PROCUREMENT OF MANAGEMENT CONTRACTS PROCUREMENT OF MANAGEMENT CONTRACTS and LEASES for OPERATION of UTILITIES – ECA and LEASES for OPERATION of UTILITIES – ECA

EXPERIENCE (*)EXPERIENCE (*)

Preamble:Preamble:This is a slightly more readable version of the “Power This is a slightly more readable version of the “Power Point” slide presentation made by Salim Benouniche (**) at the Point” slide presentation made by Salim Benouniche (**) at the Workshop on “ Management Contracts and PPPs” organized by Workshop on “ Management Contracts and PPPs” organized by Procurement Group in World Bank Fiduciary Forum 2008, Procurement Group in World Bank Fiduciary Forum 2008, National Conference Center, (Lansdowne Va).National Conference Center, (Lansdowne Va).

(*) ECA:Europe and Central Asia Region (*) ECA:Europe and Central Asia Region (**) Procurement specialist, Infrastructure & Energy , (**) Procurement specialist, Infrastructure & Energy ,

ECSPSECSPS

Part I. Typical ECA Utilities Situation and Risks Part I. Typical ECA Utilities Situation and Risks InvolvedInvolved

I.1 INTRODUCTION:I.1 INTRODUCTION:

After a short description of the common scheme, world wide, After a short description of the common scheme, world wide, the specific situation of utilities in ECA Region will be the specific situation of utilities in ECA Region will be detailed, in terms of main difficulties, risks, issues, followed detailed, in terms of main difficulties, risks, issues, followed by mitigation measures in design and procurement:by mitigation measures in design and procurement:

I.2 A COMMON SCHEME, Bank-wideI.2 A COMMON SCHEME, Bank-wide

To rehabilitate plants and networks, which are often in a To rehabilitate plants and networks, which are often in a poor initial condition, then operate and maintain them,poor initial condition, then operate and maintain them, it is necessary:it is necessary:

to determine first as clearly as possible the to determine first as clearly as possible the BASELINEBASELINE DATA.DATA.

Then to OPERATE for a few years to reorganize the utility and Then to OPERATE for a few years to reorganize the utility and measure the real parameters: this is usually the purpose of measure the real parameters: this is usually the purpose of partnerships with a private operator:partnerships with a private operator:

• There may be two phases: There may be two phases:

• a first MANAGEMENT CONTRACT a first MANAGEMENT CONTRACT with a private Operator with a private Operator lasting 2 to 6 years normally comes as a transition before lasting 2 to 6 years normally comes as a transition before launching the Procurement of launching the Procurement of

• a second phase: 2nd Management Contract, LEASE a second phase: 2nd Management Contract, LEASE or CONCESSION or CONCESSION (8 to 25 years)(8 to 25 years)

PPPs In ECA: more Management ContractsPPPs In ECA: more Management Contracts

I.3 Specific ECA SITUATION:I.3 Specific ECA SITUATION:

In ECA we currently find In ECA we currently find mainly MANAGEMENT mainly MANAGEMENT Contracts Contracts (Albania, Armenia, Kosovo, Uzbekistan), a few (Albania, Armenia, Kosovo, Uzbekistan), a few LEASE Contracts (Armenia, Turkey, Georgia), very few LEASE Contracts (Armenia, Turkey, Georgia), very few examples of CONCESSIONS (Former Yugoslavia and examples of CONCESSIONS (Former Yugoslavia and Bulgaria).Bulgaria).

The MANAGEMENT CONTRACT is the most frequent type in The MANAGEMENT CONTRACT is the most frequent type in ECA due to the difficulties encountered in ECA due to the difficulties encountered in ECAECA ((TRANSITION) COUNTRIESTRANSITION) COUNTRIES; the management contract is ; the management contract is a a TRANSITION CONTRACTTRANSITION CONTRACT because it is a mixed contract, because it is a mixed contract, only partly performance-based,with an important fixed fee only partly performance-based,with an important fixed fee component similar to a Technical Assistance contract (70% component similar to a Technical Assistance contract (70% to 80%) and a smaller performance based fee component to 80%) and a smaller performance based fee component (20% to 30%)(20% to 30%)

MANAGEMENT CONTRACTSMANAGEMENT CONTRACTS tend to lasttend to last longer in ECAlonger in ECA, , either by extension or by repetition (from 3 to 8 years). either by extension or by repetition (from 3 to 8 years).

