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PPPS: Potential Risks and Benefits

Public Private Partnerships Mexico 14-18 May 2007

Teresa Curristine, Budgeting and Public Expenditures Division,

Public Governance Directorate, OECD

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Overview of PresentationWhat is a PPP?What are the trends in developing

PPPs?What are the potential benefits?What are the potential risks?What factors to consider before going

down the PPP route?

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What is a PPP?

“Public-private partnerships (PPPs) involve private sector supply of infrastructure assets and services that have traditionally been provided by the government.” (IMF)

“In general, the term refers to forms of cooperation 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 a service.” (European Commission)

“Public sector contracts to purchase quality services on a long term basis – principally involving the construction of new infrastructure to provide such services” (PFI – UK Government)

There is no clear agreement as to what is a PPP.

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What a PPP is not?

Outsourcing - 5 year catering contracts Other partnership models Privatization Franchising

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What are some key characteristics of PPPS?

Private Execution & Financing of Public Investment Private Provisions of Services Private Risk Whole-of-Life Perspective Typically, PPPs have a design-build-finance-operate

scheme, as opposed to design-build only which is common for traditional public investment, but there are many other variants

Government frequently the main purchaser of services provided

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Examples Highway infrastructure (roads, bridges, tunnels) Railways Airports Ports

Hospitals and health care facilities Central accommodations Prisons

Water and sewage

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Trends Towards PPP

Between 1985 – 2004 globally PPF in 2096 projects nearly $887 billion

Mainly transport 656 projects total $325 billion 2096 projects 1121 projects were completed by

2004 (AECOM 2005). Developed countries extensive experience UK and

Australia UK biggest player PFI deal in excess of $13

billion

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Top 10 Countries of PPP/PFI Project Finance Deals 2004 v 2003

Rank 2004 Country Value (US$m) Deals % Share Rank 2003 Value (US$m) Deals % Share

1 UK 13,212 81 32.6 1 14,694 59 56.7

2 Korea 9,745 9 24.1 3 3,010 3 11.6

3 Australia 4,648 9 11.5 7 611 4 2.4

4 Spain 2,597 7 6.4 2 3,275 8 12.6

5 US 2,202 3 5.4 4 927 2 3.6

6 Hungary 1,521 2 3.8 11 251 1 1

7 Japan 1,473 15 3.6 10 274 5 1.1

8 Italy 1,269 2 3.1 5 714 3 2.8

9 Portugal 1,095 2 2.7 n/a n/a n/a n/a

10 Canada 746 3 1.8 n/a n/a n/a n/aSource : Dealogic, quoted in OECD (2006:57)

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What are the potential benefits?

Increase efficiency gains and better value for money Public sector opportunity to increase investment and

development of infrastructure projects Bypass some of the dysfunctional aspects of traditional

procurement- better delivery on time Maximises the use of private sector skills Force public sector to focus on outputs from the start Quality of service can be maintained for life of the PPP

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What are the potential risks?

Does not necessarily improve efficiency or provide value for money

Fails to adequately transfer risks to the private sector Avoids disciplines of the budget process- off budget

treatment Very complex contracts-can be difficult to get the right

balance on contract specificity Procurement can be lengthy and costly In long–term can be relatively inflexible structures

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Requirements for a Good PPP

Service Quality is Contractible Adequate Risk Transfer to Private Sector Competition, or Incentive-Based Regulation,

Must Be Present Good Value For Money (Efficiency gains offset

higher private borrowing costs)

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What factors to consider before going down the PPP route?

Design issues Institutional capacity Market Issues Accountability Issues Governance Issues

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Design Issues for PPPS

Is the project suitable to be a PPP? Is it more efficient than providing it through traditional public

sector procurement? Will it provide Value for money?

– Do the efficiency gains outweigh the higher costs of private capital

Is there an adequate transfer of the different types of risks to the private contractor?

What steps can be taken to maintain fiscal discipline? Can the current legal and regularity framework accommodate

PPPS?

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Transferable Risks

Construction: design problems; costs overruns; project delays

Financial: variability in interest rates & exchange rates

Performance: availability of an asset & quality of service

Demand: ongoing need for services Residual Value: future market price

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Risk Transfer & Financing Costs

In theory, risk transfer should not affect financing costs– Cost of capital should depend only on project

risks But, since governments can spread risks across

taxpayers, private sector borrowing usually costs more than government borrowing

“The key issue is whether PPPs result in efficiency gains that more than offset higher private sector borrowing costs.” (IMF)

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Assessing Risk Transfer

Very Difficult– Legal complexity of PPP contracts– Implications of renegotiations– Guarantees, explicit & implicit– Ex Post risks for providers of essential

services & those too big to fail Very Important

– Basically determines whether PPPs are more efficient & effective

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Legislative FrameworkLegislative Framework Importance of having framework

– Lack of adequate framework a factor in rating agencies country ratings

– Can affect market appetite to bid for or finance projects Problems with Definition of PPPs National laws can impose restrictions

