PUBLIC-PRIVATE PARTNERSHIPS: IN PURSUIT OF RISK SHARING AND VALUE FOR MONEY

Philippe Burger University of the Free State OECD Workshop Amman – April 2008

Overview



Session 1

: General overview of PPPs, definition and rationale, affordability and risk. 

Session 2

: Value for money and the need for competition. 

Session 3

: Institutional and accounting aspects: PPPs units and the main regulatory and accounting issues.

Session 1

: General overview of PPPs, definition and rationale, affordability and risk

3.

4.

5.

1.

2.

Overview of the day Trend towards PPPs and the rationale for PPPs Definition Affordability Risk

Session 2

: Value for money and the need for competition

6.

7.

8.

9.

Competition and Value for Money PPPs and the nature of the service The Public Sector Comparator (PSC) PPPs and the measurement of performance

Session 3

: Institutional and accounting aspects: PPPs units and the main regulatory and accounting issues

10.

PPPs, budgets and government accounting 11.

Institutional setup and issues: PPP units and legislation 12.

Transparency and accountability

2. The trend towards PPPs and the rationale for PPPs

 Really took off during the last two decades.

 Majority of the projects in OECD countries:  Transportation infrastructure: airports, railroads, roads, bridges and tunnels.  Other projects: waste and water management, educational and hospital facilities, care for the elderly, and prisons.

 European Investment Bank (2004) reports that transportation is the most prominent sector (followed by schools and hospitals).

 Regional breakdown shows that road and rail projects dominate in all continents except Middle East and North Africa, where water projects dominate (AECOM 2005).

    AECOM (2005): between 1985-2004, globally public-private financing in 2096 projects = nearly $887 billion. Of this total, $325 billion went to 656 transportation projects. Of the 2096 projects 1121 projects were completed by 2004. Total value of 1121 projects = $451 billion.

PPPs will not largely replace public procurement. In UK PFI deals constitute a mere 12-15% of total annual public investment expenditure.

Table 2.2. The capital value of United Kingdom PFI deals up to April 2007 (GBP million)

Health Defence Education Others Total Transportation Scotland, Wales and Northern Ireland Source: HM Treasury, 2007. Including London Underground projects Total capital value % of total 8 290 22 496 5 644 4 388 7 203 5 380 16 42 11 8 13 10 Excluding London Underground projects Total capital value % of total 8 290 4 902 5 644 4 388 7 203 5 380 23 14 16 12 20 15 53 404 100 35 807 100

Table 2.1. Top ten countries with the largest PPP/PFI project finance deals, 2003 and 2004

Rank 2004 Country Value USD millions 13 212 Deals % share Rank 2003 1 2 3 4 5 United Kingdom Korea Australia Spain United States 9 745 4 648 2 597 2 202 81 9 9 7 3 32.6 1 24.1 3 11.5 7 6.4 2 5.4 4 6 7 8 9 Hungary Japan Italy Portugal 1 521 1 473 1 269 1 095 2 15 2 2 3.8 11 3.6 10 3.1 5 2.7 n.a. 10 Canada 746 3 1.8 n.a. Source: Dealogic, quoted in OECD, 2006a:57. Value USD millions 14 694 Deals % share 59 56.7 3 010 611 3 275 927 251 274 714 n.a. n.a. 3 4 8 2 1 5 3 n.a. n.a. 11.6 2.4 12.6 3.6 1.0 1.1 2.8 n.a. n.a.

 UK: substantial number of road and bridge projects, as well as light railways.

 South Korea: Recently accelerated PPP/PFI. Followed similar path to other OECD countries, starting with transportation infrastructure projects.  Spain: Focus very much on transportation. Private sector key element in 2005-2020 transportation plan of government.

 €248 billion over the fifteen year period, of which the private sector is said to contribute approximately 20%

    France:   A 62-year contract with ALIS in 2001 to design, build, finance and operate a 125km motorway in the Northwest of France (total cost: €900 million). Motorway opened in October 2005. Other French projects include part of TGV Rhine-Rhone line.

Greece: Airport projects.

Portugal: Vasco da Gama bridge and toll roads.

Other OECD countries with large transportation projects: Ireland and Italy.

     What is the rationale for having PPPs? Pursuit of higher levels of Value for Money (VFM).

 VFM represents an optimal combination of quality, features and price, calculated over the whole of the project’s life.

Tapping into the perceived higher levels of efficiency of the private sector.

 Private sector skills and capability.

Government keeps control over output quality and quantity.

Access to private finance.

 To some large extent a fallacious argument.

3. Defining PPPs

 What are PPPs?

 How do PPPs differ from traditional procurement?

 How do PPPs differ from privatization?

 What is the difference between PPPs and concessions?

