Private Sector Cooperation. PPPs in the context of development cooperation an overview and approach. Manual

Transcription

1 Private Sector Cooperation PPPs in the context of development cooperation an overview and approach Manual

2 2 PPPs in the context of development cooperation Imprint Produced by Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH Dag-Hammarskjöld-Weg Eschborn Responsible Marike Ferguson Sector Project Private Sector Cooperation and Corporate Social Responsibility (CSR) T F E marike.ferguson@giz.de Author PricewaterhouseCoopers AG Wirtschaftsprüfungsgesellschaft Contact Hansjörg Arnold T E hansjoerg.arnold@de.pwc.com Layout Eva Hofmann, Sandra Winter W4 Büro für Gestaltung, Frankfurt am Main This Manual written by PwC AG WPG provides only general information and does not substitute specific advisory services. Second edition: November 2012

3 PPPs in the context of development cooperation 3 I Table of Contents I Table of Contents 3 II List of Abbreviations 4 III List of Figures 5 IV List of Boxes 5 V Executive Summary 6 CHAPTER A: PPPs An Overview 1. Introduction: Private Sector Participation in Development Cooperation 8 2. Why PPPs? Reasons for increased Attention towards PPPs Definition of a PPP Main Characteristics and Payment Structures of a PPP PPP Models Track Record of PPP Models in Low- and Middle-Income Countries A Hybrid Model: Performance-based Service Contracts Types of Financing Project Finance vs. Corporate Finance Funding PPPs 24 CHAPTER B: Practical Guide and Sectoral Analysis 4. The Relevant Issues to be considered Legal and Institutional Framework A Balanced Approach towards PPPs Stakeholders The Bidding Process PPPs in different Sectors PPP Checklist 45 CHAPTER C: Conclusion The Role of GIZ in PPPs 46 VI Bibliography 51 VII Annex 52

4 4 PPPs in the context of development cooperation II List of Abbreviations ADB Asian Development Bank IADB Inter-American Development Bank AfDB BAFO African Development Bank Best and Final Offer IBRD International Bank for Reconstruction and Development BCIE Central American Bank for Economic Integration IDA IDB International Development Association Islamic Development Bank BMVBS German Federal Ministry of Transport, Building and Urban Development IIFBL IFC India Infrastructure Finance Company Limited International Finance Corporation BMZ German Federal Ministry for Economic Cooperation and Development KfW MIGA Kreditanstalt für Wiederaufbau Multilateral Investment Guarantee Agency BOAD West African Development Bank OBA Output-based Aid BOO Build-Own-Operate ODA Official Development Assistance BOOT BOT Build-Own-Operate-Transfer Build-Operate-Transfer OECD Organisation for Economic Co-operation and Development BRLT Build-Rehabilitate-Lease-Transfer PFI Private Finance Initiative BROT Build-Rehabilitate-Operate-Transfer PPI Private Participation in Infrastructure CDP Capacity Development for Partnerships with the Private Sector PPP PSC Public-Private Partnership Public Sector Comparator DBFO Design-Build-Finance-Operate PwC PricewaterhouseCoopers EBRD European Bank for Reconstruction and Development RLT ROT Rehabilitate-Lease-Transfer Rehabilitate-Operate-Transfer EIB European Investment Bank SPV Special Purpose Vehicle EOI Expression of Interest UN United Nations EU European Union UNDP United Nations Development Programme FDI Foreign Direct Investment US United States GDP Gross Domestic Product VfM Value for Money GNESD Global Network on Energy for Sustainable Development VGF WHO Viability Gap Fund World Health Organization GPOBA Global Partnership on Output-Based Aid GIZ Deutsche Gesellschaft für Internationale Zusammenarbeit GmbH GTZ Deutsche Gesellschaft für Technische Zusammenarbeit GmbH

