In 2006 the government of New South Wales procured a $3.6 billion rolling stock PPP to build and maintain new trains for metropolitan Sydney—the largest PPP in Australia at the time. Shortly after signing, the Reliance Rail PPP won CFO Magazine’s Structured Finance Transaction of the Year award. But it didn’t take long for things to start going wrong.

What went wrong

Initially problems arose with the design and manufacture of the trains. In particular, during the design development stage, the independent certifier was not certifying the contractor’s completion of tasks. As a result, by 2011, the first trains were being delivered over a year late. This resulted in large losses for Reliance Rail and the contractors.

In addition, the global financial crisis had a significant impact on Reliance Rail’s financing, especially given the project’s high leverage. The insurers were wiped out, which affected the project’s credit rating; by 2012 the debt had non-investment, or junk, status.

The global financial crisis also led to a rapid increase in bank loan margins. As a result, financing Reliance Rail’s drawdown facility—established pre-crisis with low margins—would have meant the banks would have lost money. The banks saw an opportunity to withdraw the facility in what they considered to be Reliance Rail’s insolvency, on the basis that it wouldn’t be able to repay or refinance its debt when it became due in 2018. This would deter the directors of Reliance Rail from drawing down the debt as they could be held personally liable for any debts incurred while the company was insolvent. Instead, the banks wanted the government to guarantee the $357 million senior debt or take over financing the debt itself.


The solution

The New South Wales Treasury was concerned that this risk around the bank debt funding could unravel the whole PPP structure, forcing state government to take the $357 million in bank debt onto its balance sheet. At the same time, Treasury understood that if this risk could be dealt with, the trains would be operational by 2018 and Reliance Rail would have regular cash flows from which to service its debt when it actually became due.

Treasury’s task was to find a solution while maintaining the risk allocation and structure of the PPP—and holding Reliance Rail accountable for delivering, operating, and maintaining the trains.
Instead of conceding to the banks and providing a guarantee, the New South Wales Government provided deferred equity of $175 million over six years (due in 2018), conditional, among other things, on the delivery of the rest of the trains. This plan was designed to ensure there would be enough equity to refinance the debt in 2018, so that Reliance Rail’s solvency could not be in dispute and Reliance Rail could draw down the $357 million of senior debt without delay. In return for the deferred equity, the government obtained a call option to acquire the entire equity of the consortium for a nominal sum.

This solution maintained the structure of the PPP and forced Reliance Rail to address its management and manufacturing issues. Following the deferred equity arrangement, many of the practical problems with manufacturing the trains were resolved, and delivery rates began to improve. The final trains were delivered in 2014. As a result, the project will be able to generate a reliable payment stream going forward, from which it can service its debt and deliver double-digit returns. This means the government should have no difficulty in selling its deferred equity in Reliance Rail in 2018, potentially at a profit, without ever having to provide the $175 million.



1. Financial trouble does not have to result in collapse

While in the thick of dealing with the looming disaster of an insolvent PPP, it can be hard to envision any situation where the PPP doesn’t collapse. Indeed, at the peak of Reliance Rail’s financial trouble, the media predicted the complete collapse of the project, a massive bailout by taxpayers, and delays in delivery of the trains of at least five years. Fortunately, the government heeded the Treasury’s advice to look for solutions that held the PPP together.

In the end, by addressing the cause of the problem itself—the lack of confidence in Reliance Rail’s ability to refinance its debt in 2018—instead of bailing out the entire PPP, the government managed to salvage the project. In doing so, it enforced the original financing terms and ended up potentially making a profit.

2. Financing should follow rather than lead

With hindsight, it is easy to see that many pre-global financial crisis PPPs—including Reliance Rail—were overly focused on financial engineering, particularly through the use of monoline insurers. This was because PPPs were primarily seen from the perspective of harnessing private finance, rather than from the perspective of getting the incentives right.The Reliance Rail experience shows that financing should follow rather than lead when structuring a PPP. Establishing the right incentives and the right risk allocation should be of primary importance. In practice, this means that PPP contractual structures should require just enough equity commitment and debt risk to ensure that the private sector operator is fully incentivized, and a debt structure that spreads the cost over the life of the asset in line with utilization.

With this mindset it is clear that PPP financing does not have to be all private. Indeed, the Treasury’s solution substituted public finance for private finance without any change to the private sector’s incentives or the risk allocation of the Reliance Rail PPP. Overall, if cleverly structured, public intervention does not have to result in any loss in the benefits of the PPP structure.

Of course the experience of the New South Wales Treasury was not unique, and other governments have come to similar conclusions about public sector contributions to PPP finance. For example, the UK government has announced its intention to act as a minority equity holder in future PPPs, and to encourage the use of a wider range of long-term debt financing sources for PPPs, including public and private bonds.

The government of the Australian state of Victoria is considering taking similar steps to improve PPP financing. These include allowing government capital contributions where there are liquidity constraints or where there are opportunities to reduce project costs, and giving the government a preemptive right to purchase debt if sold in the secondary markets, together with a right to replace a financier in defined circumstances.

The author was NSW Treasury Deputy Secretary (Head: Office of Infrastructure Management) when the transaction was first negotiated and financial close reached, and Treasury Secretary when it became obvious that there was a looming risk around the refinancing due in 2018. While Treasury pre-emptively developed various options at this time, the final solution was only developed after the author had left the Treasury in March 2011.