  Lack of definitional clarity.

Grimsey and Lewis (2005:346), “…fill a space between traditionally procured government projects and full privatization”  Need to distinguish them clearly from traditional procurement and privatisation, but also from concessions.



IMF

: PPPs refer to arrangements where the private sector supplies infrastructure assets and services that traditionally have been provided by the government.



European Investment Bank

: PPPs are relationships formed between the private sector and public bodies often with the aim of introducing private sector resources and/or expertise in order to help provide and deliver public sector assets and services.

 

European Commission

a service.

: PPPs refer to forms of co operation between public authorities and the world of business which aim to ensure the funding, construction, renovation, management and maintenance of an infrastructure of the provision of

Standard and Poor’s

policy outcomes.

: Any medium- to long-term relationship between the public and private sectors, involving the sharing of risks and rewards of multi sector skills, expertise and finance to deliver desired

 Distinct from traditional procurement:

role of risk.

 Distinct from privatisation:

define what is a partner.

 Distinct from concessions:

demand risk and source of revenue.



OECD:

  

PPP

is an agreement between the

government

and one or more

private partners

(which may include the operators and the financers) according to which the

private partners

deliver the

service

in such a manner that the

service delivery objectives

of the government are aligned with the

profit objectives

of the private partners and where the depends on a

effectiveness

of the alignment

sufficient transfer of risk

private partners.

to the

    The private partners usually or directly to the end users.

design, build, finance, operate and manage

the capital asset, and then deliver the service either to government The private partners will receive as reward a

stream of payments from government,

or

user charges

levied directly on the end users, or both (Concessions vs PPPs).

Government specifies the

quality

and

quantity

of the service it requires from the private partners. There is a

sufficient transfer of risk

to the private partners to ensure that they

operate efficiently

.

Figure 1.1. The spectrum of combinations of public and private participation, classified according to risk and mode of delivery

4. Affordability

 Do PPPs create more space in the budget?

  Affordability in principle terms.

Affordability in practical terms.

 Affordability and VFM: Relative vs. absolute affordability.

 Efficiency and the cost of capital.

 Affordability, limited budget allocations, legally imposed budgetary limits and fiscal rules.

4.1 Affordability in principle terms

   

Affordability

viability. and

VFM

are the benchmarks for PPP Affordability and VFM determines whether the PPP route is the best alternative. Because of the off-balance sheet nature of PPPs, their use has led to some misconceptions regarding their impact on the affordability of projects.

Confusion stems from the impression that because government not responsible for the acquisition of the asset, that PPPs are cheaper than traditional procurement –

this is a fallacy

.

 Though PPPs may enable some projects to become affordable, this does not stem from their off-balance sheet nature. 

The point is:

Affordability not only relates to PPPs, but to government expenditure items in general.



In principle

affordability is about whether or not a project falls within the

long-term (intertemporal) budget constraint

of government.  If it does not, then the project is unaffordable.  However, because the cash flows and balance sheet treatment of PPPs differ significantly from that of traditional procurement, some confusion exists about the effect of PPPs on affordability.



In principle terms, a traditionally procured project is affordable if the present value of the expected future revenue stream of government:



equals or exceeds the present value of expected future capital and current expenditure of government,



while a portion of such future expenditure streams is allocated to such a traditionally procured project

.



In principle terms, a PPP is affordable if the present value of the expected future revenue stream of government:



equals or exceeds the present value of expected future capital and current expenditure of government,



while a portion of such future expenditure streams is allocated to such a PPP

.

 In

both cases

the positive net worth of government depends on whether or not the present value of expected

future primary surpluses

(i.e. surpluses that exclude interest payments)

equal or exceed

existing

public debt

. the value of  The only essential difference between the two cases is between the

timing

of the flows.

4.2 Affordability in practical terms

  Even though the above is technically correct, it has one shortcoming:   Although PPPs and the PSC used in PPPs involve detailed present value calculations over the whole life of a PPP contract, governments rarely use present value calculations for the rest of their activities. Governments also rarely budget for a longer horizon than the upcoming year (although some use medium term fiscal forecast). This raises the question: how should affordability of a PPP be assessed within an environment where the planning horizon is not very long?

  As with other government activities in such an environment

a PPP project is affordable if:

 

the expenditure it implies for government can be accommodated within current levels of government expenditure and revenue (as captured in the current budget and medium term forecasts) and if it can also be assumed that such levels will be and can be sustained into the future.

This

working definition

of affordability allows for the use of present value calculations when estimating cost of a PPP vs that of traditional procurement (using a PSC), but to do so in an environment with a short planning horizon.

4.3 Affordability and VFM



Relative affordability

: affordability of PPP compared to that of traditional procurement.