5 PPPs in the context of development cooperation 5 III List of Figures Figure 1: Investment Volumes for Private Sector-related/PPP Projects Figure 2: Life Cycle of Typical PPP Projects Figure 3: Range of PPP Models Figure 4: Realisation of PPP Contracts in Low- and Middle-Income Countries Figure 5: Regional Distribution of various Contract Types Figure 6: General Project Finance Structure Figure 7: Supporting Agencies in Low- and Middle-Income Countries Figure 8: Supporting Financial Instruments in Low- and Middle-Income Countries Figure 9: Regional Financial Support (US$ m) Figure 10: Regional Financial Support provided by different Agencies ( ) Figure 11: Ranking of Investors Priorities Figure 12: Legal and Economic Factors affecting Revenues and Costs Figure 13: Best Project Experiences Figure 14: Worst Project Experiences Figure 15: Selected Stakeholders of a PPP Figure 16: Outline of the Procurement Process Figure 17: PPP Opportunities in different Sectors Figure 18: Sectoral Share of Investments Figure 19: Cross-Sectoral PPP Investments Figure 20: PPP Investments in Sectors and Regions Figure 21: Private Sector Share of Enrolment in the Education Sector Figure 22: Private Health Expenditure as a Share of Total Health Expenditure (Income Groups, 2008) Figure 23: Private Health Expenditure as a Share of Total Health Expenditure in Selected Countries IV List of Boxes Box 1: Political Risk Insurance regarding Autopistas del Nordeste Box 2: Pros and Cons of a Management Contract Box 3: Pros and Cons of a Lease Contract Box 4: Example of a BOT Project in the Energy Sector with GIZ Involvement Box 5: Pros and Cons of BOT/BROT/ROT Contracts Box 6: Pros and Cons of BOO Contracts Box 7: Overview of several PPP Options Box 8: Example of GIZ support to a Performance based Service Contract in the Transport Sector Box 9: An Example of Project Finance Box 10: Corporate Finance vs. Project Finance Box 11: Example of a PPP including Output based Aid Box 12: Requirements concerning the Strategic Stakeholder Dialogue Box 13: Examples of the Advantages of involving Stakeholders Box 14: PPP Opportunities in the Education and Health Sectors Box 15: An Example of a PPP in the Education Sector Box 16: Examples of PPP Schemes in the Education Sector Box 17: Potential Areas of Involvement for GIZ Box 18: An Example of GIZ Involvement in a Concession-related Project Box 19: An Example of GIZ Involvement in a Regional Economic Integration Process with a PPP Approach Box 20: An Example of GIZ Involvement in a PPP Process in Yemen... 49

6 6 PPPs in the context of development cooperation V Executive Summary Strongly growing economies are increasingly faced by significant bottlenecks in the provision of public infrastructure and services. There is a growing awareness among these countries that not only budgetary constraints, but also the lack of adequate regulatory and institutional frameworks, pose a hurdle to structuring innovative solutions to service delivery. Public-Private Partnerships (PPPs) have attracted much attention in recent years whereby public authorities come together with the private sector in an attempt to structure an infrastructure project. The idea is that the private sector can make contributions towards closing existing and future infrastructure gaps as well as realising efficiency gains throughout the life cycle of a PPP project mutually with the public sector. Introducing competition, especially via the bidding process, achieving a better quality compared to public service provision as well as rendering know-how transfer from private to public sector based on private sector managerial practices and experiences are considered as value added contributions of PPPs. Additionally, removing the financial responsibility from the balance sheet of the public authority and working out adequate risk sharing mechanism are other advantages of PPPs. There is no universal definition of a PPP. Creating a common terminology is not easy, but is nonetheless important for facilitating the dialogue between policymakers and practitioners. The term used in this manual will be based on the definition employed by the German Federal Ministry of Transport, Building and Urban Development (BMVBS) 1 : a PPP is a long-term contractually based mutual cooperation between (the) public and private sector(s) aimed at the provision of public services. The resources of both the private partner and the public authority are combined and the different risks are allocated in the most efficient way to generate a successful project. A PPP is considered as an alternative mechanism for the provision of a public service; one whereby the public counterpart still holds accountability for the project on a long-term basis. Thus, there must be a long-term contractual relationship between the contracting authority and the private partner for a PPP to work. The service to be provided is often, in practice, specified functionally as an output. The means by which the private partner is supposed to deliver the service is not determined by the contracting authority. Thus, a PPP has an underlying risk allocation mechanism that provides for optimal risk allocation between the public and the private sector and which, in turn, secures an efficiency gain. PPPs encompass an exit strategy, for they are planned along the life cycle of a project. PPPs encompass the bundling of service components, for instance, designing, building, operating, financing can all be bundled for the private sector to assume responsibility for delivering the output specified by the public sector. From a (systemic) capacity building and institutional perspective, PPPs touch upon many areas that are of concern to the Deutsche Gesellschaft für Internationale Zusammen - arbeit (GIZ) GmbH. Historically, GIZ has been engaged in many different kinds of projects involving both public and private sector. In the recent past, GIZ has come to realise that within the scope of its technical cooperation programmes there is an increasing demand for PPPs. Both counterparts and clients are now questioning how these should be structured and implemented. GIZ s Private Sector Cooperation Unit has developed an advisory service, entitled as Capacity Development for Partnerships with the Private Sector (CDP). It aims at pooling GIZ s advisory services such that public sector institutions may attain their goals more effectively and efficiently through a joint cooperation with private sector agents. The focus of CDP has been set on three modes of cooperation between public and private sector: 1. Programmes for Development Partnerships 2. Public-Private Partnerships (PPPs) 3. Stakeholder Dialogues 1 Source: BMVBS (2003)