The procurement procedure is usuallyThe procurement procedure is usually “ “one stage bidding” one stage bidding” after prequalificationafter prequalification, It is based on a technical proposal and a , It is based on a technical proposal and a financial proposal submitted in two envelopes by each bidder. The financial proposal submitted in two envelopes by each bidder. The technical evaluation includes a minimum pass/fail score that must technical evaluation includes a minimum pass/fail score that must be secured before the financial proposal can be opened. Then , the be secured before the financial proposal can be opened. Then , the criterion is generally only price. criterion is generally only price.

One One exceptional caseexceptional case (Armenia 2, QCBS procedure) was based (Armenia 2, QCBS procedure) was based on on post qualificationpost qualification..

THE MAIN DIFFICULTIES in ECA COUNTRIES:THE MAIN DIFFICULTIES in ECA COUNTRIES:

BASELINE Data are very difficult to establishBASELINE Data are very difficult to establish (no (no bookkeeping, no reliability, etc.);bookkeeping, no reliability, etc.);

LOW REVENUES do not cover costs for maintenance, LOW REVENUES do not cover costs for maintenance, refurbishment and extension of the public servicesrefurbishment and extension of the public services; it ; it comes from low tariffs, poor billing and collection (Central asian comes from low tariffs, poor billing and collection (Central asian countries in particular face a “quasi fiscal debt” case)countries in particular face a “quasi fiscal debt” case)

In Yerevan, at start only 7% of the domestic consumers paid user In Yerevan, at start only 7% of the domestic consumers paid user fees. In some cases, the Bank waived part of its rules to finance fees. In some cases, the Bank waived part of its rules to finance operating costs at start.operating costs at start.

POLITICAL POLITICAL commitment and new LEGAL and REGULATORY frame are key commitment and new LEGAL and REGULATORY frame are key (independence of contract monitoring unit and of Management Board too).(independence of contract monitoring unit and of Management Board too).

TECHNICAL LOSSES TECHNICAL LOSSES (e.g. high percentage of “Non Revenue Water”) (e.g. high percentage of “Non Revenue Water”) reflect the poor technical conditions of the plants and networks;reflect the poor technical conditions of the plants and networks;

PERSONNEL PERSONNEL management, and RESTRUCTURING of former management, and RESTRUCTURING of former publicpublic

companies are important to improve collection and billing companies are important to improve collection and billing revenues first, and performance later.revenues first, and performance later.

Who is responsible for Procurement execution is not clear:Who is responsible for Procurement execution is not clear: Operator should be and execution of the INVESTMENT PLAN in due Operator should be and execution of the INVESTMENT PLAN in due time should bind the client.time should bind the client.

Lack of Competition in some Sectors,Lack of Competition in some Sectors, increasing risk increasing risk aversion: few Bidders Water Operators “World-size”: only 5 major aversion: few Bidders Water Operators “World-size”: only 5 major companies (=> ,only one bidder in Tbilisi: negos failed); companies (=> ,only one bidder in Tbilisi: negos failed); concentration in Power Sector also.concentration in Power Sector also.

Few Left Bidders tend to negotiate Few Left Bidders tend to negotiate amount/wording of amount/wording of Guarantees, ContractGuarantees, Contract

Underbidding Underbidding sometimes leads to sustainability problem, early sometimes leads to sustainability problem, early contract crisiscontract crisis

Parent Companies (JV shareholders) walk away Parent Companies (JV shareholders) walk away from ailing from ailing local companylocal company

The Cycle of Underperformance (after Shugart)

Inefficientoperations

Lack offunds

Low tariff Low incomes

Failure to pay Low customersatisfaction

Poorcommercialdiscipline

Poor Maintenance

Leakage

Lack ofinvestment

Waste

Water-shortages,low pressure, poor quality

A “Guidance Note on Strategy” was issued to address the A “Guidance Note on Strategy” was issued to address the case where the first Management Contract incumbent case where the first Management Contract incumbent competes for a subsequent Contract, Lease or Concession:competes for a subsequent Contract, Lease or Concession:

difficult to establish a “level playing field” for other competitorsdifficult to establish a “level playing field” for other competitors

solution adopted: waiver of conflict of interest provisions to allow solution adopted: waiver of conflict of interest provisions to allow the incumbent to compete, based on the provision of a maximum the incumbent to compete, based on the provision of a maximum of information to all competitors.of information to all competitors.

