Bridging the gaps Implementation challenges for transport PPPs in OIC member states

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1 Bridging the gaps Implementation challenges for transport PPPs in OIC member states March 28, 2013 Vanesa Sanchez, Senior Analyst Economist Intelligence Unit

2 What are PPPs? Introduction PPPs are public-private partnerships. They are increasingly important in the improvement of infrastructure and public services in both developed and emerging economies. They have existed in various forms and countries for centuries however. An old tool: Transport PPPs have existed as far back as the Roman Empire Concessions on roads and bridges were the first forms Concessions in railways fuelled by activity in the second half of the 19th century Have taken on many forms; There is no one definition PPPs in transport have had a sustained increased investment trend over the 22-years between Source: The World Bank and PPIAF " investment in transport increases in 2011, focusing on the road and rail sectors." PPI data update note 75.

3 What are PPPs? Definition of PPPs: The relationship A solution is requested (e.g. procured) by a public-sector entity but delivered by a privateentity sector Both take on risk Two key stakeholders sector Infrastructure asset / service Public sector Usually long-term contracts that usually cover the lifecycle of an asset There is no single definition, but they all broadly cover the aspects above. Examples include those promulgated by: The World Bank s Public- reference guide The US National Council for Public- Partnerships

4 What are PPPs? Definition of PPPs: Recuperating investment The manner in which the private sector recuperates their investment is a key defining factor. These elements lead to one of the key differentiators of PPP types. User-pay PPP type party recovers its initial investment and on-going costs by charging a fee to the users of the infrastructure. The typical PPP structure applied to this project type is a concession, in which the private party obtains the right to build and deliver a certain infrastructure and to charge for its use. Public-entity-pay PPP type Both types of payments can be combined, e.g. public availability payments alongside user fees. Other projects, while charging users, can receive government subsidies to improve affordability party recovers its investment and costs from the public entity that contracts the PPP. These projects often use a structure called Design, Build, Finance and Operate (DBFO). The private sector will operate the infrastructure until it is paid back by the public sector, allowing cost recovery. Another example is a shadow toll, where the government pays the private sector on a fee per user basis and users are not charged directly

5 Types of PPPs Definition of PPPs: The risks We focus on a few key risks (there are many different types): Legal and political risk Demand risk Operational and maintenance risk Relates to changes in permits required, compliance standards or early project termination. Relates to the unpredictability of future demand, for instance, traffic volumes and the willingness of users to pay. Strongly links to whether a project is user or public-pay type, or a mix. Relates to problems arising with maintenance or operation of the asset. Construction risk Refers to eventualities not accounted for at the construction stage. Financing risk Has to do with incorrect assumptions regarding financing instruments, financing terms, and interest and exchange rate hedging

6 Types of PPPs Definition of PPPs: The risks Risk is the existence of a possible gap between predicted and actual outcomes. OECD offers a categorisation of risk: Source: OECD "Public- Partnerships: In Pursuit of Risk Sharing and Value for Money."

7 Contract type Types of PPPs Assigning risks & responsibilities defines contracts and project classifications The table below is a simplified, illustrative matrix of how risks and activities are allocated and define PPPs* DBFO Yes Public Govt DBFOs are commonly known as PFI, or Project finance initiatives DBFM Yes Public Public Govt Concessions span BTOs, BOOTs and BOTs. It is the most typical form of the user-pay PPP, and ownership lies with the private sector. BOT BOOT Yes Yes Users Users When revenue sources are mixed, the line between contract types gets blurred. For example, depending on the legislation some BOTs can take the form of DBFO, if there is significant public financing and the project includes design and finance elements. BTO Yes Users In most forms of PPP, the private sector takes on operation risk. However there are examples where they do not (DBFM, etc). O&M No Public N/A N/A Govt Many transport PPP forms also include some element of asset construction, enhancement or renovation. Service concession, asset operation concession No N/A N/A User This table is for illustrative purposes only. It does not include all possible contract types, risk types or activities, however it does focus on key points. * Please note: The matrix shows which party usually takes on a particular risk however in some cases either public or private parties can take on a risk. A mix of both is also possible. Final classifications depend on countries legal frameworks.

