PUBLIC PRIVATE PARTNERSHIPS AS AN ALTERNATIVE FORM OF PROCUREMENT (CONCEPT, CONTEXT AND CONSTRAINTS)

Chukwuma Katchy PhD

Managing Director kpt associates ltd., Abuja

chukwumakatchy@hotmail.com 08033223800

ABSTRACT

Public Private Partnerships (PPP) are one way of procuring infrastructure and services which usually require the involvement of private capital.  PPPs have many advantages over traditional procurement  e.g., they tap into private funds and thus free up public funds for use in other areas such as security and welfare, enable government to embark on more projects at the same time rather than waiting till it has all the money, and are completed within budget & schedule.  However, PPP has its disadvantages – longer time to structure, higher transaction costs and politically controversial in immature PPP markets.  There are many differences between a PPP procurement and the well known traditional procurement.  Financial reasons, project efficiency and effectiveness, government efficiency and ideological purposes  are the four  motivations for using PPP all over the world.  Despite the many advantages that PPPs offer, Nigeria is yet to experience many successful PPP transactions due to a number of militating factors. These factors which are also common in Emerging Markets and Developing Economies (EMDE) and Least Developed Countries (LDC) can be grouped into three namely, inadequate budgetary provisions, unavailability of long term finance and country risks.  Finally, the paper discusses the nine factors necessary for successful PPP transactions as encapsulated in the acronym PPROBESTT

Keywords: bankability, Debt Service Cover Ratio, de-risking, ip3, jurisdiction, unsolicited proposals,

INTRODUCTION

Public Private Partnership (PPP) is a method of procurement and it usually requires the involvement of private capital.  It is one out of many ways of procuring infrastructure and services.  However, this method of procurement should only be used for projects with strong economical and social impacts and are in addition best suited to be procured as PPPs.  A project with weak economical and social impacts will not become strong simply by using a PPP procurement method because a PPP procurement method will not perform magic.  Sound preparation and good project governance are essential elements for a successful PPP.  Cuttaree 2008 used Mexico and Chile PPP programs to illustrate the importance of proper design of a PPP program. Experience in this region but also worldwide converge into the same essential elements:

• Strong public sector capacity
  • Appropriate PPP and sector Framework
  • Planning and solid feasibility study
  • Transparent and Competitive Procurement
  • Strong monitoring and flexibility towards unpredicted events.

DEFINITION OF PPP

It is not every relationship between a government and the private sector that can be called a PPP.  There is no universally accepted definition of PPP as definitions vary from one jurisdiction to another.  Governments may define any relationship with the private sector as a PPP, or they may use a more restrictive definition that entails the use of specific contractual models or financing mechanisms.  Usually, these variations in definitions are a product of the country’s private sector participation(PSP) in projects, legal or administrative history or tradition.  E.g., due to Nigeria’s  PSP history, PPPs in Nigeria are defined as Concessions only, thereby excluding other forms of PPPs such as Service Contract, Management Contract, Lease or affermage, joint Ventures and Licensing.  The Institute of Public Private Partnership (IP3) defines PPP as “ a form of legally enforceable contract between the public sector and the private sector, which requires new investments by the private contractor (money, or technology, or expertise/time, or reputation, etc.), which transfers key risks to the private sector (design, construction, operation, etc), in which payments are made in exchange for performance, for the purpose of delivering a service traditionally provided by the public sector.”  In a nutshell structuring a PPP procurement is the act of transforming a government’s desire to provide an infrastructure into an investment opportunity that is attractive to the private sector.  

Effective PPPs typically comprise three essential elements:

• A contractual agreement defining the roles and responsibilities of the parties;
• The sharing of risks between the public and the private sector partners; and
• Outcome-based financial rewards i.e. payment is based only on performance.

It is important to note that a PPP (which involves a temporary transfer of government assets to the private sector)  is different from privatization (which involves a permanent transfer of public assets to the private sector). In addition while a PPP involves a continual role by the government in the project as a partner, a privatization does not involve such a role for the government.  

