Edward Farquharson

James Ballingall

March 2011

Preparing Projects for Market

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3 key questions / 5 cases• What are the project scope and requirements?

– Strategic Case –case 1

• Can the project be delivered as a PPP?

– Affordability – case 2, Commercial – case 3 and Management – case 4

• Should the project be delivered as a PPP?

– Value for money - case 5

=>Iterative process

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Examples of guidance

• Public Sector Business Cases using the 5 Case Model: http://www.hm-treasury.gov.uk/data_greenbook_business.htm

• The Outline Business Case, 4Ps May 2004; www.localpartnerships.org.uk

• National Treasury PPP Manual Modules 3 and 4, South Africa National Treasury 2004; www.ppp.gov.za

• Practitioners’ Guide, Partnerships Victoria 2005; www.partnerships.vic.gov.au

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Process overview

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The ‘Outline Business Case’

• Audience– Project Team and Board

– Procuring Authority

– Central Government

– Other stakeholders

• Helps to ensure relevant issues are addressed

• Helps to ensure impact of issues on each other are addressed

• Basis for approval

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‘Strategic Business Case ’ - Establishing the need, scope and initial project

selection

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Needs analysis

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Needs analysis … 2

• Project fit with wider strategic objectives

• Minimise risk of significant changes later on

• Consultation

• Impact on other projects and stakeholders

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Analysis of Project Options

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Options Appraisal

• Identification of the preferred project option– Use of a do nothing or do minimum option to assess impact of change

– Measured against delivery of service objectives, affordability and sustainability

– Assessment of costs and benefits

– Role of discount rates and optimism bias

– Combination of qualitative and quantitative factors

• Identification of the preferred procurement route– Value for money

Useful references:

‘Green Book – appraisal and evaluation in Central Government’, HM Treasury 200; www.hm-treasury.gov.uk

Project Governance

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What is Project Governance?

• Ensure that the right projects are done well

• Linking procuring authority’s organizational governance with project management

• Covers the whole life cycle and will evolve over life of project

References:

‘Project Governance - draft guidance note’, HM Treasury 2007; www.hm-treasury.gov.uk

‘The Good Governance Standard for Public Services’, Independent Commission for Good Governance, OPM and CIPFA 2004; www.cipfa.org.uk

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Purpose of Project Governance

• Link the project to the authority’s priorities• Set out lines of responsibility and accountability• Enable stakeholders to manage their interests• Representative or Expert? (representative can be managed through stakeholder

route)• Ensure public sector requirements met in good time• Support the Project Team and ensure right skills and resources• Access to best practice and advice• Source of neutral/external challenge• Contact with supply side• Resolve issues• Project disclosure• Focus on needs for each stage

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Example of Project Governance Structure

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Project Governance Problems to Avoid

• confusion about roles

• a part-time Project Manager

• frequent changes in the project team;

• insufficient resources

• over-reliance on advisers for decision-making;

• insufficient delegated powers to the Project Management Group

• interference from other bodies outside the governance structure

• poor management of the day-to-day resources, including the external advisers.

• a Project Board is too large / not able to meet as required to take key decisions

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Indicative Timetable

• Public sector often underestimates the length of time that a PPP procurement will take.

• Timetable consistent with experience in sector.

• Delays in procurement can impact adversely on project –reduced stakeholder commitment, higher costs due to inflation

Project Preparation

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Project Preparation

Project Outputs

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Defining project outputs

• Distinguishing between outcomes and outputs– Reducing re-offending is ultimate policy outcome. Provision of long-term

serviced prison accommodation is an intermediate output.

• Distinguishing between outputs and inputs:– A prison building is not an output, a supply of serviced accommodation is;

– A heating plant is not an output, maintenance of a minimum acceptable temperature is;

• Framing output requirements: design outputs, availability standards and performance standards

• Standards should be SMART – Specific, Measurable, Achievable, Realistic and Timely

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Output Specifications … 2

• Requirement specified in terms of service outputs, rather than particular assets or solution – allows scope for private sector innovation and competition.

• Range of on-going services included in the requirement defined - offers scope for efficiencies and innovation and competition.

• Specification pitched at a realistic and achievable level – private sector would price up (or not bid for) unrealistic specifications.