8 Global trends in PPPs Structuring and finance Long-term project finance Before the crisis Credit enhancements Monolines More demand for public guarantees and govt facilities to ensure payments After the crisis Shorter-term financing: mini perms Search for lower-risk markets More involvement of development banks (multilateral and state-run) Islamic finance Increased borrowing in capital markets, as international banks retreat Sukuk or Islamic bonds are now an option for infrastructure financing Malaysia has substantial experience in PPPs with Islamic financing

9 Global trends in PPPs Islamic finance instruments The new Medina airport is first of its kind in the Middle East. It was entirely financed by Sukuk and has been given on concession for BTO (Build-Transfer-Operate) during 25 years. PPPs paid through Islamic finance have gained ground in parts of Asia, particularly Malaysia, where mechanisms have been developed according to the principles of Sharia Opportunities As international banks retreat, increased borrowing from capital markets in regions like the Gulf is replacing them. Sukuk are increasingly being used to finance infrastructure and their markets are expanding. Satisfying the demands of Sharia would imply no interest is charged, no uncertainty is involved and a valid contract between offeror and offeree is established. Challenges Islamic bonds can take longer to structure than conventional ones. The application of these mechanisms, may be restricted in certain jurisdictions (e.g. regulations on beneficial rights in Muslim countries). Different levels of oversight and regulatory requirements across markets. Different levels activity from one country to the next. Lower taxation regime for transactions with Islamic finance are one tool to incentivise potential investors

10 Global trends in PPPs The current state of PPPs worldwide PPPs are increasingly visible around the world, however their success and application has varied greatly by region. North America: Canada and US active in transport PPPs, but mixed experience. Canada has used DFBO and DBFM forms in rail, whereas US uses more concession and design and build models Western Europe: UK at the forefront, especially with DBFO types. Other countries have been active as well, though ooriginal EU procurement directives had to be adjusted Eastern Europe: transition economies embracing PPPs. Hungary was the first to try it with real tolls. Asia: Australia, South Korea and India increasingly active Latin America: transitioning from privatisation into more advanced PPPs Africa: building the foundations via pilot projects and with the support of development institutions

11 PPP success factors Overview of key, broad success factors There are many key elements which contribute to the success of PPPs in transport. These are highlighted in the diagram below. Successful PPPs

12 PPP success factors Solid legal framework Given the complexity and different types of contract, often the legal and regulatory framework is not adequate for PPPs Legal reforms It is important that legal frameworks broadly allow both user-pay and public-entity-pay types of PPP to take full advantage of all the different contract forms available. It should also apply to construction, expansion, rehabilitation and maintenance of assets and not be restricted to certain activities only. A good PPP law can serve as an important communication and marketing tool for investors, because PPPs tend to be more successful where there is an investor-friendly, transparent and predictable legal environment. Regulatory frameworks which are compliant with international standards tend to be linked to successful PPP implementation. An appropriate legal framework may reduce the need for public-sector guarantees, thereby facilitating the transfer of risks to the private sector Traditional procurement laws are often inadequate, as they tend to generate obstacles to certain PPP types or leave key areas untouched

13 PPP success factors Good regulations Countries need to plan and deliver transport projects differently when using PPP Regulations and planning Shift from public investment models to market-based pricing, investment and oversight models Shift from short-term planning to long-term planning; more strategic and analytical planning process, and more of a lifecycle approach to project implementation Enhanced importance of infrastructure pricing and independent sector regulator Need to reduce regulatory risk to enable long-term project viability Dispute resolution mechanisms are required

14 PPP success factors Selecting the right partner Countries need to ensure the right partner is selected to do the PPP, for the right reasons, and that they are managed appropriately Regulations and bidding, oversight Regulations to ensure transparent and competitive bids are key to attracting the private sector in the first place Competition also increases the number and quality of choices the public sector faces when executing a PPP. However countries may constrain this by preferring local bidders over international ones, or by using unilateral or unsolicited bidding processes Transparent bidding processes are important to ensure the accuracy of information bidders have to prepare bids Transparency is key to generating trust in the PPP bidding process, both from the private sector as well as the general public Regulations are necessary to ensure that post-contract awards and contract changes are not excessive Regulations also need to establish project standards monitoring and contract oversight

