i Emergence of public–private partnership
Although there is no uniform definition of public–private partnership (PPP), it is generally accepted that PPP refers to a collaboration between the public and private sector for the delivery of public services and infrastructure. It developed not only because of a need for increased investment in public infrastructure, but also as a method of improving service delivery by the public sector without having to resort to privatisation or the need for increased public funding as it is structured on a project finance basis. It differs from conventional public procurement in that it is generally a long-term, output-based arrangement with risks being allocated to the party best placed to bear them, with the aim of minimising cost overruns and delays by using private sector expertise, thereby achieving value for money. PPP involves not only the construction of the infrastructure, but more often than not also its long-term operation and maintenance.
PPP can take on various forms, the most common of which are private finance initiatives (PFIs), concessions and joint ventures. Other forms include integrators, strategic infrastructure partnerships and hybrid approaches. While all PFIs will be PPPs, not all PPPs are PFIs. In this chapter, all forms of arrangements described above involving public and private parties will be referred to as PPPs, while PFI will be a reference to a subcategory of PPP.
The characteristics and development of the concept differ from jurisdiction to jurisdiction, as does the terminology used to describe it. For example, what is referred to as PPP in the Netherlands and South Africa will be referred to as PFI or PF22 in the United Kingdom, PFI in Japan and Malaysia, and P3 in the United States and Canada.3
ii Differences between PPP and PFI
The key difference between PPP and PFI is the manner in which the arrangement is financed. While PFI will utilise debt and equity finance provided by the private sector to pay for the upfront capital costs, the same is not required in a PPP, where the parties have more freedom to structure their contributions. Depending on the structure, PPP can therefore include public sector finance.
A further difference is that while a PPP may be structured as a joint venture or through contract, a PFI will make use of a special purpose vehicle (SPV) that will not only enter into contractual arrangements with the relevant public sector entity, but will also enter into the financing arrangements with its shareholders and external financiers.
iii Various models of funding public sector contribution in PPP
Funding refers to the sources from which funds are obtained to pay for project costs during the term of the project, as opposed to the sources or types of financing used to pay for the upfront capital costs. The contributions of the public sector in PPP projects are primarily funded from the general budget and user charges.
Revenue available as part of the general budget is collected from various taxes (such as income tax and VAT, or specific taxes such as emissions taxes or fuel excise that are allocated to a specific fund) and public sector income, which is then used for the payment of project costs. This is an indirect funding option as the revenue stream is not linked to a specific project. This model is usually employed in relation to projects with availability-based payments, such as PFIs involving government head office accommodation or prisons where the project itself will not generate revenues or where revenues are uncertain owing to the uncertainty of demand.
User charges on the other hand are a direct funding option, as the fees (such as tolls) collected from users of the service or from secondary services associated with the infrastructure (such as fees or income from petrol stations and restaurants located along the tolled road), will be used to pay for the costs of the project that is providing that service. This model is usually employed in relation to concession projects involving roads or utilities that are revenue generating.
The value capture funding model is based on the assumption that an investment by the public sector in infrastructure will result in increased land value in the surrounding area, and the model tries to monetise some of that value. This can be achieved by one-off or longer-term payments, from taxes collected based on the increase in the value of land resulting from the new infrastructure, or from levying an additional tax upfront to fund the new infrastructure that the payer will later recoup by benefitting (whether directly through use, or indirectly through, for example, increased accessibility by others to its property) from that infrastructure.
Although the above are the most common funding models, the public sector may also try to obtain funding from donations, whether from the public in general or specific benefactors, sponsorships or specific levies or rates.
The options utilised will depend on the type of project, the legal framework, and the political and economic circumstances in the relevant jurisdiction, and may include a combination of the models. For example, road PPPs in the Netherlands are funded from the general budget, while in South Africa they are generally funded from user charges.
Because the funding model will only be as good as the private sector investors it attracts, it should be tailored in such a way that it provides them with comfort about the certainty and stability of funding, taking individual project and market conditions into consideration. This should not discourage the public sector from trying to develop new and innovative ways to fund PPPs, but it needs to be prepared for investors that may be looking for a more conservative funding approach. For example, the Uganda Police Force accommodation project in 2010 was based on a plan to cross-subsidise the public sector infrastructure with income from a matched commercial development. However, at that time the investors, who were still dealing with the consequences of the financial crisis, were not able to commit to the proposed structure.
II Types of assets financed by PFI
A multitude of public services and infrastructure are capable of being financed by PFI, on national or federal, provincial or state, and local levels, as well as government bodies. The type of assets financed will again be jurisdiction specific, and do not comprise a static group but will evolve over time to take into account the developing public sector services required to be provided. Projects with proven technologies are more common in PFI owing to the ability to assess the associated risk better, although that is not to say that new and unproven technology cannot be used for PFI – the parties will need to allocate the risk in a manner to ensure the project is bankable.
i Social infrastructure
Social infrastructure refers to government or accommodation infrastructure that is used to house a division of the public sector performing an administrative function, such as a specific government department, or to infrastructure that provides a social service, such as a police station. Because social infrastructure is typically not revenue producing, it is usually paid for with availability-based payments and funded through the general budget. The assets will include:
- courthouses (such as the PPP for the design, build, finance, maintenance and operation of the new district courthouse of Amsterdam in the Netherlands);
- correctional facilities (such as the New Grafton Correctional Centre, a new 1,700-bed facility located in northern New South Wales, Australia);
- educational facilities, including primary (such as the new schools PPP project for the finance, design, construction and maintenance of 15 schools in Victoria, Australia) and higher learning (such as the proposed greenfield PPP development of, among others, student and staff accommodation, and cultural facilities for the University of Abuja in Nigeria);
- hospitals and healthcare facilities (such as the upgrading and operation of the Port Alfred and Settlers District Hospitals for the Eastern Cape Department of Health in South Africa);
- government buildings and related facilities (such as PPP for the serviced head office, accommodation, as well as guest house facilities, for the Department of International Relations & Cooperation in South Africa);
- social housing (such as the social and affordable housing PPP project in Bahrain, involving the development of more than 2,800 social and affordable housing units in Al Madina Al Shamaliya and Al Luwzi); and
- sports stadiums and recreational facilities (such as the financing, design, construction and operation of the S$1.3 billion Singapore Sports Hub integrated sports and leisure complex, including a stadium, aquatic centre and a multi-purpose arena).