 Interest rate and efficiency differentials main determinants (of relative affordability and VFM).



Absolute affordability

: Can the project (delivered either trough a PPP or traditional procurement) be accommodated within the budget without violating the budget constraint.

 UK:  Procuring authorities must complete affordability model for any planned PFI (it includes sensitivity analysis).

 The models based on agreed upon departmental figures for the years available and cautious assumptions about future dept spending envelopes.

 Victoria:  Decision about how a project is funded is separate from the decision about how it is to be delivered.

 Potential PPP compete with other capital projects for limited budget funding to ensure that they fall within what is considered affordable.

 Funding is approved on the preliminary PSC.

 Brazil:  Project studies must include a fiscal analysis for the next ten years. In addition, the commitment of the federal budget to PPP projects is limited by law to 1% of the net current revenue of the government.

 Hungary:  From 2007 a limit on the amount of expenditure on PPPs within the budget, so that each program has to fit within this limit.

4.4 Affordability, limited budget allocations and legally imposed budgetary limits

 Distinction between

affordability

,

limited budget allocations

and

legally imposed budgetary limits

 In many countries there are:   Limits on second- and third-tier government borrowing.

Fiscal rules that limit government expenditure, deficits or debt.  Thus, project might be affordable, but legally imposed budgetary limit prohibits borrowing.

 In some cases the opposite is also possible.

 In addition: budgetary allocations of government departments and authorities that are done from a central budget and within which expenditure plans must be fitted.

 Even if a traditionally procured project would not violate the long-term budget constraint of government, a project may still exceed the future expected budgetary allocations of a specific government department.

 

Danger:

less of a focus on VFM and create an incentive to get project off the books of government.

Three specific cases

when there is an incentive to get project of the books of government.

 The

first case

is one where a project cannot be delivered through either traditional procurement or a PPP within budgetary limits.

 1.

2.

3.

Has 3 features, but a short-run focus on 1 st disregard for the 2 nd and 3 rd and by gov creates incentive to go PPP route: Should gov use

traditional procurement

: Large initial capital outlay will cause a gov entity to exceed its allocated budget. Should entity then decide to go

PPP

route: May not be able to make future fee payments to private partners without exceeding expected future allocated budgets. In addition, private partner also

cannot levy user charge

on direct consumers of the service.



Second case

shares the same features with the first with the exception that instead of receiving a fee from gov, the priv partner

can impose a user charge

directly on the consumers of the service.

 As a result, the project might fit within the budget allocation of the government entity.  Additional question: Is the higher

tax-plus-user charge burden of those individuals

benefiting from the good or services acceptable?

   

Third case

occurs when gov operates under a fiscal rule that sets a limit on the overall fiscal balance of gov (or a dept operates under a budget allocation).

Results from cash-flow vs accruals accounting.

Traditional procurement:

Capital outlays

contribute to

breaking

the

budgetary limit

may in the year in which government undertakes outlays. PPP: Private sector responsible for initial capital outlay and government might be able to

fit

future payment of

fees

to private partner

into

its

budget without exceeding the budget limit

.

 In all three cases the

budgetary limit main reason

may be why government might want to get projects

off its books

.  However,

main reason should be higher VFM

.

 This is not an argument against budgetary limits and rules – rather it is an argument in favour of emphasising VFM as the main rationale for going the PPP route.

5. VFM and risk transfer

      

Reason for going the PPP route: Value for money, but effective risk transfer to the private partner prerequisite to ensure VFM.

 What do we mean by risk?

Risk vs. uncertainty.

Categories of risk.

Endogenous and exogenous risk.

Degree of risk transferred and the type of PPP project.

Who should carry risk in a PPP?

Responses to risk.

    Governments interested in PPP route: Value for money. UK National Audit Office (2003): 22% of UK PFI deals experienced cost overruns and 24% delays; compared to 73% and 70% of public sector projects. Scottish Executive and CEPA study (HM Treasury 2006):  Authorities: 50% received good VFM, 28% reported satisfactory VFM. KPMG survey (2007) among private project managers in the UK:  59% of respondents said performance of their projects in 2006 was very good, compared to 49% in 2005.

     However, having private partner is not in itself sufficient to ensure VFM:

need transfer of risk.

VFM:

optimal combination of quality, features and price, calculated over the whole of the project’s life.

Studies confirmed importance of risk transfer.

Risk: The measurable probability that the actual outcome will deviate from the expected (or most likely) outcome

.

Private partner carries risk if its

income

and

profit

linked to the extent that its

actual performance

is complies or deviates from

performance.

expected

(and contractually agreed)

Figure 3.4. The categorising of risk

 Many factors that may affect its actual performance  Some can be managed, others not.

