There are several papers regarding best practices in formulating PPP policies, but Public-Private Partnerships: Eight Rules for Governments (October 2008) by Aidan Vining and Anthony Boardman is probably one of the easiest to read.
This post is just a précis of the paper (do go through the original). Though it is meant for policy-makers, the paper should be read by lenders and advisors trying to get a sense of potential risks that cannot be modeled mathematically on an excel sheet. It is especially informative for managers / financiers / consultants who work with projects in multiple geographies and have to deal with different deal structures and concessions.
The rules are simple enough:
1. Establish a jurisdictional PPP constitution
As far as possible, use existing constitutional institutions and constructs to ensure transparency in the contractual structure. Ensure public availability of contracts (except for legitimate trade secrets).
If such constitutional means are not already available, the legal & constitutional framework should be put in place before the PPP process gets underway. An well-structure framework also discourages parties from following 'win first, renegotiate later' policies.
2. Separate the analysis, evaluation, contracting / administration, and oversight agencies
Separate the agencies that (a) analyzes projects feasibility, including social cost-benefit analysis; (b) decides which of the alternative provisioning modes to employ (government production, contracting or P3); (c) organizes the tendering of bids, selects the partners, makes the final decision whether to proceed with a P3 (or not) and monitors the implementation of the contract; and (d) evaluates the overall success of projects.
Though this step introduces several layers of bureaucracy, it ensures the avoidance of the conflicts of interest which would exist if all these functions came under the same body. Discrete, independent bodies also reduce the chances of a project being undertaken due to political or external pressures, rather than the primary motive: highest social benefit with lowest possible social cost.
3. Ensure that the bidding process is reasonably competitive
The policy should be to ensure that a sufficient number of serious bidders are competing with the project. Public sector companies should also be encouraged to participate in bidding.
This ensures that the competitors put up their most cost-efficient bids, and makes it difficult for bidders to raise costs through collusion and cartelization. A sufficient number of bidders also reduces the risk of the process being rigged or influenced, and thereby being at the risk of legal action or review at a later point of time.
4. Be wary of projects that exhibit high complexity and uncertainty
Any infrastructure project involves some form of complexity or uncertainty. Change in costs, changes in design or scope over the construction period should be expected and accounted for in the contractual framework. However, political changes, unexpected events, changes in law during the project lifetime cannot be anticipated in advance.
Therefore, the framework must include a provision for a simplified, low-cost process for renegotiation when the changes are not under control of the public or private parties involved in the project.
Additionally, it is wise for both parties to ensure that any unnecessary complications (unproven technology, unrealistic milestones, etc) are not introduced by the counter-party in the pre-construction phase.
Projects that can be broken into discrete packages, should be broken down and tendered separately.
5. Include standardized, fast, low-cost dispute resolution / arbitration procedures
Disputes take a lot of time to reach a resolution or a conclusion. They are extremely expensive and increase transaction costs due to legal fees, capitalized interest expenses, insurance expenses, project management costs, etc.
The bigger issue is that the longer an infrastructure project takes to complete, the more its viability comes under question by investors, lenders and suppliers. If the project loses the support of investors and lenders, it can be quite difficult to restart and conclude the project.
Stakeholders in such long-term projects occasionally find themselves in situations where they do not necessarily agree with each other, and a solid dispute resolution process goes a long way towards attracting potential investors.
6. Avoid standalone deals with Private Sector shells bringing limited equity
PPP projects are often undertaken by private parties through project-specific SPVs. This allows them to finance these projects off-balance sheet, at a higher leverage than would have been possible if the project were financed on the parent company's balance sheet. The SPV structure simplifies tax assessments, transfer of project assets at project closure, etc. and therefore is a widely accepted structure.
However, it is important for lenders and policymakers to ensure that leverage does not reduce the equity requirement to a level where the promoter is incentivised to abandon a project rather than work towards a solution, in case that the project does not perform as per expectations.
7. Prevent the Private party from exiting the contract / project too early
The riskiest phase in the tenure of the concession is the construction phase. Therefore, the valuation of a project jumps as soon as the project is operational. This means that a developer has the incentive to sell the project and recover the invested capital as soon as the construction period is past. If this is allowed the developer may just complete a project, book their profits and leave without any further liability.
Therefore it is important to ensure that developers are present during the post-completion liability period, thereby forcing them to maintain construction standards and avoid under-investment during the construction phase.
8. Have a direct conduit to lenders / debt holders
Most PPP projects are too large to be secured with collateral. Since project assets are to be transferred to the government at the end of the concession period, the contract usually does not allow for a way to recover the outstanding debt by liquidating the project assets. Thus, projects debt is mostly unsecured in nature.
Therefore, financing a project is going to be difficult if lenders do not have some sort of recourse to the authority which awarded the contract. In the event of a default due to the concessionaire / developer, there must be a mechanism for lenders to approach the authority for redressal.