7 Private Sector Cooperation Private Sector Cooperation Private Sector Cooperation Private Sector Cooperation PPPs in the context of development cooperation 7 A major idea of initiating CDP has consisted of identifying the range of ongoing services currently provided by GIZ with respect to private sector participation in the field of technical cooperation, and to provide a proper classification thereof. Following up on GIZ s experience in the area of private sector participation in the past, this manual proposes that GIZ may focus its core advisory services in the field of PPPs on four major areas which may best be described as follows: Fostering a cooperative culture between public and private sectors and civil society; Providing advice to strengthen and develop PPP-related legal and institutional frameworks, for example, in the context of wider sectoral reform programmes; Supporting PPP units and regulatory bodies on issues related to institutional capacity development; Supporting the implementation and realisation of individual PPP projects throughout the project life cycle. Information on CDP an overview 2 The brochure Capacity Development for Partnerships with the Private Sector (CDP) Advisory Services is the main CDP advisory services publication. It examines the various forms of cooperation between the state and the private sector. Capacity Development for Partnerships with the Private Sector (CDP) Advisory Services Complementing the above brochure, there are separate publications on three central forms of cooperation: Programmes for Development Partnerships (EPW), Public-Private Partnerships (PPP) and Stakeholder Dialogues (SD). These documents provide detailed information on CDP advisory services and training courses, and guide staff through the first planning stages. For staff involved in the project management of development partnerships, Steering and Monitoring Partnerships with the Private Sector (SMP) provides a guide to design, implementation and in-process monitoring. Programmes for Development Partnerships with the Private Sector Manual PPPs in the context of development cooperation an overview and approach Manual Stakeholder Dialogues Manual 2 Contact: Marike Ferguson (marike.ferguson@giz.de)

8 8 PPPs in the context of development cooperation CHAPTER A: PPPs An Overview 1. Introduction: Private Sector Participation in Development Cooperation Private sector participation in the scope of international cooperation has gained in significance, especially during the last two decades. This comes against the backdrop of a dynamic process of market integration and fast-growing international and national private sector investment in the developing world. Hence, given its growing economic assets, private sector has a vested interest in a stable enabling environment for expanding and developing the markets here. Within its limits, private sector can take responsibility for and contribute to local development. With regard to projects pursued and implemented by German development cooperation, private sector inclusion is increasingly recognised as a service provision mechanism throughout the development process in many countries; one which has a certain leverage potential. German development cooperation has acquired a longstanding experience of various approaches in this context, from company sponsoring and self-commitment (e.g. on best practices and regulations) to using synergies in projects by structuring complex large partnerships and alliances, as well as by mobilising private funds and financing. The strategy behind these types of cooperation between public and private sector is to harness private sector managerial expertise, mobilise inputs from private sector to secure complemen - tary and (cost-) effective provision of services, raise private sector awareness and stimulate a participation culture for further developing civil society, and, ultimately, to promote private sector investment as an impetus for sustainable development. One baseline condition for sustainable development is broad public access (for urban, rural, and peri-urban populations) to infrastructure services of a sufficient quality and an affordable price. However, a large part of the world s population does not have access to infrastructure not only that related to clean water, sewage disposal, energy and transport, but also the infrastructure linked to education, health and quality governmental services. Meanwhile, those that are connected to such systems in the developing world often suffer from poor quality services and an erratic service delivery. There are several reasons for these challenges. Most commonly, these can be explained by erratic policies arising from vested interests, insufficient financial independence of public service providers, missing incentive systems for efficient service provision, and a lack of management know-how. Budgetary constraints and erratic payment behavior on the part of users also play a key role here. In this context, one specific type of private sector participation is to integrate the private sector in order to minimise these structural constraints in infrastructure provision faced by public and private sector in developing countries i.e. by implementing so-called PPPs. PPP structures are potentially efficient in the provision of certain services and can possibly contribute towards the transfer of know-how and capital in specific sectors. Under the umbrella of German development cooperation, PPP models have been primarily realised in the context of financial cooperation. In the field of technical cooperation, PPPs play primarily a role throughout the systemic and political advisory processes. The PPP models outlined in this manual will be defined narrowly and are associated with infrastructure provision. Given the increasing developing country interest in applying such models, they are becoming even more relevant for German technical cooperation. 3 This increasing relevance can best be described by looking at the opportunities and risks of PPPs. As with the tip of an iceberg, a PPP project itself is only the visible part. However, underlying it, there are a couple of essential layers. These layers concern the political, regulatory and institutional environment, i.e. in terms of contracts, procurement and policy and, more specifically, competition policy, as well as the financing environment. In addition, for sustainability reasons, PPPs need to be integrated into a particular sectoral policy to render positive results. And for this purpose, the whole chain of activities that lead to the delivery of services has to be considered. Above all, a determined political will has to be in place for realising the potential advantages of PPPs. Hence, from a (systemic) capacity building and institutional perspective, PPPs touch upon a couple of areas that are of concern for GIZ. The overriding purpose of this manual is therefore to provide an overview and to help guide GIZ and its partners on how to approach PPP models in a practical way. Furthermore, the manual intends to explore and, 3 Source: BMZ (2009). A couple of examples may illustrate this perception, for example, the SADC and ECOWAS work towards PPP-related competency, the network for PPP in Asia that is actively pursued by ASEM member states etc..