ADVANTAGES AND DISADVATAGES OF PPPs

Advantages

PPPs have many advantages over traditional procurement namely,

1. they tap into private funds and thus free up public funds for use in other areas such as security and welfare,
2. they enable governments to embark on more projects at the same time rather than waiting till it has all the money,
3. they are completed within budget & schedule,
4. there is reduced whole life costs, because of private sector efficiencies;
5. there is enhanced public management, because government now has the time to manage, rather than be distracted by operational and service provision requirements
6.  Contractual provisions  link the private operator’s remuneration with performance.  Thus there is a better incentive to perform, because failure to perform means that payment is not received by the private entity.
7. additional revenues from other sources outside the project are usually generated as a result of the business acumen possessed by the private sector.
8. control over the private partner in a PPP coupled with the involvement of users in the planning & operation of service delivery improve accountability.
9. the presence of many participants lead to greater accountability and transparency.

Disadvantages

However, PPP has its disadvantages –

a) They take longer time to structure,

b) they involve higher transaction costs and

c) they are always controversial in an immature PPP market.  In such a market   PPPs are usually politically controversial with its consequential opposition.   This controversy is caused by four factors viz,

1. People see the immediate burden of paying fees but don’t see the deferred benefit of sustainable high quality services.
2. There is a change in stakeholder behaviour and shift in existing economic & political power network.  Losers in the shift prefer that the status quo is maintained
3. Govt. employees erroneously believe that the use of PPP procurement methods mean the end of traditional procurements.
4. The public is always suspicious of the motive of the private sector because of the belief that it is only profit and more profit that drives the private sector.

DIFFERENCES BETWEEN A PPP AND A TRADITIONAL PROCUREMENT

There are many differences between a PPP procurement and the well known traditional procurement. See Table 1.

Table 1 Differences between Traditional and PPP Procurements

	TRADITIONAL PROCUREMENT	PPP
1	Input based	Output based
2	Single Contract Agreement	A web of Contract Agreements woven around a main Agreement
3	Technical experts e.g. Engineers, Architects, most important	Economic, financial, legal experts most important
4	Short term contract duration	Long term contract duration
5	Unsolicited proposals are rare	Unsolicited proposals common
6	Generally, Project implementation commences immediately after Contract Agreement is signed	Generally Project implementation commences after Financial closure is reached between lender and private entity.

WHY GOVERNMENTS EMBARK ON PPPS

There are several reasons that governments commonly cite for entering into PPP contracts and these can be grouped into four namely, those related to Financial reasons, those related to project efficiency and effectiveness, those related to government efficiency and  those related to ideological purposes  

1. Financial Reasons,

 The financial motivation may be divided into two subgroups.

• Off Balance sheet motivation 

One relates to the statistical and national accounting perspective. Government may seek private financing because it is “off balance sheet” of the government,).

• Pure cash motivation

The second relates to the pure cash motivation, that is, the access to private resources to tackle a financing shortage for infrastructure development, regardless of whether or not this is considered, in the respective accounting system, as public debt.  The “cash motivation” is usually the main driver in the case of many EMDEs.

• Project Efficiency and Effectiveness,

The other main motivation for the use of PPPs as an alternative tool to both finance and procure infrastructure is the potential long-term gain in terms of efficiency (when applying PPP to the right projects and under the right structure and procurement process)and effectiveness (when using PPPs for achieving the desired outcomes in a time and cost effective way).  For PPPs, the long-term expected cost to the public sector may be lower under a PPP structure than with conventional procurement (and/or the expected benefits may be higher). This is the case even after considering the higher cost of capital (financial costs) associated with the private financing that forms part of the PPP. For user-pays PPPs, the efficiency might also result in lower charges to users.