(see website: at the end of the “Consulting Services (see website: at the end of the “Consulting Services Manual”)Manual”)

JOINT VENTURE ISSUES:JOINT VENTURE ISSUES:

The The Operator Operator is in most cases is in most cases a new locally incorporated a new locally incorporated companycompany created after the award, its created after the award, its shareholdersshareholders are usually are usually the prequalified applicant the prequalified applicant Joint Venture PartnersJoint Venture Partners::

Typically, depending on the size of the contract (e.g. >= 1 mln Typically, depending on the size of the contract (e.g. >= 1 mln $/year), one or two subsidiaries of a major company of the sector $/year), one or two subsidiaries of a major company of the sector (Parent Company having financial capacity, technical expertise), or (Parent Company having financial capacity, technical expertise), or developed country Operator and a Technical Consulting Firm, with developed country Operator and a Technical Consulting Firm, with or without a Local Partner.or without a Local Partner.

When the locally incorporated Operator is created, the Major When the locally incorporated Operator is created, the Major Company(ies) becomes often a Company(ies) becomes often a “GRAND PARENT” of the “GRAND PARENT” of the OperatorOperator::

“ “GRAND PARENT” HoldingsGRAND PARENT” Holdings

॥॥_______ ______________ _______॥॥_ _ _ _ _ + _ _ _ __ _ _ _ _ + _ _ _ _I I II I I

Parent 1Parent 1 (Oper.) (Oper.) Parent 2Parent 2 (Tech.) (Tech.) Parent 3Parent 3 (Local or Bank) (Local or Bank)

I______________I _ _ _ _ __ _ _ _II______________I _ _ _ _ __ _ _ _I ॥॥

llllNew Locally Incorporated SubsidiaryNew Locally Incorporated Subsidiary = = PARTYPARTY to the to the CONTRACTCONTRACT

A PARENT/SHAREHOLDER COMPANY GUARANTEE, WHY?A PARENT/SHAREHOLDER COMPANY GUARANTEE, WHY?

To be pre-qualified, JOINT VENTURES often refer to financial To be pre-qualified, JOINT VENTURES often refer to financial capacity figures or technical expertise of the “Grand Parent(s).” T capacity figures or technical expertise of the “Grand Parent(s).” T OPRCOPRC has ruled in 2002 on such a case that has ruled in 2002 on such a case that “Grand Parent “Grand Parent Company (ies)” should, alternatively,Company (ies)” should, alternatively,

either ‘CO-SIGN”either ‘CO-SIGN” (i.e. be party to) (i.e. be party to) the Contractthe Contract (or put more (or put more Equity)Equity)

or provide aor provide a PARENT COMPANY GUARANTEE,PARENT COMPANY GUARANTEE,

together with a together with a letter of agreementletter of agreement stating the commitment to stating the commitment to provide the Operator with Technical expertise and support.provide the Operator with Technical expertise and support.

This Guarantee comes in ADDITION to the PERFORMANCE This Guarantee comes in ADDITION to the PERFORMANCE SECURITY. It is similar in form: UNCONDITIONAL, payable UPON SECURITY. It is similar in form: UNCONDITIONAL, payable UPON FIRST DEMAND.FIRST DEMAND.

EXTRACTS from ARMENIA II Management Contract RFP:EXTRACTS from ARMENIA II Management Contract RFP:

RFP 4.5.5. If the individual company or any of the Consortium RFP 4.5.5. If the individual company or any of the Consortium partners constituting the Successful Bidder have submitted partners constituting the Successful Bidder have submitted data, credentials, or any other information in their Technical data, credentials, or any other information in their Technical Proposal Part VII (Information Forms of Annex E to this RFP) Proposal Part VII (Information Forms of Annex E to this RFP) that are those of a parent company, the Company that are those of a parent company, the Company Management Board may, in its sole discretion, also require Management Board may, in its sole discretion, also require the relevant parent company or companies to be party to the the relevant parent company or companies to be party to the contract. by co-signing the contract, or if it is not willing to contract. by co-signing the contract, or if it is not willing to co-sign the Contract, to provide an additional guarantee of co-sign the Contract, to provide an additional guarantee of the same kind as that mentioned in RFP section 4.5.4., for an the same kind as that mentioned in RFP section 4.5.4., for an amount calculated on the basis of six month of Management amount calculated on the basis of six month of Management Fixed Fee.Fixed Fee.