9 PPPs in the context of development cooperation 9 where appropriate, to categorise the role of GIZ in this area of development. This manual touches upon the fact that PPP models are not always the right solution to integrate private partners in public sector business. A balanced approach and evaluation of the specific project is essential. This manual is structured in three chapters. The first chapter gives an overview of PPP models and their application. The second chapter provides a practical guideline for the implementation of PPPs encompassing issues such as the necessity to look into the institutional and regulatory frameworks. This chapter presents a PPP checklist for practitioners, and gives also an insight into the sectoral trends. The final chapter deals with the cooperative role to be played by GIZ and the consulting services that it provides in this field. Throughout the manual, there are a number of examples and case studies for illustrative reasons.

10 10 PPPs in the context of development cooperation 2. Why PPPs? The focus of this section is to introduce the reader into the most commonly used options for structuring PPPs, and to present the main characteristics and payment structures of the different PPP models. 2.1 Reasons for increased Attention towards PPPs Infrastructure bottlenecks exist in almost all countries around the world. They have a negative impact on economic growth and the welfare of people. They also affect the efforts of public authorities to reduce existing social and economic disparities. Public authorities have limited financial resources to devote to investments in infrastructure and to improve public services. They face restrictions on their ability to raise debt. 4 Therefore, since the 1990s, private sector has increasingly played an important role in the provision of basic infrastructure services formerly provided by public authorities. 5 Currently, based on private sector efficiency arguments and due to the presence of large infrastructure gaps, countries are appealing more and more for private sector investment and searching for alternative forms of service provision. The Organisation for Economic Cooperation and Development (OECD) estimates that to 2030, annual infrastructure investment requirements for electricity, road and rail transport, telecommunications and water are likely to average around 3.5% of world gross domestic product (GDP). 6 Globalisation, population growth and climate change all pose new challenges to infrastructure service delivery worldwide. In developed countries, many public services need to be refurbished and replaced to cope with existing and upcoming challenges. As for transport infrastructure, in the United States (US), President Barack Obama has proposed a long-term stimulus programme planning to invest US$ 500 billion in the years from 2010 until Similarly, in developing countries, population growth poses significant stress on the backbone of service delivery. The recent financial crisis and the subsequent recession faced by many countries have also impacted public service provision, due to the financial constraints faced by public authorities. The likelihood of state bailouts has increased and financing has gotten more expensive. An interruption of infrastructure investment may have negative repercussions in terms of low tax revenues and also low GDP growth rates. Needed resources to meet the infrastructure gap and, therefore, fulfil the accountability of public authorities to provide infrastructure services may be generated by involving private participants. Furthermore, private sector-related efficiency gains and risk allocation aspects of PPP projects may attract financial institutions to provide capital, and to get involved in PPP projects. 8 Investment Volume of Projects with Private Sector Involvement in Low- and Middle-Income Countries ($US m) PPP Investment Volume of Projects in Low- and Middle- Income Countries ($US m) Figure 1, Source: World Bank, PPI-Database. Source: PwC (2004a). Source: PwC (2003). Source: OECD (2007). Source: PwC (2010a). Amongst other private investments (e.g. privatisation), PPPs are included in the definition of private sector involvement

11 PPPs in the context of development cooperation 11 PPPs, whereby public authorities come together with a private sector party in an attempt to structure a specific deal/project, have attracted much attention and investment in recent years (see Figure 1). The private sector party takes the responsibility, for instance, for building new infrastructure, assuming the relevant risks. It also manages the operation and maintenance of the asset over the long term, and is expected to arrange the necessary financing, while the public sector pays for its availability and operation. Public authorities draw on different kinds of arguments to enter into such joint interventions with the private sector and to pursue PPPs. Given what has already been said, PPPs may be considered as being of relevance for: 9 achieving greater efficiency than traditional public procurement methods for the provision of public services; closing the infrastructure financing gap via private sector capital; introducing competition, especially via the bidding process; achieving a better quality output compared to that resulting from public service provision; rendering the transfer of know-how from private to public sector based on private sector managerial practices and experiences; removing the financial responsibility from the balance sheet of the public authority; and for achieving adequate risk sharing. 2.2 Definition of a PPP There is no universal definition of a PPP. Quite often, it refers to an arrangement that goes beyond simple financing; one that encompasses private sector resources, expertise and management practices. Creating a common terminology is not easy, but is nonetheless important for facilitating the dialogue between policy-makers and practitioners. 10 In many instances, PPPs are defined in a general manner, allowing for practical implementation policies. In Germany, the BMVBS defines PPPs as follows: 11 A PPP is a long-term contractually based mutual cooperation between (the) public and private sector(s) aimed at the provision of public services. The resources of both the private partner and the public authority are combined and the different risks are allocated in the most efficient way to generate a successful project. In this manual, the term PPP will be based on this definition. 2.3 Main Characteristics and Payment Structures of a PPP i) Main Characteristics There are numerous options for structuring PPP contracts. The option ultimately decided upon largely depends on the legal feasibility, the project-specific objectives of public authorities, and the interests of private sector partners. Contracts must fulfil several criteria in order to be defined as a PPP. They must: 1. involve a long-term relationship; 2. ensure the provision of a public service; 3. transfer risk to the private sector partner; 4. involve the bundling of processes; and 5. specify the output Long-term relationship: PPP contracts are usually targeted towards projects with a minimum duration of at least five years. 13 Nevertheless, in some cases, it might be practical to reduce this period by a maximum of two years Provision of a public service: the project must be set up in an area of activity where it is favourable or necessary that the public authority retains the ultimate accountability. This differs significantly from a privatisation. 3. Risk transfer to the private partner: a significant transfer of risk to the private sector partner is an important element of a PPP. Broadly, one can distinguish between six main types of risk: Operational risk The risk of failures in the availability and quality of output as well as increases in operational costs > 9 Source: Alfen (2009) Source: World Bank (2010b). Source: BMVBS (2003). 12 Source: World Bank (2007a); BMVBS (2003); IFC (2009). 13 Source: BMVBS (2003). 14 Source: European Commission (2004).

