In this arrangement, a city and a vendor perform obligations that are analogous to those that are performed in a simple contracting model. The strategy that includes forfaiting and waiver of defence, as opposed to the model that only involves contracting, ensures the involvement of a bank. The bank is considered the central element, and it participates in the accomplishment of projects under stipulated agreements with the city municipality and contractors.
Under this model, the contractor is assigned the responsibilities of selling parts of the model’s future receivables to a bank in a forfaiting transaction. Under the transaction process, the city is required to pay a portion directly to the forfaiter or the bank and another portion fee is paid to the contractor.
The bank engages in the risks that arise from unforeseen outcomes related to the receivables and earns a margin. Under this model, the city may present an assurance to the bank, commonly termed as a ‘waiver of defence’. This pledged fee reduces the risk that banks would take and ensures a guarantee to cover even the most severe cases.
The contracting model that includes forfaiting and waiver of defence is then employed as a technique to raise cash while at the same time lowering the likelihood of hazards occurring to the financial institution. As a consequence of this, the interest rate is lowered to a level that is generally only accessible to local governments. The minimisation rate could seem to be quite low, but it might add up to a sizeable sum over the course of the project's lifespan.
Advantages: This model closely relates to the simple contracting model. This also implies that advantages are the similar. The main merit of this model is off-balance sheet (OBS) financing for the city. A further advantage is that the tendering process provides an opportunity to select specialised companies that have relevant know-how and experience and offer more attractive prices than those of the city or present operator. In addition, contracting with forfaiting and waiver of protection are seen as having a lower interest rate since they are deemed to be included in the cost for contracting.
Disadvantages: Even though the interest rate of this model tends to be lower than that of the simple contracting model, it is still much higher than the low-interest rates lending programmes such as government subsidiezed loans, such as, for example, KfW loans that are currently available in Germany at zero percent. Another disadvantage is that the model has a higher complexity as well as it has a larger city’s payment, namely the payment to the bank, which needs to be assured.
Projects that can be financed with this model: As far as project size is concerned, this model is similar to the simple contracting model. Owing to the higher complexity of the model, it might not be easy to find a bank financing projects below one million Euro.
References:
Novikova, A., Stelmakh, K., Hessling, M., Emmrich, J., and Stamo, I. 2017. Guideline on finding a suitable financing model for public lighting investment: Deliverable D.T2.3.3 Best practice guide. Report of the EU-funded project “INTERREG Central Europe CE452 Dynamic Light”, October 2017.
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