Kamil Jankielewicz and Tomasz Kawczyński of Allen & Overy A Pędzich in Poland speak with Sam Duke about their work on the Third Kraków Bypass and the state of the Polish projects market

How did the firm get involved on this project?

Kawczyński : There are three clients involved, one is the EIB, one is the Polish development bank BGK (Bank Gospodarstwa Krajowego) and the third is PFR (Polski Fundusz Rozwoju), a fund setup to support energy and infrastructure projects in Poland.

We were originally instructed by PFR, who in fact have been an existing client already, but they also saw us involved in other projects on the other side and they liked us and our credentials in the infrastructure and project finance areas, so they thought it would be a good match to do the deal together, especially as it involved a little bit of engineering amongst the lenders.

When did you work with PFR before?

Kawczyński: They instructed us on setting up some funds in Luxembourg but also on a separate deal where we worked across the table from them on a PPP project related to the University of Kraków (Jagiellonian University student dormitories PPP).

Can you tell me more about the scope and origins of PFR?

Kawczyński: It’s a governmental investment vehicle. It is focused on supporting Polish investments whether public or private. PFR changed its name a year or so ago, but still the original entity was also only set up two to four years ago, so it’s quite new. 

Jankielewicz: Originally PFR was a standalone institution funded by the state, so it was a direct lender and an investor in projects. Then they transformed it into a fund manager, so along with the change of the name, they changed the way they operate. So PFR now is a manager of funds. The scope of their activities is shaped by the new industrial policy of the current government. PFR is now the leading vehicle for any state owned engagement in the economy. Under the current government and ministry of development they try to focus all development activities through PFR, so it’s a sign of a change of philosophy.

This project is part of a wider scheme to reduce congestion in Kraków, can you give me a brief background to this and the different aspects of the project?

Jankielewicz: The City of Kraków is one of the oldest towns in Poland and has an increasing issue with pollution just due to the natural position of
the city, it is in a valley next to a river and the communications of the city are pretty outdated.

The city was a capital of Poland for centuries and is still concentrated around the medieval centre, which is of a great historical value.
Therefore the city really needs new transportation infrastructure to get the traffic out of the city centre and to somehow decrease the pollution in the city.

At the same it has budgetary constraints as it has had a public investment problem over the last two decades, so the city was really
looking for an alternative option to finance this outside of its own balance sheet.

What are the next stages of the project?

Jankielewicz: There is another part of the same ring road which is just a continuation of this one, this is the third ring of the City of Kraków, connecting the Southern part of the city. This will take the heavy traffic out of the city centre.

I’m not sure to what extent the tram extension will continue. Some areas like those covered by the project really require public transportation, there are a lot of new suburbs, but others are already pretty crowded.

The City of Kraków does not have a subway so trams are the main way of providing fast connections to the centre. The EIB’s part of the funding was guaranteed by European Fund for Strategic Investments (EFSI).

How effective do you think that has been when it comes to securing financing for projects like this?

Kawczyński: Well I think it is making things easier, we’ve not been involved in projects like this before but we believe that just from the number of communications we’ve received from the EIB it means they are more and more active in infrastructure investment and this sort of set up helped them facilitate the financing of those projects.

The Juncker plan is being implemented as we speak and many Polish infrastructure projects are being considered to be financed using this facility.

When commenting on the deal previously you mentioned that it could set a precedent for future infrastructure investments. What aspects in particularly are most likely to be replicated?

Kawczyński: There are two aspects. When we were originally instructed PFR had a plan to replicate this structure in other projects. The two aspects I have in mind are that this financing is based on the relatively robust public services contract between the City and the municipal companies, which is the project company here, and they are hoping that this might be replicated. When these three companies get comfortable with the content and the way the public services contract is drafted  the hope is that they will be able to tell the other municipalities and give them a precedent for use in other projects. 

The other thing is the way that the three institutions are linked together, they are lending on the basis of separate financial agreements. PFR is providing a subordinated loan, BGK is a senior lender and EIB is a senior lender as well, but because EIB doesn’t draw on any bank syndicate we had to deal with three separate legal instruments linked through an intercreditor arrangement, which is not particularly standard in the Polish market. We and the lenders are hoping to be able to replicate that structure as well.

This project is largely financed by development banks, do you see any differences in the way they run projects like this as opposed to commercial lenders?

Kawczyński: BGK has a mission as a development bank but to a large extend it still operates as a commercial lender and we see it joining syndicates alongside commercial banks and they operate as efficiently as the commercial banks.

The EIB has its own dynamic and they need various levels of internal approvals, and it takes time to get them on-board, but it is good
marketing for the project, they provide cheaper financing as well.

What was the biggest challenge you faced on this project?

