There could also be scope for risk-sharing in relation to prison capacity and prisoner mix within defined boundaries. The DCMF or BOOT-type approach can often be more contractual than cooperative.
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Role of the private sector increasing
Private party role Infrastructure services Infrastructure and Infrastructure and Infrastructure only ancillary services partial private-to-public and service delivery
service delivery to users
Government role All public-to-public Delivery of core public Delivery of core pubilc No operational role
services services services
Examples Public buildings Non-core hospital Community facilities Rail, road, port services, non-judicial linked to educational facilities, car parks court services facilities (e.g. after-
hours usage)
Source: Partnerships Victoria (2001).
Related Services
‘Related ancillary services’ encompasses a number of operational services, including information technology services, accommodation services arising out of the infrastructure, building-related services such as maintenance and some support services. Notably, in all cases, land and property are required for the delivery of the PPP service, and often the private party can gain value from an imaginative development of the property site that is integrated with and complementary to the project. An example of this comes from the Spencer Street Station redevelopment project, designed to be fully operational for the Melbourne 2006 Commonwealth Games.
The Spencer Street Station contract provides for the Civic Nexus consor- tium (led by ABN-AMRO) to redevelop the station to an agreed standard and to operate it for a period of 30 years, after which ownership passes to the State government. Civic Nexus will also develop catering and retail services within the station, and it has acquired commercial development rights in neighbouring properties over which it has a 99-year lease. The project has a number of notable features including the iconic roof design. But from the outset the winning bidder did not think of the project as a station, which is what might have happened under traditional procurement. Instead, Civic Nexus saw the location as a junction point where people congregate with cash in their pockets, and it set about combining transport, retail, commercial office space, and residential inner-city accommodation in a way that will help integrate the adjoining Docklands development (which includes a major sporting facility) into the City of Melbourne and serve as a suitable structure to occupy a central position in an expanded central activities district of Melbourne. The idea is for the station to recover its historic role as the main thoroughfare to the city.
From a property point of view, it may seem that the analysis of a PPP project involves many of the same principles as a joint venture/development arrangement in an open commercial environment. Perhaps the main differ- ence between the PPP and the various property-based public/private joint ventures that have preceded it lies in the fact that the PPP encourages partic- ipants to focus on service delivery. This contrasts with the more traditional institution-led view of regarding the assets per se as having intrinsic value. If the private sector can add considerable value from an integration on the prop- erty side of a project and thereby reduce the cost of service provision to the government, then it is the public that ultimately benefits. In addition, on the government side, senior management is freed from the everyday issues of infrastructure ownership and management and the delivery of related ancil- lary services. Management’s focus on service delivery is not distracted by time and cost overruns in construction, maintenance needs, infrastructure that
is not quite fit for purpose, and staff and client unrest that could be resolved by a refurbishment of facilities if only funds were available.4This leads into the issue of finance.
Financial Aspects
Governments frequently have been motivated to enter into PPP arrangements by the desire to reduce debt (and contain taxation), while facing pressure to improve and expand public facilities. However, the argument that PPPs are the only way of delivering the public infrastructure (and the services) that the community wants is exaggerated, for PPPs still draw on public funds when user charges do not cover the cost of services. What differs is that the public payments are made over a very different time frame. When infrastructure is provided under a PPP, the government does not own the asset but, instead, enters into a contract to purchase infrastructure and related ancillary services over time from the private sector. These operating payments must cover oper- ating costs as well as giving the service providers a return on risk capital, therefore a project delivered under a partnerships approach will have a similar (although not identical) effect on the government’s annual operating surplus to that if the asset was publicly funded.
Figure 5.2 illustrates the cashflow differences between public funding and a PPP project. From the public sector side, PPPs require little or no upfront capital expenditure but involve a larger operating expenditure over time to purchase the services. By contrast, the public asset approach requires a large
Figure 5.2 Comparison of public funding and partnerships on cashflows
Cost to government
♦ ♦ Public funding • • Partnership approach time
♦
♦
• • •
♦ ♦ ♦
• •
Impact on cashflow statement
upfront capital funding commitment and relatively lower operating expendi- ture over time. Thus the PPP route may on these grounds hold some attractions to a government with a backlog of infrastructure projects and facing an uncer- tain fiscal climate – a not unimportant consideration for many transition coun- tries. But the major merit is in terms of the predictability of costs and funding.
A PPP ensures that whole-of-life costing and budgeting are considered, providing infrastructure and related ancillary services to specification for a significant period, and including any growth or upgrade requirements. This provides budgetary predictability over the life of the infrastructure and reduces the risks of funds being diverted (for example, away from scheduled refur- bishment) during the life of the project, impacting on residual value risk to the asset. Certainly, pricing predictability and whole-of-life costing were impor- tant considerations for the NHS Trust in the West Middlesex University Hospital redevelopment, examined as a case study in Chapter 6.