Issues :

• Does the Project Team understand the principles?

• Consistency with: Affordability model, Risk allocation, Commercial Interest, Key terms and Conditions, Suitability of Advisors, Commitment of Sponsors / Users

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Technical Assessment

• Are the output requirements technically feasible?

• Expected costs

• Assessment of ground conditions etc

• Design development

• Insurance review

• Environmental impact

• Social impact

Statutory and Legal Assessment

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Statutory and Legal Requirements

• Can the public authority enter into the contract?

• Is the proposed procurement process legal?

• Legal status of project assets – land ownership, liabilities, indemnities

• Adjacencies and counter-parties

• Ensure that statutory processes (environmental assessment, planning, public enquiry, consultation) have been considered and the timetable incorporates any implications that compliance to statutory process may entail.

• Ensure that risk of compliance with statutory processes is properly shared with private sector

• Statutory processes must be consistent with: Timetable, Risk Allocation.

Affordability

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Affordability

• Who will pay for the project and how?

• The cost to deliver the specified requirements– Contractor’s charges reflected in a “unitary charge”– Capital expenditures– Operating expenditure– Cost of capital/debt – Risks

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• The funds / assets available– Feasibility / Willingness of users to pay– Procuring Authority existing budgets– Other grants/sources– Guarantee fund availability– Up-front capital grants / public assets

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Affordability … 2

Development of a ‘shadow bid model’• Projected PPP capital / service payments identified → computed ‘unitary charge’

• Shadow bid assumptions of capex, opex, lifecycle etc.

• Funding assumptions in line with market – gearing, returns, cover ratios

• Identify budgeted and 3rd party sources of income

• Indexation assumptions

• Affordable over the whole life of the contract, taking into account all sources of revenue, additional income from capital receipts or third party income.

• Sensitivity analysis conducted to determine key variables which underpin affordability position.

• Affordability analysis and risks and sensitivity analysis, and their impact on budgets, accepted by budget holders.

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Affordability … 3

• ‘Hidden costs’ – land acquisition, surveys, authority costs

• Assessing fiscal impact

• Covering multi-annual budget commitments

• Relevance of approvals

• Use of guarantees

Risk Allocation

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Types of Risk

Planning RiskFailure to obtain planning permission, resulting in termination of the project or significant variation to the service solution.

Design RiskDesign of the chosen solution does not allow the output requirements to be met, leading to revisions in design, changes to specification or termination of project.

Construction RiskRisks associated with the construction phase, such as latent or construction defects, archaeological discoveries or unforeseen ground conditions, leading to construction delays and cost overruns.

Demand RiskRisk of fluctuations in long term demand for the service, leading to changes to specification or termination of project.

Performance RiskRisk of not achieving performance targets set out in the output specification, leading to poor quality service to users.

Technology and Obsolescence Risk

Risk that changes to technology render proposed solution obsolete, leading to expensive changes to design/scope.

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Types of Risk … 2

Operating RiskRisk of higher than expected operating costs, making it more costly to deliver services to stated standard.

Third Party Income Risk

Risk of lower than expected income from third party users, making it more costly to deliver services to stated standard.

Residual Value RiskRisk of fluctuations in value of assets associated with the service (if transferred) at end of contract, making contract more expensive overall.

Regulatory Risk Risk of changes to legislation or regulations, making it more difficult or more expensive to deliver services to stated specification.

Financing RiskRisk of inability to obtain finance to fund the project, or fluctuations in the cost of funds or the terms of financing anticipated at the outset – making it costlier to provide the service.

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Risk Allocation

• Who?:– users– investors - the private-sector– taxpayers - through the government

• Allocate risk to party best able to:

• control its occurrence and consequences – assess information about the likelihood of the risk– within context of what is likely to be commercially acceptable to the

private-sector.

• Risk does not disappear through contractual structuring

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Risk Allocation – Issues

• A risk register has been prepared, identifying all the risks associated with the scheme, and making a preliminary risk allocation.

• The preliminary allocation, as a minimum, transfers the principal risks associated with design, build, finance and operation of the facilities to the private party.

• Consider the allocation of risks associated with demand, residual values, technology and obsolescence and changes in legislation or regulation.