12 12 PPPs in the context of development cooperation Construction risk The risk of an extension to the construction period and of increasing material and/or labour costs Demand risk The risk of low revenues due to overestimated demand Financial risk The risk of changes in exchange or interest rates, as well as all the other factors that may influence the financing of a project Political risk The risk of revolts or wars, as well as unexpected political interventions regarding the regulatory framework Force majeure The risk of natural disasters, such as earthquakes and extreme weather conditions. Depending on the PPP model selected, the first three types of risk may be transferred to the private partner. The last two categories of risks normally remain with public authorities. Their probability of occurrence as well as their possible impact/relevance largely depends on the specific project and the country or region concerned. Normally, coverage of political risk and force majeure is only relevant for a number of developing countries. Political risks and also fluctuations in foreign exchange rates may be insured or guaranteed by international development institutions such as the World Bank Group. 15 Coverage of force majeure may be more difficult or quite expensive. Normally, this risk remains with the government or is unallocated. Nevertheless, handling these two categories of risks requires careful negotiations between all partners and guarantors. As a consequence, contracts may be defined such that both parties have a right of termination. Autopistas del Nordeste MIGA, a member of the World Bank Group is involved in a 30 year concession agreement regarding the construction, maintenance and operation of a toll road in the Dominican Republic. Due to the absence of long term financing, MIGA has covered political risks of the project. As a consequence, the project has been 40% oversubscribed and the rating increases significantly. Box 1: Political Risk Insurance regarding Autopistas del Nordeste. Source: MIGA, (2007). The type and level of risks transferred to private sector partners largely depends on the specific contract quite generally, the partner who can best manage the risk should cover it. 4. Bundling of processes: this means that there are different choices for transferring tasks to private partners. It is quite common to split a PPP process into four stages: design, build, finance and operate. Under most PPPs, at least the construction and operation are assumed by private sector participants. 16 In this context, a further analysis of the life cycle of a PPP (see Figure 2) may be quite useful. In contrast to pure public procurement, many projects within the scope of a PPP have a time limit. The length of the partnership between the public and private sector partners is stipulated in the contract. Especially in those PPPs where large initial investments are necessary, private sector participants will propose tariff levels in such a way that the cash flows generated will at least cover the investment costs. The selection of the right private sector partner within the bidding process, therefore, largely depends on the proposed future burden for the public authority and/or consumers. 15 Source: World Bank (2007b). Also refer to, for instance, German Investment Guarantees (Bund). 16 Source: World Bank (2007a).