 Thus, need to distinguish between

endogenous

and

exogenous

risk.



Transfer endogenous risk:

Company can influence the extent to which actual outcome deviates from expected outcome.

 Key question: Is whether the adverse outcome is

foreseeable

and if it is, can it be

managed

?

 Examples of

endogenous

risk:     Equipment and physical structure (e.g. buildings, roads) deterioration.

Wasteful use of inputs (i.e. x-inefficiency) personnel.

– includes wasteful use of raw materials, appointment of too many Failure to manage risk related to input prices (e.g. failure to negotiate best price of raw materials and labour services; failure to use hedge prices through use of future and forward contract).

Failure to implement accounting and auditing procedures that leads to theft, fraud and corruption.

 Examples of

exogenous

  risk: Unforeseen technological redundancy (e.g. ICT).

Unforeseen demographic changes (e.g. migration, changes in labour force participation, changes in population composition).     Unforeseen changes in preferences (e.g. high-speed trains vs. airplanes).

Unforeseen environmental changes (e.g. costs arising from pollution management and pursuit of cleaner energy use).

Unforeseen natural and manmade disasters (e.g. costs arising from floods, wildfires or political acts).

Unforeseen exchange rate movements driven by speculation.

 1.

2.

3.

4.

5.

There are five major types of response: Risk

avoidance

, whereby the source of risk is eliminated or is altogether bypassed by avoiding projects that are exposed to it.

Risk

prevention

, whereby actors work to reduce the probability of risk or mute its impact.

Risk

insurance

, whereby an actor buys an insurance plan – a common form of financial risk transfer.

Risk

transfer

, whereby actors relocate risks to parties who can best manage them.

Risk

retention

, whereby risk is retained because risk management costs are greater.

 Transfer of risk in PPP does not imply the maximum transfer of risk to the private partner.

 It means that the party

best able to carry the risk

, should do so.

Principles of Optimal Risk Transfer

VFM VFM max σ optimal Risk transferred

    Confusion about what ‘best able to carry risk’ means Leiringer (2005): Is this the party with largest influence on the probability of an

adverse occurrence happening

, or the party that can best deal with the

consequence after an adverse occurrence

?

Corner (2006): To best manage risk means to

manage it at least cost.

If

cost of preventing

an adverse occurrence is less than

cost of dealing

with consequences of the adverse occurrence, then risk should be

allocated

to the party best able

to influence the probability of occurrence.

 Cases where cost of preventing occurrence (incurred by private partner) is and government):

lower

than cost dealing with fallout (incurred by both private partner   

Example 1:

Cost of road maintenance vs. rebuilding sections of road once it degraded and damages paid because of accidents – probably cheaper to maintain road.

Example 2:

Cost of maintaining hospital equipment vs. cost of dealing with the consequences of broken equipment (financial cost including damages paid, loss of life).

Example 3:

Cost of keeping prisoners in prison (including cost of rehabilitation) vs. cost of escapees and unrehabilitated felons.

 Cases where cost of preventing occurrence (incurred by private partner) is

higher

than cost dealing with the consequences (incurred by both private partner and government): 

Example 4:

Cost of maintaining some types of ICT equipment vs. cost of dealing with the consequences of broken equipment – cost of dealing with broken equipment is cheaper than to maintain it.

 Cases where cost of preventing occurrence (incurred by government) is

lower

than cost dealing with the consequences (incurred by both private partner and government): 

Example 5:

Cost of leaving arrangements unchanged vs. cost of nationalisation – Cheaper for gov to leave arrangements, if it also carries the risk of paying damages in case it nationalises the private partner.

Figure 3.3. Degrees of risk sharing by project type

6. Competition and Value for Money

 Why is competition important?

   Competition

for

the market.

Competition

in

the market.

Contestability and competition.

 Foreign firms.

  Benefits.

Possible problems and pitfalls.

6.1 Why is competition important?

    

Monopolistic behaviour VFM

.

Competition important in

pre- and post-contract

phases.

Pre-contract phase

process. and lack of competition:

no

competition occurs in the bidding Zitron: 86 recent UK PPPs at tender stage: on average 3 bidders for each contract. However, 20% of 86 PPPs less than 3 bidders.

Few bidders increase danger of opportunistic (monopolistic) behaviour by the bidders.

  

Too few bidders:

VFM is not attained.

1.

2.

How does government end up with too few bidders?

  Paradox of many potential and few actual bidders.

With many bidders: probability of being preferred bidder is small. Given bidding cost, this may cause strong potential private partners not to bid, even if the project itself and the risks that it entails are acceptable to them. Few specialist companies.

Danger is that just a small group of companies may bid for every project that comes along.

 Distinction should be made between

bidding risk

and the

risk of the project

itself.

