“Bridging the gaps”

Implementation challenges for

transport PPPs in OIC member

states

March 28, 2013

Vanesa Sanchez, Senior Analyst

Economist Intelligence Unit

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 1990-2011

Source: The World Bank and PPIAF. 2012. "Private investment in transport increases

in 2011, focusing on the road and rail sectors." PPI data update note 75.

A solution is requested (e.g. procured) by a public-sector entity but delivered by a private- sector

entity

Both take on risk

Two key stakeholders

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-Private reference guide

The US National Council for Public-Private Partnerships

Definition of PPPs: The relationship

What are PPPs?

Private sector Public sectorInfrastructure

asset / service

Public-entity-pay PPP type

Private 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

User-pay PPP type

Private 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.

What are PPPs?

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.

Definition of PPPs: Recuperating investment

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

Types of PPPs

Relates to changes in permits required, compliance standards or early project

termination.

Definition of PPPs: The risks

Legal and

political risk

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.

We focus on a few key risks (there are many different types):

Operational and

maintenance riskRelates to problems arising with maintenance or operation of the asset.

Demand risk

Refers to eventualities not accounted for at the construction stage.Construction risk

Has to do with incorrect assumptions regarding financing instruments,

financing terms, and interest and exchange rate hedgingFinancing risk

Types of PPPs

Source: OECD. 2008. "Public-Private Partnerships: In Pursuit of Risk Sharing and Value for Money."

Definition of PPPs: The risksRisk is the existence of a possible gap between predicted and actual outcomes. OECD offers a

categorisation of risk:

Types of PPPs

Assigning risks & responsibilities defines contracts and project classifications

Co

ntr

ac

t ty

pe

Concessions span BTOs, BOOTs and BOTs. It is the

most typical form of the user-pay PPP, and ownership

lies with the private sector.

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.

PrivatePublic

Yes PrivatePublic

Yes Public

Private Private

Private

PrivatePrivate

Private

Yes PrivatePrivate

Private

Yes

Yes

Private

Private Private

Private

Private

Private

Govt

Govt

Users

Users

Users

DBFM

DBFO

BOT

BOOT

BTO

N/APublicNo PrivateN/A GovtO&M

N/APrivateNo PrivateN/A User

Service

concession,

asset

operation

concession

DBFOs are commonly known as “PFI”, or Project

finance initiatives

In most forms of PPP, the private sector takes on

operation risk. However there are examples where

they do not (DBFM, etc).

Many transport PPP forms also include some element

of asset construction, enhancement or renovation.

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.

The table below is a simplified, illustrative matrix of how risks and activities are allocated and define PPPs*

* 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.

Global trends in PPPs

Structuring and finance

Before the crisis

Long-term project finance

Credit enhancements

Monolines

After the crisis

More demand for public guarantees and govt facilities to ensure payments

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

Global trends in PPPs

Islamic finance instruments

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.

Lower taxation regime for transactions with Islamic

finance are one tool to incentivise potential investors

Opportunities 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.

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

The current state of PPPs worldwide

PPPs are increasingly visible around the world, however their success and application has

varied greatly by region.

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.

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

Latin America: transitioning

from privatisation into more

advanced PPPs

Africa: building the

foundations via pilot projects

and with the support of

development institutions

Asia: Australia, South Korea

and India increasingly active

Global trends in PPPs

PPP 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

Overview of key, broad success factors

Solid legal framework

PPP success factors

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

Good regulations

PPP success factors

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

PPP success factors

Selecting the right partner

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

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

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.

PPP success factors

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

PPP success factors

Institutional design and coordination

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

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

PPP success factors

Risk identification and allocation

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.

.

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

Private-sector interest is key

PPP success factors

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

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.

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?

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.

Weighing the positive and the negative of

conducting a PPP is what ultimately

determines decisions

+ Contributes additional financing

+ Contributes additional human resources and

expertise

+ Increases modernisation of technology and

practices

+ Improved investment environment

+ Can enhance the efficiency and self-

sustainability of the infrastructure

-- 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

-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?