13 PPPs in the context of development cooperation 13 Figure 2, Source: PwC. Life Cycle of Typical PPP Projects Design Build Operation, Maintenance Exploitation Investment, Finance The life cycle approach of a PPP sets strong incentives for private partners to continue being innovative and to develop more efficient ways for delivering the output specified by public authorities. This is because private sector partners often assume the revenue risks. Revenues may be contractually regulated and, therefore, insufficient to cover all the costs involved. However, it is not always possible to fully transfer all life cycle risks to the private sector. As PricewaterhouseCoopers (PwC) points out with respect to an upgrade of part of a railway line, if the assets in question are integrated into a wider network which is typically maintained by a public or private utility, then the private sector bidder cannot take life cycle risks and the incumbent utility will carry out maintenance more cost efficiently Output specification: when implementing a PPP, public authorities determine at the outset the project output, and only define the functional specifications of the service to be provided by the private partner. Therefore, private sector partners have the flexibility to adopt the most efficient technology and way of providing and realising the predetermined output. ii) Underlying Payment Structure in a Typical PPP The underlying payment structure of a PPP model is important since it influences the outcome of a PPP. For example, if the payment structure foresees a direct payment from users to a private provider and the PPP represents a monopoly in service provision, then it is essential that the government establishes a supervisory and regulatory body to ensure that the efficiency gains are also distributed to the user and thus have the intended positive impact on public welfare. The choice of payment structure largely depends on the PPP model selected, the sector involved, the underlying project, and, of course, the prevailing legal framework. Typically, one can distinguish between three main types of payment mechanisms, which may be combined and also complemented by subsidies. 1. In some cases, private partners only get paid by public authorities. There are sectors and/or large projects which are very capital intensive, and for which covering the cost through user payments is nearly impossible. A result of selecting an availability-based payment mechanism is that the demand risk remains with the public authority. Therefore, it may be useful to include sanctions in the initial contract in case the private sector partner fails to deliver or performs badly. 2. If user fees or tariffs are considered to be the right payment structure, private partners get paid directly by consumers. Especially with respect to natural monopolies, public authorities must monitor and regulate the level of the fees charged. This is particularly important for the basic services that must be accessible to all people in the population group previously targeted. 3. An intermediate way of allowing the private sector partner to share in the financial benefits of the project is to base the public payment on shadow fees/tolls. Public authorities then pay private partners depending on the number of users benefiting from the output. This mechanism is often used for road projects, or in those areas where direct user payments are quite complicated or simply unreasonable. 17 Source: PwC (2005).

14 14 PPPs in the context of development cooperation 2.4 PPP Models Within the field of international cooperation for sustainable development, the German Federal Ministry for Economic Cooperation and Development (BMZ) and GIZ have until now identified six basic forms of cooperation between the public and private sector. These range from company sponsoring and co-financing to financial and advisory services for private investments in developing countries. PPPs feature among these six basic forms. This manual aims to provide an overview of the most commonly used contracts classified as PPPs. Although they may vary according to the intended outcome of a project, the models here can basically be distinguished according to the extent to which risk is transferred to the private sector (see main types of risks specified in 2.3 above). In this context, GIZ considers the following spectrum of PPP models (see Figure 3). It is important to highlight that performance-based service contracts do not fully fit into the classical definition of a PPP (the reasons for this will be shown in section 2.6). Nevertheless, due to the ongoing discussion on the classification of PPP contracts (for instance, in the BMZ), and its relevance to important areas in which GIZ has its core activities (e.g. in the education, health and water sectors), performance-based service contracts will be considered and briefly described in this manual. However, they will be dealt with separately. The following section discusses the models in more detail. Range of PPP Models Privatisation No PPP Level of Private Involvement Private Risk BOO BOT, BROT, ROT Leasing / Affermage Management Contract Performance-based Service Contract PPP, Combinations of the Types are possible Grey Area Service Contract No PPP Commercialisation Publicly owned Enterprise Figure 3, Source: PwC.

15 PPPs in the context of development cooperation 15 i) Management Contract Under a management contract, private sector partners are contracted to manage the operation and maintenance of public-owned assets. The investment made by private partners is either small or non-existent. While the operational risk is transferred to private sector partners, the construction risk largely remains with public authorities. In exchange for assuming managerial tasks, private partners get paid a fee by public authorities. Only in cases where the fee structure is performance-based, part of the demand risk may also be transferred to the private sector partner. However, the responsibility for increasing investment outlays remains with the public sector. It must be highlighted that management contracts may only be classified as involving a PPP under certain circumstances, since there is a limited transfer of risk, the length of term is not very long (typically only 3-8 years, i.e. of a medium term), and service provision is not output driven, but rather clearly defined. Quite often, management contracts are used as a first step towards preparing for further and more complex private partner involvement. Pros Rapid implementation Not complex Widely politically accepted Operational risk is shifted to the private partner First step of entry prior to developing more complex contracts Box 2, Source: PwC. Management Contract Cons Only moderate improvements of existing assets possible, little investment incentives for the private partner Risk transfer limited Demand risk and responsbility of further investments widely remain with the public authority, few incentives to improve quality ii) Lease Contract A lease contract is quite similar to a management contract since it covers the operation and management of publicowned assets. The main difference relates to the payment structure as the lessee may be authorised to set tariffs and get paid directly by the consumer. Next to operational risks, the demand risks may broadly be shifted to the private sector partner. The duration of a lease contract may range from 5 to 20 years. Thus, a lease contract is normally longer than a management contract. Often, a lease contract is connected to other complex models such as the Build-Rehabilitate-Operate-Transfer (BROT) or Rehabilitate-Lease-Transfer (RLT) models. The duration of the contract is then extended and linked to large capital investments by the private partner. Pros Rapid implementation Widely politically accepted Often combined with more complex contracts (BRLT,RLT) Operational and Demand risks are to some extent shifted to the private partner Incentives to realise efficiency gains Box 3, Source: PwC. Lease Contract Cons Only moderate improvements of existing assets possible, little investment incentives for the private partner Complexity moderate Risk transfer moderate Investment responsibilities remain widely with the public authority, few incentives to improve quality iii) BOT, BROT, and ROT Models Under the Build-Operate-Transfer (BOT) model, which is based on a concession agreement, the construction, maintenance and operation of assets are bundled together. BOT models can be classified as greenfield projects because the asset is newly established within the scope of the PPP. During the concession period, which typically runs for more than 20 years, ownership may be fully, 18 partly or not transferred to private partners. The underlying payment structure provides the opportunity to private partners to generate cash flows recovering at least the investment costs. In this context, public authorities often guarantee payment of up to a specific amount for the acceptance of goods/services by consumers and therefore cover part of the demand risk. GIZ s experience with a BOT project in Madagascar is described in Box BOOT=Build-own-operate-transfer.