 Can address this by having

government cover

the

bidding cost

.

 However:   Government will have to enter this

subsidy

as as part of the

total project cost

.

Before agreeing to pay a private company’s bidding cost, that

company

must first

demonstrate

that they have the

capacity to bid and to deliver the service

in the event that they should get the contract.



Competition

in the

post-contract phase

complex issue. also a  Once preferred bidder is announced and the contract is signed, the

unsuccessful bidders

move on, some leaving the industry.  Thus, once the contract is signed, the

preferred private partner monopolist supplier

.

becomes a  Exception if the market is

contestable

.



While risk transfer is the driver of efficiency and VFM, competition and contestability ensures effective risk transfer.

 In the absence of competition or potential entry it will be difficult to attain higher efficiency and VFM.

6.2 Foreign firms

  Benefits:   

Skills

and

know-how

of foreign firms. May be able to

get credit cheaper

than developing/emerging market governments.

Size

of contract (may have capital to undertake very large contracts).

Possible problems and pitfalls: 

Size

of contract (not interested in

relatively

contracts).

smaller   Differences in

national, institutional (i.e. public vs. private) and corporate cultures

.

Government may

lack skills and capacity

negotiating skills of foreign firms.

to match

7. PPPs and the nature of the service

 General interest goods.

 Contractual flexibility and renegotiation.

7.1 General interest goods



Public goods

and

goods

with

externalities

.   The

free-rider problem rivalry

and of goods characterised by

non-excludability non-

Textbook examples: lighthouse vs. food    PPP relevant examples: inner-city vs. inter-city roads, correctional facilities Goods suffering from free-rider problem: because

demand

is

not fully revealed

; private companies unable to estimate the future

demand

If government then defines/poses that demand,

demand risk disappears

.

Sufficient risk transfer

will then depend on whether there is enough

supply risk

.

    Goods with an ‘

inelastic social demand

’ and

basic (private) goods and services

delivered to the poor

Healthcare

one example where government historically played a large role – particularly with the advent of the modern welfare state (

education

another example) Traditional procurement, i.e. state-run hospitals and clinics, but also state-run medical aid schemes Given that it is health, emphasis often more on

effectiveness

(i.e. delivery of desired quantity and quality), than on

efficiency

(i.e. minimising cost; maximising output relative to input)

 Has potential to be a very

sensitive political issue

 Political sensitivity linked to the

confusion

about the difference between a health PPP and privatised healthcare  Confusion heightened particularly when user charges are involved  In this setting ensuring

good communication

to the public as to how the role of government differs between PPPs, concessions and privatisation becomes important

   Also a distinction between PPPs:   where priv partner delivers capital goods, admin & management, but gov delivers medical service (same for schools), and the case where private partner also delivers medical (or education) service, though in accordance with PPP contract For gov issue is Value for money (VFM): Balance between

interests of the ill

vs.

interests of taxpayers

VFM: combining

quality

and

features

that closely fit client’s (i.e. gov’s, but ultimately the patient’s) specifications and at the best

price

possible (i.e for gov, but ultimately for taxpayer)

7.2 Contractual flexibility and renegotiation

Contract flexibility

 PPP contracts usually long-term contracts (25-30 years)  Even a 62-year French road contract mentioned above   Gov

specifies

on

delivery

quality & quantity and

payment depends

of specified quantity & quality As such, PPP contracts can be very

inflexible

. 

Example

time : Toll road that is best option today, but with new technology and higher petroleum prices, a high speed train might represent more VFM in ten year’s



Design

,

standards

and

forecasted demand

may prove inadequate or irrelevant to shifting societal needs   Given the continuous change in ICT and medical science, PPPs involving ICT, schools and healthcare might be more exposed to this than, say, a water purification and toll roads In ICT there might be fast technological redundancy that changes the type and unit cost of services required

 Even education (schools) is affected as modern teaching methods are increasingly more ICT intensive  In healthcare there might also be technological redundancy or changing demographic health features that changes the demand for services

    Government might miss out on

cost-saving effect of new technology

if it has to pay private partner to deliver service, while new technology causes technology that partner uses to become

obsolete

With traditional procurement government would have been able to switch to the new technology Inflexibility together and long-term nature of contracts: major weaknesses of PPPs Thus, contractual commitment might result in government buying a relatively expensive service:

destroys

relative

VFM

of PPP



This raises the question:

Who should bear the risk of technological redundancy?

 The

allocation

of this

risk

will depend on the degree of

rigidity

(as opposed to

flexibility

) of contracts:  The

more rigid

the contract, the

more risk government

carries, while the

more flexible

the contract, the

more risk the private partner

carries  The private partner, though, will probably only be

willing to carry

the additional risk if government

pays

it to do so.

