modern age in the areas inter alia of healthcare, social organisation and communication etc.