16 16 PPPs in the context of development cooperation Energy Sector: Madagascar: Lokoho Hydro for Rural Development The aim of the Lokoho project was to develop a replicable business model for private sector investment in Madagascar and at the same time demonstrate the commercial viability of a BOT project in the energy sector that both improves energy supply from sustainable sources and fosters rural development. To this end, a comprehensive cooperation of international utilities (the e8 group, namely EDF, RWE and Hydro Quebec), a local private partner (Electricité de Madagascar) and international development organizations (GIZ, KfW, EU) established the basis for the construction and operation of a hydro power plant in the northeast of Madagascar. On the public side, ADER, the agency for the development of rural electrification associated to the ministry of energy, was supposed to assume a pivotal role in the replication of the exemplary PPP project. GIZ aimed at strengthening ADER s capacities to efficiently and effectively identify, plan and implement projects for the development of rural electrification by use of renewable energy sources. The PPP project also focused on supporting the private investors. Throughout the initial phase, GIZ promoted particularly those areas that are highly relevant for rural development such as the business for rural power supply, the promotion of productive use of electricity or the participation of the local workforce. A feasibility study was prepared in close cooperation with the e8 partners to which GIZ contributed market analyses, socio-economic baseline- and demand studies and an environmental impact assessment. GIZ also worked as a facilitator to mobilise additional grants from the EU Energy Facility and soft loan financing from KfW and helped to eventually set up the financing structure. Another important aspect concerned the creation of a beneficial policy, institutional and legal environment at both national and regional level in order to make the Lokoho project replicable in other regions of Madagascar. The project set-up helped to integrate private infrastructure investment into a broader promotion of rural development. After tendering the first construction lot an unexpected cost increase prompted the private partners to thoroughly review the project. At the same time, the coup d état of 2008/09 shook up the political situation fundamentally and created a lot of uncertainty for private investment. Therefore, despite considerable efforts and its evident role model character, the project could not be realized. Nevertheless, the synergies between private investors and development agencies can serve as a blueprint for similar future projects in Madagascar or other developing countries. Development Cooperation played an important role in the facilitation of the whole project and was highly appreciated by both the private and the public partners. To learn more about this project, see Annex. Box 4: Example of a BOT Project in the Energy Sector with GIZ Involvement. Source: GTZ, In many cases, a special purpose vehicle (SPV) is set up by private and public sector partners to implement and operate the project. Usually, the share or influence of the private partner in the SPV is quite high. Therefore, most of the initial investment is undertaken by private sector partners. Additionally, debt financing is essential to widening the financial resources of the SPV. Typically, the share of debt financing in PPPs is between 70-90%. 19 To reduce the overall financing costs, public authorities often partially guarantee the debts of the SPV. Under the Build-Rehabilitate-Operate-Transfer (BROT) model, the private sector partner rehabilitates existing assets and improves them through extensions. The Rehabilitate- Operate-Transfer (ROT) model is a weaker form of the BROT model because it is limited to rehabilitation and operation. During the entire PPP cycle, ownership typically Pros Provides scope for private investments Incentives to build on and provide high quality standards Optimised risk allocation possible Public borrowing probably more expensive than private borrowing High efficiency gains possible Box 5, Source: PwC. BOT/BROT/ROT Cons Complex Provides scope for political backlashes Private borrowing probably more expensive than public borrowing 19 Source: World Bank (2009a)