   Of course, government can take

steps to improve flexibility

of PPPs. Examples:

UK:

The right to modify specifications (of course at a cost to government) and the right to set out a tender for modifications.

France:

Contracts between local authorities and private operators are administrative contracts. Thus, authorities have the right to change specifications once contracts are signed.  Of course, the authority must justify the changes and compensate the private operators for the changes

    

The question, though, remains:

Who should bear the risk technological redundancy?

Ex ante

a private partner can probably agree to carry this risk, but only if it is paid to do so

Technological redundancy

is an

exogenous

risk (i.e. private partner cannot prevent the actual outcome from deviating from the expected outcome) Thus, having the private partner carry it, will not improve the efficiency with which it delivers the good As such, it makes sense for

government to carry this risk

, or to at least share it with the private partner

 What about

changing demographics

that change the

level and composition of demand

(e.g. modern lifestyles that increase heart disease relative to other diseases)?

 If risk is

endogenous

, i.e. if private partner can manage demand risk, it should also carry it. Otherwise, government can carry it or share it with private partner.

 Most demand for health services, not endogenous.

    Above explains why PPPs more common in

infrastructure development

and

health

(e.g. roads and water works), followed by projects and lastly

ICT education

 In the UK ICT projects deemed unsuitable for PPP option

In short:

  Complex goods usually do not make for good PPPs Countries new to PPP game: start with infrastructure (i.e. simpler) projects  Standardised contracts Source: See example of UK defense contract http://www.hm treasury.gov.uk/documents/public_private_partnerships/ppp_index.cfm

Renegotiation of the terms of contract

 Wish to

renegotiate

may come from either

government

or the

private partner

 May deal with costs incurred by private partner  Though strictly speaking, if cost increase was part of the initial risk that the private partner took and if the private partner has been remunerated for that risk, the scope for renegotiation is less

  Areas of contract negotiations and renegotiations may include the following:   

project agreement:

of both parties; establishing the rights and obligations

performance specifications:

requirements; technical, financial, and service

collateral warranties:

establishing direct links between the public authority and all the contracting parties; 

direct agreements:

regulating the relationship between all parties and financers Table 3.1 sets out more specific areas of negotiation and renegotiation

8. The public sector comparator (PSC)

 What is a Public Sector Comparator (PSC)?

 What do countries do? 

Rigorous use of PSC:

Africa.

UK, Australia and South 

Not all use PSC:

France.

 Furthermore, all those who use PSC, do not use it in same manner.

 From the

most

to the

least

complex methods.

Figure 3.5. The spectrum of methods to assess value for money

Source: Grimsey and Lewis, 2005:347 and 351.

   PSC construction enables government prior to concluding the contract to:   assess the

affordability costing

of a PPP by ensuring

full life-cycle

be sure that

compared

better VFM to traditional procurement PPP will deliver PSC also helps to:   manage

discussions

as

risk allocation

and with private partners on critical issues such

output specifications

;

stimulate bidding competition

by building greater transparency and trust in the bidding process.

Importance of PSC when competition is limited  In the past, if there is only one bidder: compete against PSC; but this is increasingly not done in the UK and Australia

The use, abuse and pitfalls of PSCs

 The

use

,

abuse

and

pitfalls

of PSCs     Efficiency and the cost of capital revisited Choice of discount rate Dating of cash flows Weighting of risks   Danger of point estimates Need to carry out sensitivity analysis

    The UK and South African examples Websites and sources: HM Treasury (2006c), “Value for money quantitative evaluation spreadsheet”: 

www.hm-treasury.gov.uk/documents/public_private_ partnerships/ additional_guidance/ppp_vfm_index.cfm

.

 HM Treasury (2006b),

Value for Money Assessment Guidance

, The Stationery Office, London.

National Treasury (2004),

National Treasury PPP Manual

, South African National Treasury, Pretoria: 

www.ppp.gov.za

9. Measuring performance

   

PSC

to measure relative VFM of a PPP

prior

contract   to Helps to set a

performance benchmark However:

not sufficient to ensure that actual performance will yield the expected VFM. PPP contract needs to state

Key Performance Indicators (KPIs)

These have to be measured and monitored

during

the lifetime of the contract

Key element: dependent

on Private partner remuneration

actual

,

measured performance

relative to

contractually agreed performance

    What do countries do?

UK:

monitoring in form of both

formal analysis

to assess VFM   and

informal Formal analysis:

Market-testing and benchmarking exercises for soft services as set out in the original contract

Informal analysis:

assessments. Compare outturn data to original Government uses

target benchmarks Performance Indicators (KPIs).

for

Key

KPI targets often specified in terms of

acceptable range

of performance

rather than single-point

measures of performance.

