Malaysian IPP goes international
The Tanjung Bin Energy transaction was the first IPP financing in Asia to close in 2012 and is a project notable for a number of innovative features. By Lindayani Tajudin and Naufal Barakbah of Malakoff Corporation Bhd; and Audra Low, Marat Zapparov and Mark Ee of Hongkong and Shanghai Banking Corporation Ltd.
THIS ARTICLE WAS FIRST PUBLISHED IN PFI ISSUE 486
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Earlier this year, Malakoff Corporation Bhd (Malakoff) and a group of Malaysian and international financing institutions inked the documentation for the financing of Tanjung Bin Energy Sdn Bhd (TBE), a 1,000MW supercritical coal-fired power plant in Johor, Malaysia.
The project represents the first time competitive bidding has been used in Malaysia to procure power generation capacity, the first time international banks have participated in financing an IPP in Malaysia and consequently, the first time a US dollar-denominated project finance term loan was utilised alongside a Malaysian ringgit-denominated Islamic project bond (sukuk) issue – the traditional instrument used for greenfield infrastructure financing in Malaysia. The financing was also the first and largest limited recourse project financing sukuk issue closed during 2012 at the time of writing.
An innovative multi-tranche funding plan comprising three senior debt tranches and a junior equity bridge tranche was structured and successfully executed by Malakoff’s financing team together with financial adviser HSBC, resulting in the lowest all-in cost of finance and a highly competitive electricity tariff for Tenaga Nasional Bhd (TNB), the power offtaker for the project.
The competitive tender organised by the Energy Commission of Malaysia (EC) for this project had placed significant pressure on bidders to drive down the electricity tariff, thus requiring creativity on behalf of sponsors in developing a winning proposal. As the EC moves towards competitive bidding as the preferred route to procure all large-scale generation capacity in the country, the authors believe the innovations developed for the TBE transaction will continue to be adopted in future IPP financings in Malaysia.
The TBE financing represents an evolution in the Malaysian market and sets a number of new precedents for project financings, not only in Malaysia but for the broader Asean IPP financing market. This article shares some of the unique aspects of this deal.
One of the key trends emerging in the recent years in the power sector in Asia is the increasing competition among all participants in the industry. As a leading utility in South East Asia and the Middle East, Malakoff has remained at the forefront of evolution of the market.
Incorporated in 1975 and headquartered in Kuala Lumpur, Malaysia, Malakoff is the leading independent power producer domestically, with a 25% share of the generation market in Peninsular Malaysia and a portfolio of generation assets of 5,020MW effective capacity.
Internationally, Malakoff’s interests comprise equity holdings in power and water desalination projects in Saudi Arabia, Bahrain, Jordan and Algeria. Malakoff is an experienced player in the project finance markets, having raised financing for all greenfield projects in the portfolio under non-recourse structures sourced from capital markets, commercial banks, export credit agencies (ECAs) and multilateral institutions. Project financing transactions closed by the company have consistently received awards from recognised industry bodies, including publications such as PFI Magazine.
On November 15 2010, the EC issued a request for proposals (RFP) for the design, supply, construction, commissioning, operation and maintenance of a 1,000MW coal-fired power plant, for commercial operation to commence on March 1 2016. The project was designed to serve the increasing demand for power projected under the 10th Malaysia Plan – a strategic initiative of the government charting the development of Malaysia for 2011–2015 and setting out the priorities in the key areas of economic and social development.
The IPP sector has a long and successful history in Malaysia, with the first privately owned power generation assets commencing supply of electricity to the grid in 1993 and 1994 pursuant to long-term power purchase agreements (PPAs) with TNB, the country’s national electricity utility. Traditionally, the Malaysian energy sector regulator has preferred to maintain power generation reserve margins at comfortable levels of 40% and above to ensure grid system stability and supply reliability, a key condition for sustainable economic growth.
As the second decade of the new millennium dawned, Malaysia was facing looming capacity constraints, with first generation PPAs nearing expiry and a number of large-scale economic growth initiatives under the 10th Malaysia Plan requiring additional generation capacity. Without additional supply capacity in the grid, the reserve margin in Peninsular Malaysia was forecast to drop to 11% by some estimates. As such, fundamental supply and demand dynamics in the country necessitated significant additions of base load power supply. Coal-fired power was the EC’s technology of choice to address the power supply constraint, reflecting the government’s strategic intention to diversify the power generation mix in Peninsular Malaysia away from gas fuel.