• Government Efficiency

The efficiency of government in delivering infrastructure is highly improved because waste and corruption commonly associated with traditional procurement method are highly reduced using PPP route. The examples of Abuja CCTV project and the award of contract for the removal of invasive plants with fund set aside for Internally Displaced Persons readily come to mind,

•  Ideological Purposes  

A government may adopt the PPP method for ideological reasons e.g., to have a lean government.

PROBLEMS OF EMDE AND LDC COUNTRIES

Despite the many advantages that PPPs offer, many Emerging Markets and Developing Economies (EMDE) including Nigeria and Least Developed Countries (LDC) are yet to experience many successful PPP transactions due to a number of militating factors. These factors can be grouped into three namely, inadequate budgetary provisions, unavailability of long term finance and country risks perception.

1. Inadequate Budgetary Provisions,

EMDE and LDC countries suffer from inadequate budgetary provisions. This militates against the implementation of a large number of PPP projects that will be based on government pays payment mechanism such as projects in the social sector of education and health.

• Unavailability of Long Term Finance

Private finance PPPs require long-term finance, the majority of which should be in the form of debt so as to maximize financial efficiency through gearing.  A sound financial structure requires that the debt is denominated in the same currency as the revenues of the debtor (that is the private partner or SPV).  Therefore, when the PPP revenues are denominated in local currency, debt should be provided by local lenders (unless the currency of a country is a supranational currency, as in the case of the Euro).  Otherwise the project will be affected by one of the more severe and difficult to manage risks, that is foreign exchange risk.  A country without a relatively developed financial system —that is one able to lend significant amounts for long terms(e.g. above 10 years)—will have to rely on cross-border financing in hard currency, such as US dollars or Euros, thereby exposing the project to foreign exchange risk. unavailability of local financing makes structuring of deals difficult and increases attendant financing costs.

•  Country Risks Perception.

Country risk represents the collection of risks associated with investing in a foreign country, including exchange risk, economic risks (GDP evolution, inflation risk), transfer risks (the risk of suffering a block in repatriation of distributions and cash flow to the investor), political risks, social risks(including risks of general riots), regulatory and legal risks(the risk of existing legal provisions affecting a foreign investor, or being more onerous than in the home country), corruption, and sovereign risk(the risk of default of financial obligations by the country).

   In EMDE and LDC countries, having bankable projects is difficult because bankability for such countries involves more than de-risking projects. More importantly, it entails de-risking the country and its PPP program. Creating an enabling environment for private sector participation in infrastructure delivery is a task for the whole of government. First, aligned and consistent policies on ease of doing business need to be put in place. This includes registration of new businesses, and for foreign investors – ease of capital repatriation. The country’s credit worthiness is also a fundamental requirement in encouraging project finance including attracting offshore financing interests. (Cosette C 2017).

NINE CRITICAL SUCCESS FACTORS – PPROBESTT

The nine critical success factors necessary for successful PPP transactions as encapsulated in the acronym PPROBESTT are,

1. Programmatic and Structured Approach

To become a major government agenda, PPPs must be undertaken in a programmatic and structured approach.  Governments should not adopt  the implementation of PPPs in an ad-hoc or haphazard manner but should adopt a programmatic and structured approach to attract the interest of reputable players in the market.  This programmatic  approach involves having a pipeline of deals while a structured approach involves having a written PPP Framework 

a) (Programmatic approach) Pipeline of deals

A pipeline of deals sends a message to the market that the Government is committed to the use of PPPs to improve its infrastructure deficit. It underscores the commitment of governments in pursuing a sustainable PPP program and that there is top level political commitment to PPPs.  In addition a pipeline of projects confers the following benefits on the investor,