• Ensure consistency with: Affordability model, Commercial interest, Key terms and Conditions, Output Specification.

• Note: there will also be allocation within the private sector.

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Risk Mitigation and Monitoring

• Risk Mitigation– reduce the likelihood of risks and its consequences for the risk taker

– implications for project scope

• Risk monitoring– use of a risk management plan, linked to the risk register

– updated over project life

Assessing Commercial Interest

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Typical Project Feasibility Issues

• Pricing risks - water

• Demand risks - road, rail

• Rehabilitation - water, power, accommodation

• Environmental - transport, power

• Interface - power, accommodation

• Size

• Location/ complexity

• Foreign currency

• Technology

• Workforce

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Indication of Commercial Interest

• Capacity of bidding market

• Evidence of bankable contract terms and project specification

• Certainty of income stream to meet contract payments

• 3rd party income opportunities

• Adjust scope if necessary

• Evidence of commercial interest through “market sounding”

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Tips for successful market-sounding

• Ensure that:– In line with any relevant procurement rules– Give best account of the public authority– Consider at an early stage, but not too early– Prepare the background documentation– Clear about the issues to be discussed with the market– Clear about the process to select organisations– Consider use of a one-to-one format but no special treatment in any subsequent

procurement– Involve more than one individual on the public sector side, be consistent and ensure

meetings are documented

• Avoid:– Wasting time with sales pitches / shaping the project to suit a proposal – use of third

parties?– Restricting scope: aim to select operators and contractors etc.– Focusing on outcomes rather than means of achieve them– Using procurement language such as ‘bidders’

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Bankability

• Importance of cashflow over assets

• Limited recourse finance versus corporate finance

• Role of lenders in due diligence

• Dangers of guarantees

• Currency risks

• Tenor and affordability

• Role of equity

• Role of SPVs and allocation of risk within the private sector

• ‘Step-in’

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Typical PPP Contractual Structure

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Typical Project Lender Concerns

• certainty of the project cash flows to meet debt service requirements;

• bankability of public-sector obligations;

• effectiveness and enforceability of PPP contract and related agreements;

• rights to step-in in the event of project failure and availability of alternative contractors;

• ability of contractors to perform/quality of their management;

• bankability of contractors and quality of contractor guarantees;

• risks that are understood, controllable, finite and appropriately allocated;

• reputation (environmental, social);

• effectiveness of insurance cover where needed.

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Typical Contractor and Investor Concerns

• cost/time/quality of the PPP bid process — are major approvals still awaited?

• what bid evaluation criteria will be used?• fairness of competition• subjective use of evaluation criteria• dealing with clarifications fairly• leakage of good ideas• quality of the public-sector project team and their advisers;• security of the project income stream (demand, bankability of public-

sector obligations);• what they will be expected to deliver and how their performance will be

measured;• availability and cost of long-term debt funding;

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Typical Contractor and Investor Concerns … 2

• (for financial investors) effectiveness of the construction contractor and operator to deliver the service and manage to time and budget;

• status and availability of connecting infrastructure / availability of inputs;• effectiveness and enforceability of the PPP contract and related

agreements;• potential foreign-exchange risks;• the wider operating environment for private capital;• the allocation of risks both between the public and private sectors• allocation of risks between the private parties;• returns commensurate with the risks they are asked to assume;• how effectively the public-sector will manage the contract and take

decisions;• opportunities to refinance the debt or sell their investment.

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Engaging with the Private Sector: Commercial Strate gy

• Manage the PFI/PPP supply market (to generate interest, understand constraints, familiarise with procurement process and manage expectations)

• Determine achievable share of whole-life project risks

• Determine the scope of the competition

• Determine the number of competitors

• Design the nature of the competition (process and timing)

• Determine the bidder requirement

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Recap

RiskIdentification

Bankability

Project Agreements

Outputrequirements

Risk allocationand mitigation

Risk monitoringand review

Developing Project Contracts and Information

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Developing the Project Contract

• If the risks do in fact arise during the project life, both parties are agreed on what to do about them

• Outline contract prepared – Outputs reflected in output specification and payment mechanism

– Bankability of contractual terms needs to be established early on, otherwise bidders will waste time and money.