Competitive bidding was chosen as the preferred process to procure the additional capacity, as a proven method to deliver the lowest level of electricity tariff to the offtaker and, ultimately, the end-consumers of electricity. The process was rigorous and would be familiar to those involved in competitive tenders internationally. Tender participants were provided with an RFP containing commercial and technical parameters for the bid along with a PPA and a coal supply and transportation agreement (CSTA).
Two clarification rounds were held by the EC to respond to queries on the documentation and issue amendments to the PPA and CSTA prior to bid submission date. Bidders were required to submit proposals in two parts: (i) a technical proposal and (ii) a commercial proposal. The evaluation of the commercial proposal focused on the levellised tariff proposed, the deliverability of the financing plan and the materiality of deviations to the PPA and CSTA proposed by the bidder.
Pre-bid sounding of the bank market generated strong interest for the project from Malaysian and international banks. As well as the customary interest from local lenders, international banks were keen on the opportunity to participate in a pathfinder project in Malaysia supporting a leading sponsor in its home jurisdiction. International lenders were brought into the structure to seize on the arbitrage opportunity offered by the US dollar-Malaysian ringgit basis swap market and the tenor advantage of US dollar-denominated commercial bank debt contributing to lower all-in financing costs for the project. Letters of support were obtained from financing institutions to ensure confidence in the deliverability of the financing plan.
After an intensive bid preparation period, the tender package was submitted on April 15 2011. On June 13 2011, the Malakoff special purpose vehicle was announced as the winning bidder and accepted the conditional offer made by the EC to implement the project.
The location chosen for the project was Mukim Serkat, Pontian, in the south-western region of the state of Johor, Malaysia. The site is adjacent to Malakoff’s existing Tanjung Bin Power Sdn Bhd 2,100MW coal-fired power plant (TBP), meaning the project has some characteristics of a brownfield asset from a construction risk perspective. The project also benefits from being able to share a number of common facilities with the existing plant as well as proven and tested coal supply, power evacuation facilities and access routes.
The project contractual structure has been developed around the well-tested Malaysian PPA framework: a take-or-pay PPA with a tenor of 25 years from commercial operations date (COD) with TNB; a 25-year CSTA with TNB Fuel Services Bhd, a wholly-owned subsidiary of TNB acting as the nominated fuel supplier to coal-fired power plants in Peninsular Malaysia; an IPP licence with the EC and other customary contractual agreements.
From the perspective of international financiers, the lack of a government guarantee for the offtaker’s obligations under the PPA (as would be expected in Indonesia or Vietnam, for example) was no obstacle due to TNB’s strong creditworthiness reflected in its BBB+ S&P credit rating. Neither was ECA cover needed to bring the international banks into the deal, reflecting the international financing community’s confidence in the fundamental strength of Malaysia’s economy and Malakoff’s exemplary track record in executing such projects on time and on budget and achieving commendable operating targets during the operational period.
The PPA contains customary provisions for a project financing of this nature, including delay LDs, performance bonds, force majeure, events of default, termination and lenders’ step-in rights. The tariff is fully availability-based with no element of demand risk – a positive departure from some of the previous generation PPAs.
Nevertheless, while local lenders were intimately familiar and highly comfortable with the Malaysian PPA, international banks have not been exposed to the document and hence subjected the contractual arrangements to a higher level of scrutiny. No relief for political force majeure events was accepted as banks expressed confidence in the strength and stability of Malaysia’s economy and political system. The risks around the construction cost-saving sharing mechanism in the PPA were mitigated with structuring features. The presence of a junior equity bridge tranche also necessitated structuring to protect the full termination payments upon events of default.
The EPC contract was negotiated through to the autumn of 2011 and provides for a fixed-price, date-certain turnkey arrangement, including customary provisions for performance guarantees, warranty and latent defect periods, LDs, rejection limits and others. The EPC consortium is led by Alstom Power, with certain works carried out by other members of the consortium. Parent company guarantees provide comfort over the creditworthiness of the contracting counterparties.
The operations and maintenance of the plant is to be carried out by a wholly-owned Malakoff subsidiary and the largest privately owned O&M service provider in Malaysia, Teknik Janakuasa Sdn Bhd (TJSB), pursuant to a fixed fee arrangement and a robust performance incentive regime. A shared facilities agreement (SFA) set out the terms and conditions under which common infrastructure was to be shared between the existing TBP plant and the project. The contractual structure allowed Malakoff to raise senior debt for the project on a fully non-recourse basis.
The financing solicitation process was not without customary periods of turmoil. As the tender process moved beyond preferred bidder selection and banks were again approached for refreshed financing commitments, the relatively benign market backdrop turned increasingly uncertain.