   

Victoria:

VFM as part of the contract. Agreement on

fixed price

for delivery of services that meet

specified financial and non financial KPIs.

After conclusion of contract, focus not on whether government is getting better VFM than was agreed upon in contract. Rather, government assesses 1.

2.

whether or not the contractor is

actually delivering the VFM agreed upon

in the contract and whether or not the

financial and non-financial investment benefits

of the project (identified as part of the business case / investment logic map in the pre-contract phase) are being delivered. The government of Victoria expects all

KPIs target levels

to have

specified

that contractors are expected to deliver on.



France:

Where performance is measurable, PPP contracts contain

key performance benchmarks

, i.e. target levels for performance benchmarks. 

Brazil:

Contracts generally establish

standards or target levels

that must be followed by the private partner 

Hungary:

Contracts also contain

performance indicators

 PPP performance measured using basket of performance indicators. These indicators include: 

Efficiency measures

defined in terms of inputs and outputs (e.g. the provision of a health service at the fee (if government pays) / user charge (if client pays) agreed upon with government)    

Effectiveness measures

in terms of outcomes (e.g. quantity, level of coverage of area or population.)

Service quality measures Financial performance measures Process and activity measures

Table 3.2. Performance indicators used by selected governments to measure the performance of public-private partnerships

Efficiency measures defined in terms of inputs and outputs Effectiveness measures in terms of outcomes Service quality measures Financial performance measures Process and activity measures Victoria, Australia    (1)  Brazil     France   Hungary     United Kingdom      1. Although contracts in Victoria do not typically include financial performance measures, the government does monitor the financial performance of a concessionaire and its principal contractors (private parties must submit their financial documents to the government).

 The

frequency

with which governments

measure

the performance of private partners also differs between countries. 

UK:

Performance is measured continuously. 

France:

Private parties must report annually their results to government.



Brazil:

It depends on the indicator and the of type of project (highway, railroad, etc). 

Hungary:

Private parties must report their results on a quarterly basis to government.



Victoria:

 Private party must prepare and deliver to government a

regular periodic performance report

(usually monthly).     The private party must (on an annual basis) also provide government with:   a copy of its

business plan

its

budget

for the following year and for the next two financial years. It must also provide

unaudited financial documents

six-monthly basis and on a

audited financial documents

on an annual basis.

At any time up to six months after the end of the contract term, government may (at its own cost) require an

independent audit

of any financial statements or accounts provided.

 If in case where government pays a fee, the

private partner falls short on a KPI

, effective performance management requires that the

fee is reduced

to the extent to which they fall short. 

Threat of a fee reduction:

Incentive to the private partner to ensure that its performance matches the target defined in terms of the performance indicator. 

Thus, fee reductions ensure the effective transfer of risk to the private partner.



UK:

   Increasingly punitive deductions are involved where KPIs are missed. Small one-off miss may not incur a payment deduction A continuous small miss or large one-off miss will have proportionally higher payment deductions. 

Victoria:

 A similar regime in place, with a distinction between a 'major' and 'minor' default regime is considered appropriate.



France:

  Fee component linked to the operation may be affected if performance falls short; Fee component relating to the investment is not necessarily affected. 

Brazil:

  PPP Law requires that any payment by government must be linked to service provision. If the private partner does not meet service level parameters, there can be deductions from the agreed fee.

10. PPPs, budgets and government accounting

       What are the basic

points of departure

?

Problem:

Different sets of books

Potential problems:

  Capital and current financial flows may not be captured in either government or private sector books Capital and current financial flows may be captured in both government or private sector books

IMF solution:

Who carries most of the risk?

IPSASB:

Who controls the asset?

Risk disclosure, recording of guarantees and contingent liabilities Sources: See discussion documents from IPSASB and SAASB (note that these are currently only discussion documents)

11. Institutional setup and issues: PPP units and legislation

 What is the

role

of the

PPP unit

?

 The

main function for money

of most PPP units is to ensure that all PPP agreements

comply

with the legal requirements of

affordability

,

value

and

sufficient risk transfer

.  By

providing technical assistance

PPP unit can guide government departments and provinces to follow international good practice that will ensure the successful creation of PPPs.