Treatment of Risk
Financing is only one element of the calculation. Infrastructure procurement has traditionally been viewed by the public sector as asset acquisition from private sector contractors, the responsibilities of which were limited to the construction of the asset, while the risks associated with the financing and operation of the facility remained with the public sector. With a PPP, the emphasis is on the purchase of infrastructure-based services, and the alloca- tion of risks in the transaction is quite different.
In theory, the conception of risk allocation with a PPP is straightforward.
The government frees itself entirely from asset-based risk (including design, construction, operation and possibly residual value risk), and becomes the purchaser of a product that is risk-free in the sense that government does not pay if the service is not delivered, or is not delivered to the specified standards.
That is, the public sector purchases the long-term provision of a service of a guaranteed standard, along with the security that if the service is not provided at the right time or to a satisfactory quality then reduced payments are made or compensation is received.
That is the underlying philosophy. In practice, risk allocation in a PPP is more complex. Rather than shifting all risk to the private sector, the policy aims at allocating risk to the party that is best suited to manage it and demon- strating value for money for any expenditure by the public sector. Those in the best position to manage a particular risk should do so at the lowest price.
Unloading inappropriate forms of risk onto the private entity merely adds unnecessary cost to a PPP agreement, as the private sector does not bear risk cheaply. Driven by the requirement for ‘value for money’, the government may agree to assume some risks for which the private party would charge too
much if the risk transfer to the private party were to remain complete. Only
‘efficient’ levels of risk should be transferred to the private party, reducing individual risk premia and the overall cost of the project.
Thus the conceptual framework underlying PPPs is that, as service recipi- ent paying only on satisfactory delivery, the government initially transfers all project risk to the private party. It is then a matter for government to deter- mine, on a value-for-money basis and having regard to the cooperative frame- work of the partnership, what risks it should ‘take back’ to achieve an optimal risk position. Taking back means a deliberate decision by government to assume or share a risk that would otherwise lie at the door of the private party.
The outcome of this analysis is reflected in the contract.
The upshot is that a PPP contract differs from a standard procurement contract because it is not part of a traditional product supplier/buyer relation- ship. Under a PPP, the parties allocate risks between them and work together in an ongoing relationship to meet project objectives. It is also more complex than a procurement agreement. For example, the contractual framework for a County Court in Victoria included a Crown lease, a court services agreement, a multi-party agreement for financiers, a commercial site and building, bond issuance contracts, and subcontracts for operation, maintenance and finance.
Whole-of-Life Cycle Contract
When considering risks and negotiating a risk allocation position, the public sector party would prefer to deal with a single entity which is fully account- able for all contracted services. From a government point of view, risk trans- fer is most effective if there is a ‘whole-of-life cycle’ contract with a single private party, to give that party the strongest possible incentive to ensure that the design and construction phase converts into a highly effective operations phase. Behind the private party, however, there may be a number of private sector interests. The distinctive feature of current PPPs is the bundling of finance, design, construction, operations, and maintenance. Because these functions are highly specialized, private sector providers tend to be consortia consisting of engineering and project management firms, construction compan- ies, financial underwriters, and operating enterprises that come together to develop a particular facility.
Generally speaking, private entities take on risks if they can be appropri- ately priced, managed and mitigated, which often involves transferring the risk to a third party, by way of subcontract or insurance. Should there be a risk, say, that an innovative design for a project may not be suitable for the designated purpose, that risk may be partly mitigated by appointing an experienced (and insured) designer. The consortium then accepts the risk, provided it can earn a commensurate return.
However, if the risk is one which carries a significant probability of inter- rupting or diminishing the payment stream that will service the debt, a signif- icant premium may be demanded to assume that particular risk. This in turn greatly increases the cost of financing the project. The private party’s uneasi- ness becomes more acute when the risk is not within its control. In such cases, it may be possible to change the nature of the risk so that it can be taken on.
If this cannot be done, it may well be more cost-effective for government to
‘take back’ the risk and reduce the costs of financing the project.
Hence one way to get value for money in a PPP is through sensible risk allo- cation, but it is not the only means. One of the appeals of PPPs is that they may be a vehicle through which the ‘can do’ mentality of the private sector is imported into public services, and the integrated PPP structure creates incen- tives to realize ‘synergy’ gains (such as fewer disputes between builder, opera- tor and owner and a closer examination of capital/maintenance costs) that are not available if the owner is government and the other functions are simply contracted out. Effective use of public funds on a capital project can accord- ingly come from private sector innovation and skills in asset design, construc- tion techniques and operational practices, as well as from shifting the responsibility for design risks, construction delays, costs overruns and finance and insurance to the private sector entities. Without the risk transfer the incen- tives would be blunted, and all parties need to understand the implications of the risks to be managed. The value-for-money test, considered in Chapter 6, is one way of drawing attention to the risks. So is the development of a risk matrix for the purpose of risk management and allocation, examined in Chapter 7. For the moment, we consider the parties to a PPP and their respective functions.