Liquidity from international banks was being curtailed as the European sovereign debt crisis gathered momentum and as a result some institutions were no longer part of the bank group for the project. Nevertheless, a financing strategy with built-in back-up options, together with the project’s compelling fundamentals, resulted in strong interest from a range of local and international banks, with sufficient commitments to underwrite the full debt requirement.
The development of the final financing package was iterative, as market conditions evolved and the structure was tuned to maintain the most competitive all-in cost of financing for the project. The final financing mix contained a number of innovations, including: the presence of refinancing risk (with structural mitigants) stretching the effective tenor of the debt beyond the stated final maturity; junior equity bridge loans structured as effective equity; a combined US dollar loan, Malaysian ringgit loan and Malaysian ringgit sukuk senior debt package with varying tenors contributing to the lowest all-in cost of financing. All senior debt providers share security on a pari passu basis, while the junior equity bridge tranche enjoys no recourse to the project and as such is an equity instrument.
The interest rate and currency exposures under the various loan tranches have been largely hedged by way of cross-currency or interest rate swaps of equivalent tenors. Notably, the 15-year US dollar-Malaysian ringgit cross-currency swap establishes a new benchmark in the market as one of the longest dated transactions for this currency pair, marking the first time that international banks have had the opportunity to participate in such transactions since obtaining their Malaysian onshore banking licences. Through close monitoring of the market and careful co-ordination with the swap counterparties, Malakoff and HSBC as hedge co-ordinator, were able to secure an attractive rate well within initial estimates, thus preserving the rate arbitrage that was envisaged when the financing plan was originally conceived.
The debt package was documented using a Malaysian law Common Terms Agreement, individual facility agreements (Malaysian law for the ringgit loans and English law for US dollar loans), subordination deed, various call and put option agreements to balance the interests of the sponsor and the creditors and other ancillary documentation. An intercreditor deed set out the voting and other arrangements among a diverse group of creditors. On the environmental and social side, the project was developed to comply with Malaysian and IFC standards and guidelines, ensuring the requirements under Equator Principles are consistently met.
The sukuk issue was implemented as a sukuk murabahah (commodity murabahah) – a structure that is tested and well-understood by the Malaysian Securities Commission and the local investor base, chosen in order to facilitate a smooth and timely approval and execution process.
Notwithstanding a number of innovative features not previously seen in the Malaysian market, the Sukuk Murabahah was awarded an AA3 rating by Malaysian rating agency RAM, reflecting the project’s strong credit profile, robust mitigants to residual risks in the structure and the exceptional track record and execution capability of the sponsor. The structure set a new benchmark for AA3-rated Malaysian project bonds, paving the way for future non-vanilla financings in the Malaysian market, as increased competition in the IPP sector necessitates the use of non-standard solutions. The transaction was successfully executed through an accelerated two-hour bookbuilding process and attracted over M$16.9bn in bids from a wide group of investors to arrive at an oversubscription rate of more than five times the issue size.
The financing documents were signed on February 29 2012 following an intensive due diligence and documentation period. The final TBE debt financing package amounted to M$6.5bn (US$2.1bn equivalent) sourced from a mixture of local and international banks, and the ringgit bond markets and was split among the following facilities (see Table 2)
Conclusion and outlook
The TBE transaction was a large and complex debt-raising exercise from 10 international and Malaysian financing institutions and a diverse sukuk investor base, with the financing mix designed to provide the project with the lowest all-in cost of finance and thus translate into the lowest possible levellised tariff for the offtaker. The project is strategic for Malaysia, as the country implements a large-scale economic and social development strategy under the 10th Malaysia Plan.
It will underpin the country’s development by providing a stable, reliable and environmentally sound source of base-load power to the grid. The project was procured and closed under a timeframe of little over 16 months from the solicitation RFP, showcasing Malaysia’s ability to bring projects to market fast and achieve financial close without undue procedural delays.
This transaction is ground-breaking in many ways: the pathfinder project for international bank financing of Malaysian IPPs, an evolutionary structure for the Malaysian greenfield bond market, and a precedent for successful competitive tenders in the country delivering a highly competitive electricity tariff to the offtaker.
The successful financial close of the project serves to strengthen Malakoff’s position as the leading independent power producer in Malaysia and within the Asean region, as Malakoff continues to actively capitalise on greenfield and brownfield opportunities globally. Both Malakoff and HSBC look forward to participating in the plethora of upcoming opportunities in the power sector locally and internationally and bringing the structuring and execution know-how developed on this and other transactions to future projects.