“After all is said and done, more is said than done.” Aesop
As an unsurprising consequence of the global financial crisis of 2007/08, a number of reviews have been commenced worldwide to verify the value of the contribution of private finance to public sector projects. As the earliest of such projects were established in the late 1990s, it has been an opportune moment to consider their outcomes. Here in the UK, whilst the analysis of a considerable volume of PPP projects across the globe continues, the Government has reduced the amount of public subsidy available to, and the pipeline of projects to be procured under, the private finance initiative (PFI). The UK Government has also modified the model form of PFI contract (relaunched as PF2(1)) in order to enable a separate competition to be held to determine who will provide the private finance to a specific project and also to allow the public sector to choose to take an equity stake in the project, if they so wish. However, PF2 has evolved out of the UK PPP experience and has sought to take on board other international perspectives. Therefore, many of the original features of PFI, as set out in the Standardisation of PFI Contracts Version 4 (SOPC4)(2), have been retained. To date, PF2 in the UK has been adopted largely within the schools sector but recently health sector schemes have adopted it too. In June 2015, the UK Government published guidance on early termination of PFI projects, although this anticipates that “the incidence of voluntary terminations of PFI arrangements [is likely] to be low”.(3)
That said, projects continue to be procured under Public Private Partnership (PPP) arrangements worldwide (and in the UK). Major infrastructure is in demand across the globe in the form of airports, new ports, high speed rail, telecoms and energy supply and generation to mention just a few key projects. Increasingly, the PPP model is being used to invest in social infrastructure, to provide and improve health services, education and schools and for housing projects, for example.
After this period of analysis, is it time to consider the learning points emerging from the research into existing PFIs and PPPs in order that new public projects are able to be progressed successfully with the input of the private sector?
Some signposts to success
Consider the type and value of the public project proposal. Is private finance the best solution?
Use of private finance and a PPP approach is necessarily complex and is an expensive procurement method in itself. The reasoning behind working with a private sector partner is to bring innovation founded on competition in the market place to resolving difficult issues with major public sector procurements. Inevitably, this means that there are no shortcuts to achieving such an outcome. All stages in delivering the project are crucial; the consultation or soft market testing process; the procurement itself; ensuring that there is real competition in identifying the best solution (encouraging new ways of working and value for money); the final selection process; negotiation of the contract terms with a preferred bidder; post-completion of the project documents, monitoring implementation of the project through the construction phase and further service delivery by a concessionaire or otherwise; and providing opportunities for regular contract review, to enable changes to the circumstances in which a project is delivered to be reflected and to allow for new technological solutions to be incorporated. Such a process for delivering major projects will take time and will cost money.
The role of Government – national or regional or via Government agencies
This is critical. Any PPP programme needs the clear and well defined support of national Government and needs to be progressed by the relevant body or agency in accordance with a transparent procedure. The purchaser in the public sector will require certain skills in pursuing a private finance solution and these may be provided by the public sector itself or via consultants. The public sector approach has to be consistent, ideally adopting model forms of contract documents. Without these key foundations, the private sector will be sceptical (correctly in my view) about the prospects of programme delivery and whether any private sector bidder will be wasting its time and money in seeking to deliver a project that may be cancelled or delayed many times over.
The legislative framework
Similarly, to inject confidence in the process, investors will need to be assured that national legislation will enable the programme of projects, and the individual project, to be delivered. In applying the PPP model to different sectors, specific legislation applicable to that sector may have to be reviewed and amended.
The form of finance
Those bidding to provide private finance will need to consider the full range of options, including debt financing, the proportion of equity and whether the public sector takes an equity share, the use of bond financing and whether the private sector’s financial contribution will be reduced by an element of Government subsidy. As mentioned above, there is an increased appetite for holding stand-alone competitions for the provision of private finance to a project and so careful consideration of the private finance solution may well be critical to investors’ success.
Changes to international accounting rules seem to require that more and more PPP projects are considered to be on the balance sheet of the public sector body procuring it. Inevitably, this raises issues as to how much debt and committed expenditure is held within public body accounts, particularly at times of close economic scrutiny following the global financial crisis of 2007/08.
Managing key risks
This too is an essential consideration with decisions taken early on. The PPP project needs to be clear about who takes the significant commercial risks associated with the project. These will include:
- purchasing/otherwise assembling the land;
- the construction phase and critical issues relating to sector specific construction/ innovative construction techniques;
- provision of services in the concession period;
- payment guarantees and the payment mechanism more generally, including penalties for poor performance and bonuses for high quality performance;
- assuming that termination is not envisaged as an everyday event, providing for appropriate compensation to be paid to the private sector on termination, in the case of a “no fault default”; and
- selecting an appropriate and proportionate form of dispute resolution.
Of course, these are vital components of the commercial and legal negotiations around any project and they will necessarily impact on the price that will be paid by the public sector for the project. The equation is as follows: the more risks taken by the public sector, the less the payment to the private sector and so, perhaps, a smaller private sector equity return? (See below.)
What is the appropriate return on investment for the private sector?
This is a difficult one to determine. It is influenced on a project-by-project basis by issues including: the number of projects similar to the project with a proven track record in that particular sector; whether the project is particularly innovative; and the cost to the public sector of procuring the project without the involvement of the private sector. It can also be impacted by the learning points above on the role of Government, regional government and other agencies and the legislative framework. Again, analysis of the learning over time suggests that as a pipeline of particular projects is rolled out within a sector, there is an expectation of greater efficiency, better value for money and, therefore, lower rates of return on investment.
Executing the contract documents is only the beginning
With contract terms of 20 years or more, PPP projects will raise a number of operational phase issues over many years. The public sector will be keen to monitor performance and payments in order to ensure that value for money is achieved. Contracts may well include provisions relating to market testing and benchmarking on price for any services supplied to the public sector once the project has been built out. Increasingly, contract terms look ahead to enable the delivery of services and lifecycle replacements which are able to adapt to new market conditions and adopt new technology. The private sector partner may choose to undertake a refinancing of the project at the end of the construction phase or following other critical project milestones. The contract terms are likely to provide for gains to be made under any refinancing to be shared with the public sector.
Taking a little time out to consider the learning from other projects across the globe may well prove to be a good tactic to employ, whether working with the public or with the private sector, either at the outset of a new programme of PPPs or before embarking on an innovative stand-alone project. After all, to quote Aesop once more:
“Slow but steady wins the race.”