17 PPPs in the context of development cooperation 17 remains with the public authority. Due to the relatively low investment costs involved under the ROT model, it is common practice for projects to be financed by user fees. iv) BOO Model The Build-Own-Operate (BOO) model consists of transferring the construction, ownership and operation of a public asset to a private partner. It is in some respect similar to a privatisation because ownership remains permanently with the private sector. The difference is the ongoing accountability and often the ongoing financial obligations of public authorities. In contrast to most privatisation Pros Provides large scope for private investments Incentives to build on and provide high quality standards High efficiency gains possible High level of risk transfer BOO Cons Provides scope for political backlashes Private borrowing probably more expensive than public borrowing Risk allocation may not be optimal Scope for creating monopolies approaches, BOO models are targeted towards providing essential basic infrastructure services. Their implementation will not automatically result in more competitive markets. In an attempt to avoid the negative consequences of private monopolies, public authorities consider it important to remain involved and to assume the ongoing regulatory oversight (for instance, by balancing tariff levels). Also, due to the high capital investments of private partners and the limited possibilities for increasing tariffs (because of government regulation), public authorities may often be forced to secure the ongoing cash flow of such projects. v) Summary The following table provides a summarised overview of those major characteristics pertaining to the different PPP options as described in the previous section. There are a number of other PPP models that diverge in varying degrees with respect to the level of risk transfer and the level of public influence. For instance, one option involving a high level of public influence is the so-called turnkey model and an option with a moderate level of public influence would be the franchise model. Meanwhile, the Design-Build-Finance-Operate (DBFO) and Private Finance Initiative (PFI) models involve a comparatively low level of public influence. 20 Box 6, Source: PwC. PPP Model Level of Accountability by Public Sector Ownership Investments Allocation of Risks Duration in Years Management Contract High Public Public Public/Private 3-8 Lease Contract High Public Public Public/Private 5-20 BOT/BROT/ROT High Public/Private Public/Private Public/Private BOO High Private Private Private (limited Public) Box 7: Overview of several PPP Options 20 See also: World Bank (2010b): In a recent policy paper, the World Bank considers the various structures and proposes a practical methodology for classifying PPPs in infrastructure based on their fundamental characteristics and parameters.

18 18 PPPs in the context of development cooperation 2.5 Track Record of PPP Models in Low- and Middle-Income Countries The track record of PPP models in low- and middleincome countries shows that in the transport and water and sewerage sectors, the number of contracts involving concessions e.g. of the BOT, BROT, and ROT model type outnumber all other types of PPPs (see Figure 4). In the energy sector, BOO models, whereby ownership is ultimately transferred to the private sector, are similarly important as BOT models. In contrast to concession-based and BOO projects, the number of lease and management contracts is quite small, with most of these being realised in the transport and water and sewerage sectors. Quite interestingly, a breakdown of contract types by region reveals that concession-based PPPs (BOT, BROT, and ROT) are predominant in nearly all regions, accounting for the highest share of PPP contracts. While BOO type contracts are also quite significant, the proportion of lease and management contracts varies considerably. In East Asia and the Pacific, as well as in South Asia, these are simply not relevant. In the Middle East and North Africa, PPPs involving lease contracts are non-existent, but those involving management contracts are as frequent as the number of BOO-related contracts realised. In Sub-Saharan Africa, both management and lease contracts outnumber those PPP contracts based on the BOO model. In Europe and Central Asia, management and lease contracts account for almost 30% of all the contracts realised. Realisation of PPP Contracts in Low- and Middle-Income Countries Energy Telecommunication Transport Water and Sewerage BOO BOT/BROT/ROT Lease Contract/BLT/RLT Management Contract Figure 4, Source: World Bank, PPI-Database.

19 PPPs in the context of development cooperation 19 Regional Distribution of Various Contract Types Figure 5, Source: World Bank, PPI-Database. 2.6 A Hybrid Model: Performance-based Service Contracts It is important to bear in mind that performance-based service contracts do not fully fit into the classical definition of a PPP. However, due to its relevance to important areas in which GIZ has its core activities (such as in the education, health and water sectors), performance-based service contracts are considered and briefly described here, though separately from the other models. The classification of service contracts is not clear cut, even if the payment structure is performance-based, as: 1. performance-based service contracts feature only a limited transfer of risk; 2. most of these contracts are of a short term (i.e. 1-3 years); 3. no investment by the private sector partner is required; 4. service provision is limited to specific areas within projects; and 5. the way in which the output should be realised is very clearly defined. Service contracts are targeted towards involving private partners in specific areas related to the operation of a public asset. This kind of contract aims at introducing private sector knowledge and efficiency into public sector business. However, since service contracts clearly define output levels and how these should be achieved by the private partner, there is not much room for private sector innovation. Partially linking private partner revenues to the output to be delivered may have an impact, because there would then be an incentive to deliver the output more efficiently. Performance-based service contracts are, for instance, used in the health sector. In developing countries, these contracts are often combined with the broader objectives of public authorities, such as ensuring that the service reaches the poor. One instrument for combining pro-poor subsidies with a service contract involves the usage/allocation of vouchers. Here, private health service providers only get a part of their revenues if they present vouchers previously collected from their customers. Obviously, any competition for the targeted population groups has its limits, 21 as the private provider also gets paid by non-targeted population groups. The incentive to attract voucher clients, in particular, is thus checked. Performance-based service contracts are sometimes defined as the lowest stage of a PPP model. 22 In the opinion of others, classifying models with higher levels of 21 Source: GTZ (2010). 22 Source: BMZ/GTZ/KfW (2008), ADB (2008).