• The investor benefits from economy of scale in his bidding.  This is due to massive pre-investment activities that investors commit to.  It takes a deliberate decision to invest in a country and set-up the ancillary support systems.  A pipeline enables them to set up offices and attendant supply chain on a longer timeline while trying to win bids. A pipeline of PPP projects provides them the rationale and justification to do so.
• He is encouraged to put in his best knowing that he has higher chances of winning.
• He benefits from lessons learnt from one project especially in projects of similar contextual background

b) (Structured approach) PPP framework

This entails that the PPP method of procurement should be implemented in a system format and this is readily done using a PPP framework, which is a document that contains the policy, the rules, established procedures, institutional responsibilities, decision criteria and decision making lines used in selecting, implementing and managing PPPs in a jurisdiction. It is a formal way of announcing to the market the readiness of that jurisdiction to implement PPPs.   A good PPP framework aims to ensure that the right projects are selected as PPPs, and that they are developed, delivered and managed in a structured, transparent and efficient way and has the following benefits,

Increasing the capability of government agencies to deliver PPPs

PPP projects may be developed by various agencies across the government. Each of these agencies may be an expert in its own sector – for example, in highway development, or water service provision. However, most agencies will not be experts in PPPs. If each agency has to learn how to do PPPs on its own, learning costs will be high, as will the risk of mistakes. Codifying standard practices in a framework reduces learning costs and the risk of mistakes

Generating market interest

PPP frameworks reduce investors’ perception of risk, because the investors will have the belief that the projects will be delivered by governments using transparent, fair and competitive processes.

Facilitating probity and oversight of the PPP program:

 As with any important government program, independent oversight and evaluation are desirable. Having clear processes, decision making criteria, and allocation of responsibilities makes such oversight more effective.  Clarity about what officials should do makes it easier to assess if they did what they were supposed to do. Clarity about objectives makes it easier to assess if those objectives are being achieved.  If things are going wrong, a clear and well documented framework makes it easier to learn lessons from the experience.  Evaluators of the program can distinguish between whether the officials are following the framework and the framework needs to be improved, or whether the problem is that officials did not follow the framework.  If the problem seems to be with the framework itself, having a well-documented framework can make it easy to see which particular parts of it need to be changed.

• Public champion

Public champion, external to the government team should be identified to serve as PPP advocate in order to minimize misperceptions.  A person will accept an advice from another  person when two conditions exist – that the adviser is knowledgeable and that he is acting in good faith.  Those external to the project will not usually believe that a government official is acting in good faith and except in situations where the government has a very high credibility it is not advisable for a government official to be the advocate of PPP projects.

• Revenue sources

Revenue sources with acceptable rate of return, that are clear,  predictable and with potentials for strong growth should be identified by both parties.  Most PPP failures can be attributed to inadequate or non-existent feasibility studies, including unrealistic traffic forecasts and undefined public contribution of funds.  Strong emphasis should be put on forecasting revenues and costs as part of the feasibility study. Overestimation of revenues can bankrupt the project.  In the failed infamous Mexico Road concession, Construction cost overruns averaged 25% and average actual revenues were about 30% below forecasts (only 5 projects met or exceeded targets).  Cuttaree 2018. Another example is the Hungary M1/M15 which was the first toll motorway tendered and implemented in Central and Eastern Europe.  Traffic volumes were about 40% lower than anticipated, despite the forecasts being prepared by independent experts.  As a result, the concessionaire was unable to service its debt and ultimately the government had to take over the concession at a high cost.

• Organised structures for both public and private sectors

Organised structures should be established by both the public sector (by setting up a PPP unit) and the private sector (by forming an SPV). This means that dedicated teams are created to handle the PPP project.

The benefits of creating an SPV include

• SPV improves lenders’ confidence in the process.  

An SPV is a usual requirement by lenders in order to provide finance through project finance techniques, as this allows for better control of the credit risks with the revenues accruing to the project being ring-fenced.  Project finance techniques allow equity investors to limit their exposure to risk, and they provide high leverage without the need for investors to (generally) provide corporate guarantees.

• The public party also benefits from the existence of a SPV, as it means that the public party’s partner will only be dedicated to the specific PPP contract. It is common for both the public party through the Request for Proposals(RFP) and the contract and lenders to prohibit the SPV from developing other projects so that its only object is the delivery of the PPP works and services.

