Overview of PPPs

Raymond BourdeauxThe World Bank

St. Petersburg – May 22, 2008

What is a PPP?

What is a PPP: Key characteristics

• Agreement between Public and Private sector entities

• Often (but not always) on a long term basis)

• For the provision of services or a facility, most often defined as outputs

• Payments may flow in either direction between private sector and the government (sometimes both)

• Risks are shared between the private sector and the Government

• But foremost this is a partnership

PPPs : Spectrum of Options

Private Participation in Infrastructure (PPI) Private Participation in Infrastructure (PPI)

focus is payment for delivery of services rendered

and transfer of the performance risk.

Sectors where PPPs are involved

• Tendency for project to cascade from central to local government / municipalities.

• Most countries commence PPP programmes in transport, with later migration to other sectors.

• Rate of ‘migration’ to other sectors (health, education, energy, water, waste treatment) reflects i) national priorities and ii) legal frameworks.

• Pathfinders set the path for better or worse

Sectors where PPP are involved, natural evolution

PPP are also a procurement process …

• Procurement mechanisms are different from a “typical” State procurement and require a specific legislative framework

• Overall process has steps specific to PPPs

• Process seeks to get the best of competitive tension to achieve an optimal risk allocation and a low price

• Contrary to a typical public procurement, there is significant steps post contract award

• Procurement timetable might seem longer, but this because the project is procured once, not in slice over many years

… an evaluation methodology….

• What are the risks faced by the Government over the life cycle of the project and how they should be allocated?

• Evaluation looks at all risk related aspects (commercial, financial, technical)

• How does a PPP compare with a typical procurement?

• Evaluation looks at cost to the City over the life of the project, not over the construction period

… and a way of raising finance

• Project Financing:– Usually, revenues are generated only once

construction is completed– Based on evaluation of future cash flows– Based on contractual documentation

• Limited recourse Financing:– Capabilities of sponsors and track records– Risk allocation is key

What PPPs are not

• A magic wand

• A time traveling machine

• A way of transforming capital markets instantly

• A way to make investors forget about their objectives

Implications:

• Procurement objectives should be different than for public procurement

• Ways of identifying and evaluating risks should be adapted to PPPs

• Time table should reflect specifics of PPP (3year average for PFI tender)

• Approval process within Government bodies should reflect the specifics of the PPP process

Why bother doing one?

Why bother doing one?

PPP requires significant upfront preparation

But such preparation is precisely the assurance that the risk allocation is thought through for the period of the concession, not

just construction

Everything needs to be evaluated in advance rather than as the (public) procurement is done

Why bother doing one?

For the first deals but the learning curve is there

But if the process is well managed and transparent, it works and delivers benefits

Until financial close there is no certainty that the project

will be successful

There are so many players involved that this requires

large amount of management throughout the

process

Why bother doing one?

Private sector cost of capital is higher than public sector cost of

capital, so is it cheaper?

If the projects are badly structured or the situation

changes radically

PPPs get restructured anyway

But the real cost to the Government is a risk

adjusted cost over the life of the project

Key Benefits of DBFO Contracts ALEC BRIGGS, SENIOR PROJECT LEADER, HIGHWAYS AGENCY march 07

• Fostering development of a private sector road operating industry

• Better outturn cost certainty

• More reliable and accurate expenditure forecasts

• Transfer of appropriate levels of risk to private sector

• Improved partnerships between public and private sectors

• Provide scope for innovation in all areas including finance

• Overall, provides better value for money

OBJECTIVES FOR PRIVATISATION of UK RAILWAY SECTOR (legal team associated with the privatisation process)

• Official objectives were:– Provide greater incentives– Allow choices through competition– Give railway managers the freedom to manage– Set clear and enforceable quality standards– Reflect regional or local identities– Improve efficiency and reduce costs

• Real objective was desire to use private sector funding and to reduce subsidies

• Labour’s threats to re-nationalise increased risks of investing and led the Government to moderate competition

• Political necessity made privatisation itself the objective rather than the means

% of projects in sample

Conventional procurement

PPP procurement

Cost overruns for the public sector

73% 22%

Delay in project delivery 70% 24%

PPP performance: Evidence on construction projects from the UK’s National Audit Office

