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

1. Overview of the day

2. Trend towards PPPs and the rationale for PPPs

3. Definition

4. Affordability

5. Risk

Session 2: Value for money and the need for competition

6. Competition and Value for Money

7. PPPs and the nature of the service

8. The Public Sector Comparator (PSC)

9. 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)

Including London Underground projects

Excluding London Underground projects

Total capital value

% of total Total capital value

% of total

Health 8 290 16 8 290 23

Transportation 22 496 42 4 902 14

Defence 5 644 11 5 644 16

Education 4 388 8 4 388 12

Others 7 203 13 7 203 20

Scotland, Wales and Northern Ireland

5 380 10 5 380 15

Total 53 404 100 35 807 100

Source: HM Treasury, 2007.

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

Rank 2004

Country Value USD

millions

Deals % share

Rank 2003

Value USD

millions

Deals % share

1 United Kingdom

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 United States 2 202 3 5.4 4 927 2 3.6

6 Hungary 1 521 2 3.8 11 251 1 1.0

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.a.

Source: Dealogic, quoted in OECD, 2006a:57.

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: 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 a service.

Standard and Poor’s: 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 policy outcomes.

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 effectiveness of the alignment depends on a sufficient transfer of risk to the private partners.

The private partners usually design, build, finance, operate and manage the capital asset, and then deliver the service either to government or directly to the end users.

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 and VFM are the benchmarks for PPP viability.

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 the value of existing public debt.

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.

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

1. Should gov use traditional procurement: Large initial capital outlay will cause a gov entity to exceed its allocated budget.

2. 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.

3. 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 may

contribute to breaking the budgetary limit 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 may be main reason 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 is

linked to the extent that its actual performance complies or deviates from expected (and contractually agreed) performance.

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) – includes

wasteful use of raw materials, appointment of too many personnel.

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.

There are five major types of response:1. Risk avoidance, whereby the source of risk is

eliminated or is altogether bypassed by avoiding projects that are exposed to it.

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

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

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

5. 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 VFMmax

σoptimal 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 lower than cost dealing with fallout (incurred by both private partner and government): 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 and lack of competition: no

VFM. Competition important in pre- and post-contract

phases. Pre-contract phase competition occurs in the bidding

process. 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. How does government end up with too few bidders?

1. 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.

2. 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 also a complex issue.

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 becomes a monopolist supplier.

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 smaller contracts).

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

Government may lack skills and capacity to match negotiating skills of foreign firms.

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 of goods characterised by non-

rivalry and non-excludability 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 quality & quantity and payment depends on delivery of specified quantity & quality

As such, PPP contracts can be very inflexible. Example: 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 time

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 (e.g. roads and water works), followed by education and health projects and lastly ICT 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: establishing the rights and obligations

of both parties; performance specifications: technical, financial, and service

requirements; 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: UK, Australia and South Africa.

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 of a PPP by ensuring full life-cycle

costing be sure that compared to traditional procurement PPP will deliver

better VFM PSC also helps to:

manage discussions with private partners on critical issues such as risk allocation and 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/ additi

onal_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 to

contract 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: Private partner remuneration

dependent on actual, measured performance relative to contractually agreed performance

What do countries do? UK: monitoring in form of both formal and informal

analysis to assess VFM Formal analysis: Market-testing and benchmarking

exercises for soft services as set out in the original contract Informal analysis: Compare outturn data to original

assessments. Government uses target benchmarks for Key

Performance Indicators (KPIs). 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. whether or not the contractor is actually delivering the VFM

agreed upon in the contract and 2. 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 to have specified target levels 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

Victoria, Australia

Brazil France Hungary United Kingdom

Efficiency measures defined in terms of inputs and outputs

Effectiveness measures in terms of outcomes

Service quality measures

Financial performance measures (1)

Process and activity measures

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 for the following year and its budget for the next two financial years.

It must also provide unaudited financial documents on a six-monthly basis and

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 of most PPP units is to

ensure that all PPP agreements comply with the legal requirements of affordability, value for money 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 to government departments,

provinces and municipalities who want to set up and manage PPPs, and

To provide National Treasury approvals during the pre-contract phases of a PPP agreement.

However: PPP unit should not be involved in post-contract management of

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

revisions 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 will not terminate support to PPPs

Location of PPP unit In government there is a natural tension between

spending ministries and the treasury 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: to assess affordability and value for

money 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: to assess economic impact of large projects Experts 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, demonstrate that they have the capacity to manage project

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 between accountability

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

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 by an independent auditor

There should also be proper internal financial and accounting controls to manage (i.e. prevent and detect) corruption

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 of the private sector to

produce VFM 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 panacea to all government’s problems. Indeed, as we have seen, there are several prerequisites 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_ partnership

s

Partnerships Victoria (State of Victoria

(Australia)): www.partnerships.vic.gov.au

PPP unit (South Africa): www.ppp.gov.za