• Proposed payment mechanism that reflects risk allocation – Unrealistic or overly penalistic payment mechanism may not be accepted by

funders/contractors, leading to delays in negotiation and/or termination.

• Use of bankable standard contract terms

• Key terms and conditions must be consistent with: Risk Allocation, Affordability, Output Specification, Bankability

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Project Information Memorandum

• Project Sponsor– details on the public-sector parties involved in the project – VISIBLE LEADERSHIP

FROM TOP OF THE SHOP;

– how the public-sector team is organized to manage the procurement process;

– details of public-sector advisers.

• Project information– project rationale and strategic objectives;

– outline of project requirements—scope, services, size, location, potential capital investment and therefore of the risks expected to be borne by the private sector;

– anticipated payment mechanism (user fees, availability fees or a combination of these);

– status of all project approvals, planning consents, environmental assessments;

– status of public consultation;

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Project Information Memorandum … 2

• Project Information cont..– possibly an outline of model designs and design requirements;

– information on enabling works, status and availability of infrastructure services upon which the project may depend;

– potential funding sources (including potential development bank finance).

• Proposed procurement process– stages and anticipated timetable (this might be dictated by legislation);

– details of any proposed bidders’ conference;

– outline of what will be required of bidders at each stage;

– outline of information that will be released at each stage;

– outline of the evaluation at each stage.

Stakeholders

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Identifying Stakeholders

• Those with an interest or stake in the project:– Procuring authority and policy stakeholders

– End users

– Project owner

– Project delivery team

– Supply side

– Third party funders

– Audit

• Updated list and role of stakeholders

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Managing Stakeholders

Deliverability Considerations:

• Demonstrate support from all key sponsors and, where appropriate, users

• Consultation with all other stakeholders

• Use of stakeholder boards

• Consistency between stakeholder support and affordability commitments

• Effective communications strategy re progress/key decisions

• Consult before not after decisions taken!

Value for Money

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Value for Money

• VfM looks at the costs and risks over the life time of the different project output delivery options

• Underpins risk allocation

• Relevant to use of public resources

• Relevant to choice of procurement route

• Quantitative approaches e.g. public sector comparator

• Qualitative approaches e.g. competition

Appointing and Managing Advisors

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Appointing and Managing Advisers

• when to use advisers

• clarity of requirements and roles

• cheapest advice is not necessarily the best advice

• role of PPP units / project development funds

Useful references:

‘Toolkit: A guide for hiring and managing advisors for private participation in infrastructure’, PPIAF; www.ppiaf.org‘Technical Note 3: How to Appoint and Manage Advisers to PFI Projects’, HM Treasury; www.hm-treasury.gov.uk

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Appointing and Managing Advisers … 2

• depth and relevance of expertise;

• clear understanding of the project requirement and process;

• availability of the individuals

• use of weighting

• use of written submissions and interviews

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Appointing and Managing Advisers … 3

• payment of advisers

• pros and cons of lead advisers impact on project credibility

• willingness of advisers to share lessons and approaches,

• arrangements for periodic review of performance of advisers

• strong Project Manager to manage external advisers

• willingness of advisers to sign-off at key stages

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Legal Adviser Support

• assist public authority is assessing the requisite powers and legal feasibility of the PPP project;

• develop the PPP contract documentation for the project;

• develop legal aspects of project bid documents

• analysis of project assets, land ownership, inter-face agreements and other site related issues;

• prepare legal and contractual submission requirements;

• ensure bids meet the legal and contractual submission requirements;

• evaluate and advise on all processes and legal and contractual solutions throughout the procurement;

• undertake legal due diligence on bids;

• support in clarification and fine-tuning of legal aspects.

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Technical Adviser Support

• support development, feasibility and costing of the project• site condition, planning and design work draft project output

requirements and specifications;• develop any payment mechanisms with the financial

advisers;• ensuring technical aspects of the project meet the project

objectives;• evaluate and advise on all technical solutions throughout the

procurement;• scrutinise costs of the bidders’ solutions• technical due diligence on bidders’ solutions;

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Financial Adviser Support

• support development of the financial aspects of business case

• appraisal of options and financial modelling

• liaise with the DFIs;

• develop project payment mechanisms with the technical advisers;

• prepare the financial bid submission requirements;

• ensure all financial aspects of the bidders’ solutions meet the financial bid submission requirements;

• optimise and scrutinise the financial models submitted by bidders;

• evaluate and advise on all financial proposals

• review funding and taxation aspects of solutions;

• undertake financial due diligence on bid submissions;

• support clarification and fine-tuning of financial and commercial issues.