15 PPP success factors Public sector capacity and coordination Given the complexity of risk identification and allocation (among other aspects), specialised knowledge of PPPs is required in the public sector There must be a structure in place for government agencies involved or dedicated to PPP implementation, with responsibilities clearly defined. To address the complexity of PPP transactions, countries around the world have created specialised institutions that facilitate project planning coordination and evaluation, quality control, policy formulation and technical advisory. Know-how also needs to be developed within line ministries and across contracting agencies Expertise needs to span legal, financial, technical and economic domains Communication between line ministries, PPP agencies and bodies is paramount

16 PPP success factors Institutional design and coordination Although PPPs can fill capacity gaps in public service provision, they do not eliminate the need for institutional capacity and oversight The private sector needs oversight over the project lifecycle, from procurement to completion This element is often forgotten For communication between agencies to exist, the institutional roles and responsibilities for PPP planning, implementation and oversight must be clear Regulations meant to establish sector and project oversight need to ensure that there are independent institutions that ensure continuity of oversight or handover of project knowledge internally There is also a need to ensure tariffs remain viable, which also relates to the presence of a sector regulator

17 PPP success factors Risk identification and allocation As PPPs are long-term contractual agreements with a partnership element, responsibilities and risk allocation should be clearly defined. Different stakeholders are better at controlling some risks and not as good at controlling others Things to keep in mind about the private sector It is advisable not to transfer all the risks to the private sector, as this will result in less interest For example, the public sector has certain powers and advantages in the process of land acquisition. Therefore is can be better suited to taking the associated risks. Nevertheless Construction risk is usually transferred to the private sector, which means it will be responsible for delays and cost-overruns in completing the works. The private sector, in a competitive environment, should make use of improved management practices and technology and may be better suited to managing the design and construction risks..

18 PPP success factors -sector interest is key Without the private sector, there is no PPP There must be a basic understanding of how the private sector operates and is motivated for public entities to attract the private sector properly when designing and implementing PPPs. Things to keep in mind about the private sector The private sector will do what it is paid to do and no more than that, therefore incentives and performance requirements should be included in the contract. Finance will only be available where the operating cash flows of the concessionaire are expected to provide an acceptable return on investment. Bidding and ongoing costs in PPP projects are likely to be greater than for traditional government procurement processes. There is no unlimited risk bearing private firms will be cautious about accepting major risks beyond their control, such as exchange-rate risks, the risk of existing assets, and some demand risks. Country instability and institutional instability are major deterrents, especially without risk guarantees. Countries that have developed a coherent, transparent pipeline of projects will be more attractive, as this generates confidence in the PPP system of a country and also generates the possibility of conducting multiple projects

19 PPP success factors Trade-offs: PPPs are not free Areas to consider include*: -The overall financial impact? Is the PPP delivering value? -Fiscal implications Does the PPP deliver a viable fiscal solution? -Risk allocation Are risks assigned to the party best able to manage them? -Management issues Are private managers doing a better job than public managers could be expected to? Weighing the positive and the negative of conducting a PPP is what ultimately determines decisions -- Higher complexity in procurement: costlier and longer -- Higher cost of finance -- Reduced control in service delivery and low flexibility during project -- Generate higher general public scrutiny and is thus more politicised -- Does not fully remove regulatory burden of public sector, and requires development of PPP expertise and institutions + Contributes additional financing + Contributes additional human resources and expertise + Increases modernisation of technology and practices + Improved investment environment + Can enhance the efficiency and selfsustainability of the infrastructure Assessment of the validity of PPP model can be conducted through: Value for money (VfM): comparing the PPP project to other options for procuring the same service (usually comparing with public investment options) to determine whether the PPP option provides positive value in comparison. Public sector comparator (PSC): estimating the cost of a PPP to the net present cost to government if it was to deliver the project under a more traditional procurement method, for example, design and construct.