(The Guarantee mentioned in RFP 4.5.4 is the Performance (The Guarantee mentioned in RFP 4.5.4 is the Performance Guarantee)Guarantee)

WHAT IS THE RISK COVERED?WHAT IS THE RISK COVERED?

This guarantee is needed: This guarantee is needed:

to ensure that the capacityto ensure that the capacity (financial & technical) taken (financial & technical) taken into account at prequalification stage is really backing the into account at prequalification stage is really backing the Operator during execution.Operator during execution.

to cover the risk of J.V. partners stepping outto cover the risk of J.V. partners stepping out of the of the Operator’s Contract, either by selling their shares, or by Operator’s Contract, either by selling their shares, or by stopping their (financial/technical) support: the Operator stopping their (financial/technical) support: the Operator would then become an empty shell unable to reach would then become an empty shell unable to reach performance standards. performance standards.

THE OTHER GUARANTEES:THE OTHER GUARANTEES:

The The GENERAL PERFORMANCE SECURITYGENERAL PERFORMANCE SECURITY is triggered by is triggered by lack of performancelack of performance or not meeting the main or not meeting the main Levels of Levels of ServiceService;;

The PAYMENT GUARANTEEThe PAYMENT GUARANTEE ,for leases only, covers the ,for leases only, covers the payment of the Operator’s Monthly repayment [of the payment of the Operator’s Monthly repayment [of the Grantor’s part] of the total Grantor’s part] of the total Customer Tariff CollectionsCustomer Tariff Collections, , especially in the case of especially in the case of Bankruptcy of the Operator Bankruptcy of the Operator (annually maintained). (annually maintained).

. HOW IS THE AMOUNT CALCULATED?. HOW IS THE AMOUNT CALCULATED?

In case of In case of BankruptcyBankruptcy, or , or Termination Termination of the Contract due to of the Contract due to Operator’s Default, the Grantor often needs Operator’s Default, the Grantor often needs 6 months or 6 months or more to award a New Operator Contractmore to award a New Operator Contract following a following a competitive procedure. During this period, the services to competitive procedure. During this period, the services to end-users must be ensured at an acceptable level of end-users must be ensured at an acceptable level of performance, and this is financed by the total amount of the performance, and this is financed by the total amount of the two (cumulative) Guarantee and Security:two (cumulative) Guarantee and Security:

Parent Guarantee + Performance Security >= 6 months of Operating Expenses

Part II. Procurement IssuesPart II. Procurement IssuesA) Procurement procedure launch: Timing and A) Procurement procedure launch: Timing and

IssuesIssues FINANCING should be reasonably known to avoid FINANCING should be reasonably known to avoid

uncertainties in the Design of Contractuncertainties in the Design of Contract – example: Contract – example: Contract designed for 6 years, financing available only for 4 years. Result: designed for 6 years, financing available only for 4 years. Result: 4 years firm tranche + conditional tranche of 2 years (+1 year 4 years firm tranche + conditional tranche of 2 years (+1 year possible extension)possible extension)

Borrowers should explore in advanceBorrowers should explore in advance funding availabilityfunding availability from various sources not to affect or delay contract signing.from various sources not to affect or delay contract signing.

ParticipationParticipation in competition may be an issuein competition may be an issue – example: – example: previous incumbent allowed to compete for a subsequent previous incumbent allowed to compete for a subsequent contract?contract?

(see conflict of interest/level playing field guidance note)(see conflict of interest/level playing field guidance note)

Preparation costs can be very high for the BorrowerPreparation costs can be very high for the Borrower, (e.g. , (e.g. for an aborted lease contract more than $ 1 million)for an aborted lease contract more than $ 1 million)

B) Prequalification (PQ)B) Prequalification (PQ)

““criteria” or requirements should be balancedcriteria” or requirements should be balanced: if excessive : if excessive in number or level, risk to reduce access and competition, on the in number or level, risk to reduce access and competition, on the other hand: risk for the client => foresee the real needs/data over other hand: risk for the client => foresee the real needs/data over the period (population to be served, etc.)the period (population to be served, etc.)