Next Steps

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Preparing for the Next Phase

• Bidding phase timetable and strategy agreed

• Project information documents prepared

• Evaluation criteria established

• Project team, advisers, budgets and governance in place

• Development of a risk register

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Engaging with the Private Sector: Deciding Tactics

• Relevant procurement law

• Timetable

• Information flow

• How many stages of selection are feasible/appropriate?

• Prequalification– Quantity of information– Criteria– Number– Bid bonds?

• Request for Proposal phase

• When to select a ‘preferred bidder’?– after full and final bids– completion of discussion on commercial terms

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Other Potential Issues

• Accounting and fiscal treatment/impact

• Design quality

• Employee transfer issues

• Arrangements for contract monitoring

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Common Mistakes

• lack of clarity by the public authority of what it wants from the project / ambiguous specifications;

• lack of project ownership and leadership;

• under-resourced project teams;

• selecting advisers on the basis of cost rather than quality and experience;

• lack of effective engagement with stakeholders;

• lack of understanding of and contact with the private sector at senior levels and poorly-conducted market sounding;

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Common Mistakes … 2

• expecting the private sector to deal with issues such as land acquisition that are better handled by the public sector;

• optimism - on land acquisition issues, shadow bid model assumptions;

• sub-standard financial models preventing financial close;

• lack of clarity about the public authority’s legal powers to enter into the PPP contract;

• conflict between the procurement process and procurement regulations;

• over-ambitious project preparation timetables;

• releasing project information that is incomplete.

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Checklist

• Clarity of requirements and scope• Risk allocation• Indication of commercial interest• Project information and contract terms prepared• Affordability• Expected accounting treatment• Project team/processes• Suitability of proposed advisers• Indicative timetable• Value for money• Commitment of stakeholders/users• Approvals / appropriate powers confirmed• Commitment of sponsors / users

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Checklist – detail (1/2)

• Clarity of requirements– Are the scope, requirement and term of the project clear and stable? Have they been approved?

• Risk allocation– Have the project risks been fully identified and their potential allocation assessed?

• Key terms and conditions– Has the draft PPP contract been prepared reflecting the project requirements, proposed risk allocation and payment

mechanism?– Have external project interface issues, agreements, terms and conditions been identified and assessed?

• Indication of commercial interest– Is there evidence of contractor, lender and investor market interest to justify launching the project on the proposed

terms? – Has a project marketing strategy and prospective bidders list been drawn up?– What are the expected availability and terms of equity and debt finance? – Have the DFIs been approached?

• Project information– What plans exist to publicise the launch of the project to potential bidders?– Has a project information memorandum been prepared by the project team?– Have the bidder qualification and bid evaluation criteria been developed?

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Checklist – detail (2/2)

• Affordability– Is the project scope fully affordable?– Are the user tariffs realistic/are budgets and approvals in place for any public-sector payment (or asset provision)

obligations?– Is the expected accounting treatment clear?

• Indicative timetable– Is a realistic procurement timetable in place for the procurement phase?

• Project team/processes– Is a credible and well resourced team in place to manage the procurement phase and an effective bid evaluation

strategy agreed?– Are project governance structures and processes in place to ensure timely and effective decision-making?– Are credible and experienced advisers appointed?– Has the appropriate assessment be carried out to demonstrate that the proposed approach is expected to meet any

value for money criteria (to the extent required by policy)?

• Commitment of stakeholders/users– Have all relevant stakeholders been identified, are they committed to the project, and are arrangements in place for

continued communication and consultation?

• Legal processes– Have required approvals been identified / obtained (e.g. environment, planning)? – Is there clarity about site and land issues?– Are all relevant project approvals in place?– Are appropriate powers confirmed for the public authority to award and enter into the long-term contracts?

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