– For example national law impose complex requirements for sub-contracting (Germany)

Restrictions on ability of local or regional governments to contract (Czech republic)

Public finance law restricts long –term budgetary commitments (Poland)

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Countries with Legislative FrameworkCountries with Legislative Framework

Examples of European countries with comprehensive legislative framework: Ireland, Spain, Poland and Turkey

Other countries e.g. South Africa and Chile, Australia at state level

Comprehensive legislation being drafted or sector specific legislation: Belgium, France, Greece, Portugal, Czech Republic, and Latvia

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Legal Framework: For example Chile Concessions Law of

1991

Establishes nature of concessions Creates competitive biding process Specfies conflict resolution procedures Special purpose company With authorization, transferable Breach of contract: end of concession and

rebidding Step in rights provision for creditors

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Legislative framework for example South Africa

– National and provincial PPPs: Treasury Regulation 16, issued 2004 to PFMA (1999).

– National Treasury PPP Practice Notes that constitute the PPP manual of the PPP unit

– Municipal PPPs: Municipal Public-Private Partnership Regulations, issued 2005 to Municipal Finance Management Act (2003)

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Institutional capacity

Does the public sector have the necessarily technical expertise and trained staff to design, negotiate and monitor these contracts?

How will the public sector maintain the necessary institutional memory and staff over the long term?

What are the advantages of a PPP unit?

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What can a PPP unit Achieve?

Promotes Credibility with the Market Promotes Projects to the Market Co-ordination of public bodies Can be the promoter of initiatives eg legal guidance

documentation Can bring in new knowledge, skills, mindset and

experience Can check proposed projects for errors Advice and support to project sponsors Can approve projects

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EU Countries with PPP Units 2005

Active PPP unit involved in PPP promotion

Austria, Ireland, Netherlands, UK PPP unit in progress or existing in purely

consultative capacity

Denmark, France, Germany, Italy, Portugal

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For example: The role of the South African dedicated PPP unit

Main functions: Ensure affordability, value for money and sufficient risk transfer

In line with international best practice:– Main drivers of value for money: risk transfer

and competition – Prerequisite for value for money is affordability

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PPP unit in South African Nat Treasury has two broad tasks: – Provide technical assistance to government

departments, provinces and municipalities – Provide Treasury Approvals during pre-contract

phases Initiative, ultimate management of and accountability

regarding PPP agreements originates and rests with individual government departments and provinces

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Market Issues

Is there a competitive supplier markets?

Will a competitive market be maintained over the long-term?

What can be done to avoid over-reliance on a single supplier in a sector?

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Accountability Issues

Are PPPS accounted for in a transparent manner on the government books?

What are safe guards in the tending procedures and process to avoid bias or corruption?

What impact does it have on transparency to citizens?– Public access to information – commercially

sensitive contracts– Impacts on citizens’ redress

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Criteria for Scoring PPPs Off Budget

UK

– Demand: service payments must be dependent on future need for services

– Residual Value: asset must be transferred at true economic value

– No guarantees of private liabilities Eurostat: PPPs are non-government assets if private

partner bears both:

– Construction risk and,

– Demand or Performance risk

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More on PPP Accounting

No internationally accepted accounting standard has been developed to reflect varying degrees of risk transfer

Country practices differ substantially Classifying PPPs as either public or private fails

to recognize risk sharing A more appropriate treatment might be to reflect

the range of fiscal costs & risks, but few, if any, accounting (let alone budget) systems can handle this treatment

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Governance Issues

What are the political considerations of failure? Will the public always hold the minister responsible?

How will these contracts limit the budget flexibility and policy potions of future political administrations?

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It is important to get it right

Good projects: – create economic benefits and growth– create confidence in a country’s economy– create value for money solutions thus minimising tax-

take Bad projects:

– create ongoing liabilities for many years– big projects = big risks– failure is often high profile: nationally and

internationally– can undermine investor confidence in the country– can make the good projects unaffordable

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Conditions to create a good quality PPP Programme

Political Support Clear legal framework and guidance Institutional co-ordination New skills and new mindset Decide on a case by case bases Projects that have:

– Clear objectives

– Clear boundaries

– Clear links to stated policy objectives

– Clearly defined and understood risk strategy Previous experience – what will/won’t work

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To PPP or Not To PPP

Service Quality is Contractible Focus on end result, not means of delivery Clearly specify outputs & performance

standards Public Sector Comparator Value For Money

No presumed advantage to private or public sector

Refined project appraisal & prioritization process

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To PPP or Not To PPP

Fiscal Implications Properly Accounted & Reported

Pay For Performance See www.partnerships.vic.gov.au

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Conclusion

Should be considered along with traditional public sector procurement and other MTM and financing sources

Fundamental question -does it provide better value for money?

Everything rests on adequate design and risk transfer

Even then accountability, transparency, and governance issues must be considered