For the latter reason, it is not uncommon that the RFP requires the creation of an SPV. (APMG 2016).

 The roles and Benefits of PPP units include

• Control and oversight of the PPP process: This includes ensuring that the right steps are taken in developing a PPP, so that the required analysis shows the project is consistent with appraisal criteria, and that all required approvals have been obtained.  The PPP unit may also act as an approving body, as is the case in a number of European countries and Nigeria.  For example, Croatia’s PPP unit approves the eligibility of projects and any contract renegotiations and Nigeria’s Infrastructure Concession Regulatory Commission (ICRC)  approves the eligibility of projects and any final contracts before final approval by the Federal Executive Council.
• Development of the PPP framework: The unit manages the evolution (but sometimes not the creation) of the PPP framework, including developing and keeping updated the process guidelines;
• Promoting PPPs within the government: For example, reminding implementing agencies that it may be desirable to do large new projects as PPPs;
• Advising and supporting agencies to implement PPPs: Offering experience and specialist skills acquired because of their focus on PPPs and involvement in numerous projects.
• Acting as a knowledge center: Collating and disseminating knowledge and information about PPPs, thus ensuring that knowledge is shared across procuring authorities and made available to the public;
• Providing communication channels to investors: Helping bidders and financiers, who may otherwise be unsure who to ask, with information about the program and upcoming opportunities; and
• Monitoring and support after financial close: Assisting the procuring authority with contract management, and ensuring critical information is communicated to relevant central agencies that need to be aware of changes in the PPP’s risk status in order to monitor the project’s contingent liabilities.

• Business Plan

Both Parties must insist on Business Plans & detailed contract so as to increase the probability of success. An Outline Business Case (OBC) which should contain baseline technical requirements, financial model and preliminary Contract should be prepared by the government entity before launching the project to the market. Unfortunately,  government officials in Nigeria often have pushed out to the markets projects without adequate or even no preparation.  Good preparation and sound project governance underpin successful PPP transactions.  A Full Business Case should be prepared by the preferred bidder before contract implementation commences.

• Environment

Procurement environment should be fair, economical, transparent and competitive while the political environment should be stable.  A competitive procurement gives confidence to the investor that a change in political leadership will not lead to a re-negotiation or even the termination of the project.  While the essence of doing a PPP procurement is to transfer substantial risks to the private sector, investors still seek a stable and predictable environment that would enable them recover their investment and earn a reasonable return. Between 1993 and 2001 Chile awarded 21 road concession worth US$ 5 billion on a competitive basis.  The bidding attracted 27 consortia and more than 40 Chilean and foreign companies, from 10 countries.  The PPP program is viewed as transparent and competitive and adjudged a success and  surveys of users, consultations with local and national leaders, and focus groups graded the Concessions System at 6 on scale from 1 to 7. Cuttaree 2008.

             Contrast this with the (in)Famous PPP Failure, the  Road Concession Program in Mexico. Between 1987 and 1995, 52 projects (only 25 were competitively tendered) were awarded . By the end of 1995, 34 projects had reached financial close for US$ 9.9 billion in private investment committed.  However, the projects started floundering and government as of necessity had to take over 23 projects and paid outstanding debt to Mexican Banks (about US$ 5 billion) and construction companies (about US$ 2.6 billion). In summary, out of 52 projects only 11 were successfully implemented as PPP projects.