Main criteriaMain criteria: (i) population served, (ii) operator’s experience, : (i) population served, (ii) operator’s experience, (iii) financial capacity, (iv) joint venture leadership, (v) ability to (iii) financial capacity, (iv) joint venture leadership, (v) ability to provide qualified staff.provide qualified staff.

Whose qualificationsWhose qualifications form basis for prequalification? The form basis for prequalification? The entities seeking PQ should have adequate qualification and entities seeking PQ should have adequate qualification and experience (parent or “sister” company data issue)experience (parent or “sister” company data issue)

Withdrawal of partnersWithdrawal of partners (or change) should be avoided (or change) should be avoided

C) Selection Process (incl. RFP) up to signing C) Selection Process (incl. RFP) up to signing (1 stage, 2 envelopes bidding)(1 stage, 2 envelopes bidding)

Criteria for each phaseCriteria for each phase (quality vs. price): Least Cost or QCBS (quality vs. price): Least Cost or QCBS method? (If QCBS, respective weights in combined evaluation: method? (If QCBS, respective weights in combined evaluation: 70/30 or 50/50?)70/30 or 50/50?)

Fine tuning the RFP (amending RFP is possible)Fine tuning the RFP (amending RFP is possible): after pre-bid : after pre-bid conference and “questions and answers”, but not laterconference and “questions and answers”, but not later

Withdrawal/Changes in JVWithdrawal/Changes in JV partners or parent companies support partners or parent companies support

““LOW BIDDING?”LOW BIDDING?” Bidder choice, Client risk: Bidder should remain Bidder choice, Client risk: Bidder should remain responsible for consequences of low bidding => Bidding responsible for consequences of low bidding => Bidding documents can be made more specific about minimum standards documents can be made more specific about minimum standards of quality and quantity of inputs required (e.g. minimum number of of quality and quantity of inputs required (e.g. minimum number of staff months)staff months)

Performance IndicatorsPerformance Indicators should be realisticshould be realistic, easy to , easy to measure, and their number tends to be reducedmeasure, and their number tends to be reduced

Conditional BidsConditional Bids and inappropriate assumptionsand inappropriate assumptions made by bidders in their bid are a problemmade by bidders in their bid are a problem

Contract negotiation delays: some Bidders try to “re-Contract negotiation delays: some Bidders try to “re-write” write” all clauses (this may lead to abortion)all clauses (this may lead to abortion)

D) Implementation problems and issuesD) Implementation problems and issues

Inappropriate staffInappropriate staff/ early changes of key staff/ early changes of key staff

Investment fund delayedInvestment fund delayed, delays in procurement by operator, delays in procurement by operator

Inappropriate Financial ModelInappropriate Financial Model: Tariffs and Regulation issues: Tariffs and Regulation issues

Political, red tape, delaysPolitical, red tape, delays: If authorities or local party do no : If authorities or local party do no comply with assumptions/obligations in time (impact on comply with assumptions/obligations in time (impact on performance indicators, role of Independent Auditor)performance indicators, role of Independent Auditor)

Control on PersonnelControl on Personnel: conflicts or lack of operator leverage: conflicts or lack of operator leverage

Withdrawal by OperatorWithdrawal by Operator or sale of shares of locally or sale of shares of locally incorporated Company (“empty shell” problem may be the incorporated Company (“empty shell” problem may be the consequence of low bidding)consequence of low bidding)

Attempts to re-negotiateAttempts to re-negotiate, or to sell expensive , or to sell expensive proprietary software should be avoidedproprietary software should be avoided

Confusion of rolesConfusion of roles: Bank/Independent Auditor or Dispute : Bank/Independent Auditor or Dispute Resolution BoardResolution Board

Part III. Innovations or experiments in thePart III. Innovations or experiments in the Procurement and Design of ECA Management Procurement and Design of ECA Management

Contracts ( nuts & bolts )Contracts ( nuts & bolts )