ii Economic infrastructure
Economic infrastructure on the other hand refers to infrastructure that provides utilities, such as power production, and infrastructure that aids economic activities, such as ports. It is usually paid for through concession payments funded by user charges. The assets will include:
- airports and supporting facilities (such as the PPP-style project for the renovation, extension and operation of the Queen Alia International Airport in Amman, Jordan, with a unique financing structure comprising both conventional financing and an Islamic finance istisna'a and ijarah facility);
- gas transmission and distribution systems (such as the liquefied natural gas receiving and regasification terminal in Bahrain, with a capacity of 400 million standard cubic feet per day (expandable to double this capacity));
- ports and marine terminals (such as the US$1.5 billion greenfield deep-sea container port on the Lekki peninsula in Lagos State, Nigeria);
- power (such as the US$142 million KivuWatt methane to power project, at Kibuye, on the shore of Lake Kivu in Rwanda, which utilises innovative technologies that are unique to this project);
- transmission facilities and systems (such as the 500 kilovolt, 500km, C$1.65 billion transmission line for Alberta Electric System Operator, the largest public–private financing ever completed in Canada);
- rail, including passenger rail (such as the Sydney Light Rail Project PPP in Australia involving the finance, design, construction, testing and commissioning of a new light rail line between the CBD and south-east Sydney, and the operation and maintenance of the Sydney Light Rail network, which includes the new CSELR and existing inner west light rail) and mass transit (such as the design, construction and maintenance of the A$6 billion Melbourne Metro Tunnel and Stations project involving twin 9-km rail tunnels underneath the CBD and five underground stations);
- roads (such as the €1 billion Blankenburg Connection project in the Netherlands to improve road links between Rotterdam and its port, the largest PPP project awarded in the Netherlands to date) and bridges (such as the US$374.2 million BOT PPP Rosario Victoria 608-metre toll bridge project in Argentina);
- technology, including broadband and telecommunications (such as the Red Dorsal Fiber Optic PPP in Peru on a country-wide scale, and financed through a US$274 million greenfield project bond);
- tourism (such as the 11 PPPs entered into by the South African National Parks);
- waste and waste-to-energy (such as the construction and commissioning of Australia's first thermal waste-to-energy facility in Kwinana, Western Australia, which will process 400,000 tonnes of waste into 36 megawatts of baseload energy);
- water (such as the Kigali bulk water treatment plant PPP in Rwanda, which will provide 40 million litres a day of fresh and clean water, being 40 per cent of the Kigali city's potable water requirements, and which is also the first project financed bulk surface water project in sub-Saharan Africa (outside of South Africa));
- wastewater (such as the Core Area Wastewater Treatment Program in Canada within the Capital Regional District, which includes a wastewater treatment plant, a residuals treatment facility, pump stations and conveyance pipelines); and
- desalination plants (such as the seawater desalination plant PPP for the provision of irrigation and water supply in the Grand Agadir and Souss-Massa regions Morocco, which will have a production capacity of 275,000 cubic metres per day, expandable to 400,000 cubic metres per day).
Other infrastructure includes:
- defence (such as the Allenby & Connaught PFI project in the United Kingdom involving the redevelopment of garrisons and the construction of new barracks); and
- water defences (such as the Eefde Lock PPP for the design, build, financing, operation and maintenance of the second lock on the Twente Canal in the Netherlands, including supporting infrastructure).
III Principal characteristics of PFI financing
Because most PFI financings are also categorised as project finance, the same principal characteristics will apply to both, including being structured on a limited or non-recourse basis through an SPV (therefore on an off-balance sheet basis), with the main difference being that the public sector is a party to the project documentation.
Owing to the complexity and costs associated with PFI, only large projects (or a collection of smaller, related projects grouped into one) will be financed in this manner. PFI is therefore characterised by a significant upfront capital investment during the construction period, resulting in a high (usually between 90:10 and 80:20) debt-to-equity ratio. As the returns on the capital investment will be realised over the life of the project (typically 20 to 30 years), the PFI financing will be long-term financing to align it with the lifecycle requirements.
The equity portion is usually made up of share capital and subordinated shareholder loans provided by the sponsors and financial investors, although often externally financed during the construction phase. The debt portion is usually provided by commercial and institutional lenders, and to a lesser extent debt capital markets. As the SPV will only start receiving income after the construction of the infrastructure is completed, the repayment of debt will be aligned with cash flows. In the case of a default, the lenders will have the option to step in.
This article is an extract from The Project Finance Law Review, 2nd Edition. Click here for the full guide.
1 Ania Gorna is a senior associate at Norton Rose Fulbright LLP.
2 The 2018 Budget published on 29 October 2018 stated that PF2 (which replaced PFI in the UK) will no longer be used on new projects. https://www.gov.uk/government/publications/budget-2018-documents/budget-2018.
3 This chapter discusses PPP and PFI in general terms and sets out the underlying principles associated with them. Jurisdiction-specific treatment of PPP and PFI is beyond the scope of this chapter.