   To fulfil the abovementioned function the PPP unit has two broad tasks:   To

provide technical assistance provinces and municipalities

to

government departments,

who want to set up and manage PPPs, and To

provide

National Treasury

approvals

phases of a PPP agreement.

during the pre-contract However:   PPP unit should

not be involved

in

post-contract management

contract. That is responsibility of line department of It does, nevertheless, need to

revisions approve

major

contractual

that might result from

renegotiation

after the conclusion of the contract

Examples of PPP units:

Partnerships Victoria, SA PPP unit, PPP Knowledge Centre (The Netherlands)



Empowerment

of PPP units     Proper legislative framework Political support Location of PPP unit Skilled staff



Proper legislative framework

 If possible,

steer clear

from

fragmented legislation

(e.g. separate legislation for PPPs in defense, education, health, or for each PPP deal)   Thus, legislation should be

encompassing

Legislation should ideally link up with other

public sector procurement legislation

(e.g. a public sector finance management act)

  Though specific enough to ensure proper regulation, legislation should

allow room

for

contractual flexibility

and

innovation in design

Without relaxing legislation to the point that it will undermine the pursuit VFM, the

legal requirements

on private partners and government should not serves as a

disincentive for bidders

. (Keep in mind: Bidders can always bid for non government contracts, if government (PPP) contracts are too cumbersome and costly)



Political support

 Potential private partners (operators and financers) need to know that

next government

not terminate support to PPPs will 

Location of PPP unit

  In government there is a

natural tension

spending ministries and the treasury between Putting the

PPP unit within the treasury

strengthens the regulatory position of the PPP unit, as it can rely on the natural tension

 

Skilled staff

What type of staff do PPP units and government departments wishing to create PPPs need?

     

Financial analysts:

money to assess affordability and value for

Legal experts:

particularly experts in corporate and contract law, as well as specific legislation on public procurement and PPPs

HR and labour law experts:

PPPs may involve the transfer of public sector staff to a SPV

Economists: Experts

to assess economic impact of large projects to assess

environmental impact studies

Skilled

project managers

in government departments

 Typical

HR issues

that PPP units and government departments wishing to create PPPs encounter:  Relative

quality

of private and public sector staff    

Remuneration

issues Staff

leaving

government to go to private sector (cooling-off clauses) Use of

‘roving’ project managers

Require from departments who wish to create PPPs to first, prior to anything else,

capacity demonstrate

to manage project that they have the

12. Transparency and accountability

    Are PPPs in general and the private providers specifically, less transparent and accountable than government and its departments? To answer, first ask what transparency and accountability we require from government?

Transparency and accountability with regard to: 

Policy objectives

(equity and effectiveness)  

Processes

(e.g. procurement, operating and management processes) through which government pursues these objectives (equity (i.e. fair) and efficiency)

Honesty

and the

absence of corruption Can (and should) require the same from a PPP

   The

PPP contract

can and should ensure transparency regarding

PPP objectives

 Also recall that government might prefer PPP to full privatisation because it keeps control over the quantity and quality of output Transparency of processes Potential for improved efficiency is already established if:  Competition and effective risk transfer occurs   If private partner beats PSC and Performance measurement (measured against KPIs) occurs and penalties enforced

   In addition, government can assess whether or not private partners comply with

legislation

that ensure they act

fair and equitable

 This ensures that there is

no tension

and

efficiency

between

accountability

(i.e. ‘cannot cut corners to save on costs’)

Framework

needed within which a PPP bids for contracts are awarded that are

clear, open and beyond dispute

However, that if good is

complex

, ensuring transparency and accountability becomes more difficult (but also if government should deliver the complex service)

   Transparency regarding financial and other information.

What information should be in the public domain?

Essential details of contract, particularly information that has

implications for public expenditure and revenue

charges, transaction costs etc.) (amount of capital, payment structure of unitary charges and fees, user

Financial statements

of Special Purpose Vehicle and holding companies can be put in public domain   Similar to publicly listed companies Note that by doing this

the private partner does

, in fact,

not necessarily provide less information than government

provides in its statements on its public procurement activities

   Financial statements should be

audited

independent auditor by an There should also be proper

internal financial and accounting controls

detect) corruption to manage (i.e. prevent and

Human resource issues

regarding fair treatment of staff who are transferred from government to SPVs:  Employment contracts,   Remuneration and benefits (e.g. transfer from government to private pension fund) Working conditions

Concluding remarks

   PPPs are able to

harness the capacity

produce VFM of the private sector to In a setup where the debate about privatisation has become ideologically highly divided and charged, PPPs provide an ideal vehicle to

pursue value for money

through the participation of the

private sector

, while

government

, nevertheless still keep

control over quantity, quality and cost

However, it is important to deal with PPPs on a

case-by-case basis

and to acknowledge that PPPs are not a several

prerequisites panacea

to all government’s problems. Indeed, as we have seen, there are that need to be in place to ensure that a PPP works.

Some valuable websites

 HM Treasury (UK): 

www.hm-treasury.gov.uk/documents/public_private_ partnerships

  Partnerships Victoria (State of Victoria (Australia)):

www.partnerships.vic.gov.au

  PPP unit (South Africa):

www.ppp.gov.za