(i) (i) Previous incumbent allowed to competePrevious incumbent allowed to compete with full with full disclosure of information to others in the case of a second disclosure of information to others in the case of a second Performance-Based contract (after conflict of interest/level Performance-Based contract (after conflict of interest/level playing field discussion: see OPCPR Guidance Note at the playing field discussion: see OPCPR Guidance Note at the end of the Consulting Services Manual)end of the Consulting Services Manual)

(ii) (ii) Parent Companies or Partners of JV can choose:Parent Companies or Partners of JV can choose: either to either to co-sign orco-sign or to to provideprovide an additional Parent an additional Parent Company Guarantee Company Guarantee

(= 6 months of operator’s cost) – [see Clause slide](= 6 months of operator’s cost) – [see Clause slide]

[Georgia + 2 recent examples: ALBANIA 4 and ARMENIA 2 [Georgia + 2 recent examples: ALBANIA 4 and ARMENIA 2 (MWWPP “out of Yerevan”)](MWWPP “out of Yerevan”)]

(iii) (iii) Method of Selection and Criteria:Method of Selection and Criteria: One Management One Management Contract has been selected under Quality and Cost Based Contract has been selected under Quality and Cost Based selection method selection method (QCBS(QCBS usually applied to Consultant’s usually applied to Consultant’s contracts) contracts) with 70% weight on Quality, and 30% on with 70% weight on Quality, and 30% on price)price)

Note: 70% may be a redundant use of quality criterion with Note: 70% may be a redundant use of quality criterion with the first stage pass/fail requirement of 75 points in the first stage pass/fail requirement of 75 points in technical quality score, and may lead to a very high pricetechnical quality score, and may lead to a very high price

(iv) (iv) The yearly percentagesThe yearly percentages of fixed fee payment are no of fixed fee payment are no more equal, but partly more equal, but partly “front loaded”“front loaded” to take into account to take into account the wish of the operators to reflect the higher level of needs the wish of the operators to reflect the higher level of needs in the first years of a Management Contract.in the first years of a Management Contract.

(example: Breakdown on six years Armenia 2 RFP: 23%, (example: Breakdown on six years Armenia 2 RFP: 23%, 21%, 14%, 14%, 14%, 14%, and on 4 years: 32%, 29%, 21%, 14%, 14%, 14%, 14%, and on 4 years: 32%, 29%, 20%, 19%)20%, 19%)

(v) RFPs and draft contracts are updated and fine tuned (v) RFPs and draft contracts are updated and fine tuned after pre-bid conferenceafter pre-bid conference and series of questions and and series of questions and answers, and answers, and an amendment to RFP is issuedan amendment to RFP is issued..

(vi) To take into account and mitigate the “perceived risk” (vi) To take into account and mitigate the “perceived risk” of undue unilateral encashment of the unconditional of undue unilateral encashment of the unconditional Performance Security, a clause has also been added to Performance Security, a clause has also been added to have anhave an assessment by the Independent Auditor of assessment by the Independent Auditor of the Breach of Contract before encashment.the Breach of Contract before encashment. (Turkey (Turkey lease, Armenialease, Armenia 2) 2)

(vii) (vii) Performance Guarantee amount can now be Performance Guarantee amount can now be reduced on a yearly basisreduced on a yearly basis..

(viii) In Albania, RFP allowed, in case of Joint Venture, a (viii) In Albania, RFP allowed, in case of Joint Venture, a consultant to take the lead of the J.Vconsultant to take the lead of the J.V . .

(ix) New wording in RFP was used (Armenia 2) to avoid (ix) New wording in RFP was used (Armenia 2) to avoid Partners in joint venture using the references of sister Partners in joint venture using the references of sister companiescompanies belonging to the same group (not members of belonging to the same group (not members of JV)JV)

(x) In a re-bidding case, the Bank has suggested to (x) In a re-bidding case, the Bank has suggested to decrease decrease the minimum figures of population servedthe minimum figures of population served required for required for prequalification, to keep them at the present real level.prequalification, to keep them at the present real level.

(xi) (xi) To avoid underbiddingTo avoid underbidding, the Bank is considering to , the Bank is considering to suggest a borrower to try indicating in the RFP a suggest a borrower to try indicating in the RFP a required required minimum number of man-monthsminimum number of man-months for key staff. for key staff.