Kawczyński: I would say that combining various interests and the various mental attitudes as well is the main challenge. We’ve been dealing with the City of Kraków, who are treating the project company as their own as if it was an inherent part of the municipality. The banks lending to the project were more inclined to protect the interest of their investment. That was the main area of discussion.

The Polish market, while pretty mature in terms of understanding the project finance and PPP aspects of deals still has some trouble understanding that some risk has to be taken by the municipality. This may prove problematic in terms of securing new projects under the PPP structure.

The municipality sees the company as its arm and doesn’t see the need to take any risks and they need to understand the need to take risks.

Let’s look at the market more broadly, in which sectors are you seeing the most energy and infrastructure activity?

Kawczyński: Well In projects generally the last year or two has been relatively passive. A large part of the energy sector is dominated by the state and following the change of the government there has been quite a shift in the policy and top management of those state owned energy companies.

We have been waiting to see some developments. Before the change in government the renewables market had been quite active, but the new government is not particularly keen, the new legislation around wind projects basically killed the industry. No new large scale wind farm developments are being seen at the moment and the auction scheme is being delayed. Generally in energy we do not see much project finance outside the renewables market.

In the electricity generation space you have the four major producers and they fund mainly on the group level by issuing bonds, this is the peculiarity of the Polish market. Loans used to be subject to public procurement rules, whereas bond were not. They were raising funds this way at the top company level, though this may now be ending as they invested in a lot of projects, including in the mining sector and now they may need to look for more project finance financing.

Currently the main energy policy of the government is securing energy independence which basically means a coal base, as it is theonly natural energy resource in Poland. This clashes with the policy of the EU and international banks who say they will not finance new coal fired projects. 

The other problem is that the electricity prices are pretty low on the market and its really tricky to secure the long term PPA which would secure the profitability of the projects. It is still unclear how it will evolve.

There is a new auction scheme for renewables, but there is a discussion with the European Commission over certain aspects of the scheme. There is no target for offshore wind generation so it remains to be seen whether offshore will happen at all and there is a question mark over the future of the nuclear industry. The minister has said there is a need for at least three new (nuclear) plants but this contradicts his stance from the last year, so we are in the situation where it is hard to say what the picture is.

Jankielewicz: In terms of broader infrastructure, a lot depends on EU financing. After the last round ended, projects are being assessed at the moment. So we might see the investment picking up, but it remains to be seen whether it is publicly funded with EU money or whether we will see more PPP type deals where the municipalities will decide to incorporate private financing.

Last year it was announced that 330km of new express roads would be built in Poland. When it comes to transport and logistics roads are a priority for the government.

Looking at the energy sector, as you mention, the Polish government has come into conflict with the EU about emissions and its focus on coal. Do you see it changing its stance any time and what does that mean for the renewables sector?

Kawczyński: The government is looking at hydro which is an important part of the future energy mix, but it is hard to say how serious that is. There is also more interest in biomass.

In regards to solar, the initial statement by the government was that it would be treated like wind energy, but the government was
convinced by the operators that solar might be needed to balance the grid during the summer. There is a fundamental change in the way
that Poland consumes electricity. Previously it was the winter where there was the greatest demand, now it is the summer due to air conditioning, so the energy authority realised that solar might be needed during the summer months to balance things out.

If there is one piece of legislation that affects energy or infrastructure projects that you could amend or scrap what would it be?

Kawczyński: There is a piece of legislation which makes some projects very complicated which is the Act on the control of certain investments.
This allows the government to put certain energy companies on a list where every change of ownership is subject to scrutiny of the government. This makes it problematic to start discussing a deal without involving the government and this might even have an effect on the securities structure, as banks might need to involve the government during deals. I don’t think it makes life easier.

Jankielewicz: The renewable legislation which has killed one whole sector of project financing is what I would change.

How about the legal market, have you seen any changes in regards to the types of firms involved on energy and infrastructure projects work?

Jankielewicz: It is a relatively small market and we haven’t seen any change. It’s the same.

What about the firm’s own practice, are there any plans for expansion or shifts of focus?

Kawczyński: It’s pretty much business as usual, we never believed in major takeovers and are probably one of the more stable firms in the market. We believe in organic growth we don’t see any areas where we need massive investment.

Tomasz your focus is in financing, how much time are you spending at the moment on project finance matters?

Kawczyński: There has never been enough project finance work to focus just on that. In recent months I believe that project finance has taken
about 30% of my time.

Kamil, you are perhaps best known for your energy sector experience. Had you had experience in the transport sector prior to this project?

Jankielewicz: In the last 12 months it was probably 60% M&A related to energy and 35% various project finance issues, including transportation and other public infrastructure.


Third Kraków Bypass

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