Benefits of Private Sector engagement

• To mobilize private funds, and focus public funding in areas where private money cannot be channeled

• To leverage public resources by spreading public costs over the life of the project,

• To link quality of services to payments and focus role of the state on improvement of service

• To benefit from private sector expertise and know-how

• To respond in time to increasing public demand for public services

• To meet expectations for access to more and better services

• To address backlogs in infrastructure maintenance

• To drive costs down by introducing competition in areas where competition might not be present

• To increase transparency

Advantages of long term Concessions in the Transport Sector

• Facilitate and create flexibility for the development of projects where users have willingness to pay for services;

• Facilitate establishing specific level of service standards that can be easily monitored;

• Allows addressing anti maintenance bias of Public Work Ministries;

• Create market discipline if allocation of risks are properly designed(commercial risks should be born by the firms);

• Allows technology modernization through FDI;

• Reduce natural monopoly costs and information monopoly creating competition for the right to provide the services;

• Facilitate the trade off between investment and operational cost;

• Create incentives for capital market reform;

• Rationalize the use of infrastructure promoting efficient user charges.

Main stakeholders

Main Stakeholders

Government

Operator

Investors

Lenders

End Users

Equipment suppliers

Construction companies

Decision making process during bid for investors

• Approval to proceed with prequalification

• Approval to proceed with bid preparation

• Update on bid and discussions on main parameters

• Management approval to submit a bid

• Management approval to close the transaction

Typical bank decision process

• Marketing phase “ of course we can do it”

• Letter of interest “we may be interested in doing it”

• Management approval in principle

• Letter of support “we are interested subject to”

• Draft term sheet “this is how we are thinking of doing it”

• Mandate letter “you have an obligation to do it with us, against payment of fees”

• Credit committee approval

• Loan signature

Incre

asin

g co

mm

itment

Government support: what does it mean?

• Strong, political will and leadership

• Clear and supportive legal framework

• Coordinating entity within the Government, to provide support for PPP

• Setting priorities among most promising projects, in terms of economic efficiency

• Listen to the market and react accordingly

• Be prepared to be flexible

Some practical conclusions

When PPPs go wrong …

• Some external elements are difficult to manage:– Macro economic shocks– Lack of interest of international investors “Enron crisis”– International banks withdrawal

• But often design problems that can be overcome with the right process:– Partial feasibility study– Unrealistic risk allocation– Financial viability of project poorly defined– Unclear legal environment (legal, regulatory, tax etc..)– Lack of capacity for project follow up during construction

and operation

PPP Pros. PPP Cons.

• Competitive process• Increased transparency• Well designed risk

allocation• Cheaper over the life of

the project• Private sector

efficiencies and innovation

• Commercial risk sharing

• Complexity

• Time to prepare• High transaction

preparation costs• Skill deficit for

Administration• Structuring risks• Public perception and

political reactions

What have we learned?

• PPP need serious commitment at all Government levels and require a carefully coordinated approach by all Government counterparts

• PPPs are time consuming process

• The more preparation at the beginning, the quicker the process to financial close:

• The more hurried the preparation the longer the process to financial close and the higher the chance of failures

• Bid award is not the end of the story (larger scope for project modification and half time in development process on average)

Some practical conclusions

• PPPs are about risk sharing: this requires a flexible approach in ways that are different from the typical procurement process

• Some risks are not taken into account in public procurement processes: if they are taken under consideration under a PPP it does not mean that the risk should be allocated to the private sector

• Stronger the competition, the more the project is likely to lead to significant benefit to the Government

• The worst negotiating position is not to be able to walk away. There is always the possibility not to conclude a deal and to do a typical public procurement

Some practical conclusions

So, yes, it is difficult, but it delivers results!

Investment commitments into infrastructure projects with private participation in developing countries by sector, 1990-2006

Energy

Telecom

Transport

Water

Total

0

20

40

60

80

100

120

140

160

1990 1992 1994 1996 1998 2000 2002 2004 2006

2006

US

$ b

illi

on

Source: The World Bank and PPIAF, PPI project database

Overview of PPPs

THANK YOU !!!

Raymond BourdeauxThe World Bank

Rbourdeaux@worldbank.org