• Stakeholders’ Management

There should be adequate stakeholders’ communication and management for quality control, increased buy-in and minimized resistance.  For a PPP to be successful, stakeholders and their different interests must be identified and appropriately addressed. Generally, there are four very important stakeholders who must be identified and their interests addressed.  They are the Public entity, the Investor, the Financier/Lender, & the Consumers. Their interests are varied namely,

1. Public entity:-  The interests of the public entity are that the product should be affordable to the payer, the quality of the product should be acceptable and the project sustainable.
2. Investor:- The interest of the Investor is that the Return on Investment (ROI) should be comparable to similar investments in the same industry.
3. Financier/Lender:- The interest of the Financier is that the project should be “Bankable.” “Bankability” is the term used to denote that the Lender has confidence in the project that the project will successfully pay back the loan. It is a technical term that includes factors such as Project Risks being within the Lender’s Risk Thresh-hold and Debt Service Cover Ratio (DSCR) being adequate i.e. greater than 1.5 for multiple off-takers or greater than 1.3 a for single off-taker.
4. Consumer:- The interests of the consumers are that the product should be affordable & of adequate quality.

Although the media is not a primary stakeholder in PPP projects, its importance in shaping the opinion of the public cannot be over emphasised.

Widespread public opposition to a PPP project can prematurely end the concession. The absence of an assessment of willingness to pay(an important aspect of stakeholders’ management)  can lead to public dissatisfaction, and even violent protests.   In 1999, the Bolivian government concessioned the water system in Cochabamba by granting a 40-year concession to an international consortium called Aguas del Tunari  and without conducting a willingness to pay survey, tariffs were modified, which resulted in increases of up to $20 in water bills for local families, many of whom often earned as little as $100/month.  In October 1998, groups gathered in protests, which led to an outbreak of violence, and the Bolivian army killed as many as nine persons, injured hundreds and arrested several local leaders.  Finally, the Concessionaire withdrew from the project

• Transaction Adviser

An external Transaction Adviser should be employed for the following reasons.

1. PPPs are usually controversial.  A serving public servant should be saved from the hazards of controversy .
2. PPP is a new concept and as such the knowledge is not commonly available in the public sector.
3. Public officials prefer public spending. Therefore, it will amount to conflict of interests to allow the same public officials to drive a PPP process which involves private spending.  The public officials are most likely to scuttle the process.
4. Govt. experts differ from private experts in commercial & financial knowledge. Such experts e.g.,  architects, engineers, Quantity Surveyors, have the same technical knowledge as their private counterparts but differ greatly in commercial & financial Knowledge.  The private expert is more versed in risks’ analysis and sustainability issues.
5. Technical Advisers  have the much needed independence to advise CEOs & other important decision makers and   
6. The use of Technical Advisers confers credibility on the entire process and attracts the confidence of reputable investors and lenders.

• Top political commitment

Support from the highest political office in the country is required for investors and lenders to have confidence in the project.  When PPP investors are asked what they look for in a project, they would typically reply they like projects that are bankable, where risks are fairly allocated between the government and the sponsor.  When one probes deeper though as to where they normally invest, you might elicit this response: in a market where there is deep commitment by the government to undertake an effective PPP program.  This is a very telling answer sometimes lost to governments that want to pursue ambitious PPP programs (Cosette C. 2017).

Among other factors, the existence of a PPP framework and pipeline of deals is an indication to investors that there is top level political commitment.

CONCLUSION

A properly designed PPP can yield positive results for government, end users and the private partner.  Unfortunately, many PPPs have been poorly designed with the attendant consequence of failure with the Government suffering reputational damage and this experience has in many cases eroded support for the concept of Public Private Partnership.  Key success factors that are needed to select, implement and manage PPPs successfully include careful planning of the PPP project, solid revenue and cost estimate, a supportive user willingness to pay and good stakeholders’ management, a thorough feasibility study using Transaction Advisers, PPP Framework, strong PPP units and SPV, and above all a competitive, a fair and transparent procurement process.

References

APMG Public-Private Partnership Certification Guide Chapters 1 – 7 The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA 2016

Cosette Canilao Bankability: More than de-risking projects 2017. Retrieved from World Bank website 23/8/2017

Cuttaree V. Successes and Failures of PPP Projects. Retrieved from World Bank website 17/6/2008

Katchy C.C. Public-Private Partnership El Demak Ltd. 76 Robinson Street, Uwani Enugu State Nigeria. 2015