The South African Public-Private Partnerships as well as the Renewable Energy Independent Power Producer Procurement Programme  is still in its infancy with projects only recently being brought to operational phase. As a result the need for reliable Operations Phase Project Models are an essential tool for project owners and investors, project company managers, and debt providers; as stakeholders and financiers need to be regularly informed of the project status and be continuously assured of the financial health of their investment in the project.

Mazars Project Finance is one of the leading specialist project operations phase model audit firms internationally, with experience on more than 300 OPPM models. In our experience, the great majority of sophisticated financial close models cannot be used reliably as operational project forecasting tools. By “sophisticated”, we mean any model which the original sponsors and arranging banks deemed necessary to have audited prior to project financial close. By “reliable”, we mean a forecasting model which is capable of having its financial statements, banking covenants and other key outputs being generated by the progressive replacement of the original inputs and assumptions with actual performance, such that at each reporting or calculation date:

• The model can record the historical financial performance consistently with management account data up to that date;
• The integrity of model logic is preserved to allow accurate forecasting of future periods notwithstanding the updating of the historical inputs, and continues to apply inputs and assumptions consistently with the original or agreed calculation methodology

Why can’t financial close models be used as forecasting models?
Typically, sophisticated financial models cannot be updated simply by overwriting calculation cells with hard-coded inputs of historic values. Detailed consideration of individual row calculations would be necessary to ensure that forecasting logic was preserved.

In any model there are numerous other places where careful analysis would be needed to check the effect of any overwriting of model logic. In most cases, amendment to model logic is needed to ensure that any such overwriting does not interfere with future period calculations. As a result, the model swiftly diverges from the original financial close model, so that users have less and less confidence in the reliability of the model. This often manifests itself in being the sole modeller who alone knows how to update the model. From an operational risk perspective, such a position is generally unsustainable!

Additionally, financial close models typically include swathes of coding and analysis for project structuring purposes which are no longer relevant in the operational phase of a project. One example is debt sizing and repayment sculpting coding. At best this can be a distraction from the coding that is actually relevant, and at worst it cannot be deactivated and start to change fixed repayment profiles!

What is the best practice solution?
Building an OPPM necessarily involves converting core parts of the financial close model, and deleting logic which is redundant after financial close. However, this is only part of the task. Clarity of layout is vital for the user-friendliness of such a model, both for the modeller / inputter to prepare updates, and for management and funders to review its results.

When is the OPPM process initiated?
In a project with a construction period, a monitoring model is not required immediately, since funding drawdowns are controlled mainly by checks against the construction budget and technical reports to check that no funding shortfall or breach of longstop date might occur.

If the Project has been constructed on time and to budget, and there have been no change to technical or cost assumptions, then arguably the financial close model will still suffice as a forecasting tool – although it may no longer be accurate as to some economic data, e.g. CPI assumptions.

However, a proper OPPM certainly is needed before the first calculation date after completion as specified in the loan agreement:

In practice, experienced sponsors or banks will identify this need in advance of construction completion, and will have arranged for an OPPM to be developed in advance of it being needed, to allow for testing, refinement, and acceptance by all users (and less experienced sponsors will struggle on, using the financial close model for the first couple of years of operations before eventually procuring an OPPM).

Typically the OPPM will be independently reviewed to confirm its fitness for purpose.

Who is best placed to initiate the OPPM process?
Sophisticated sponsors and developers, especially those with portfolios of projects, will recognise that not only do they need an OPPM in order to comply with senior debt covenants, but also that they need it as a valuable management reporting and evaluation tool.
They will also liaise with the senior funders to ensure that the model is an agreed form – this is generally a loan agreement obligation. As part of this, almost invariably, the banks will require the model to be audited or independently reviewed to confirm its fitness for purpose.

However, at times even sophisticated sponsors will need a “nudge” from their banks to ensure the model is prepared in good time for use!

In certain cases, for example on smaller projects or with less sophisticated clients, banks themselves will procure OPPMs, and use them in one of two ways:

• As an “in-house” model: from financial updates provided by the project borrowers, the Bank’s portfolio monitoring team will update standardised forecasts using the same template for each borrower
• As a tool to provide to project borrowers, to have the borrowers populate forecasts and to return them to the bank

This approach can however lead to a degree of false accuracy. For example, the standard model might not accurately reflect the capital structure of the borrower, or its tax position, and so the model might not reflect the borrower’s true cash flow, tax liabilities or capitalisation. It also does not necessarily instil strong responsibility in borrowers for accurate reporting to their project lenders, and arguably causes banks to get too involved in the management of their clients.

Nevertheless, this approach may be valid in certain project sectors where project contract and finalising structures are relatively homogeneous – for example in smaller scale renewable IPPPP projects.