guidelines for successful public

EUROPEAN COMMISSIONDIRECTORATE-GENERALREGIONAL POLICY

GUIDELINES FOR SUCCESSFULPUBLIC - PRIVATE

PARTNERSHIPS

MARCH 2003

Guidelines for Successful Public – Private Partnerships

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Ce Guide est publié sur le site internet de la Commission européenne :

http://europa.eu.int/comm/regional_policy/sources/docgener/guides/PPPguide.htm

Le Guide a été rédigé à l’initiative de la Direction générale de la Politique régionale encollaboration avec :

DG Marché intérieur DG ConcurrenceDG Transport & EnergieDG Office de Coopération EUROPEAIDEIBEBRD

et tient compte des résultats du Séminaire qui a réuni 100 opérateurs nationaux de 18 pays àBruxelles le 4 juillet 2002.

PPP Coordinator : Mr Roberto Ridolfi, email : [email protected]

Disclaimer : These Guidelines are funded by the European Commission. They are the result ofindependent review and do not necessarily reflect the views and opinions of the European Commissionnor attempt to define current or future policy.


Bruxelles, février 2003

Dans ce cadre, les intervjouer un rôle de levier en

L’intégration territorialeaccrus en équipements pde l’environnement (eauafin d’assurer un dévelfinancement est, et reste

Déjà utilisé dans le contnouveaux Etats membre

Conscient des difficultédirectives européennes services de préparer undevrait faciliter l’analynégociations entre les au

J’espère que ce guide sactuels et futurs.

Michel BarnierCommissaire européen ret de la réforme des insti

Preface

Le secteur privé, de par son expérience et ses moyens financiers,est un partenaire à privilégier tant pour le financement que pour laréalisation et la gestion directe et déléguée de missions de servicespublics.

Dans le contexte actuel de rigueur budgétaire, l’intérêt du recoursau partenariat public-privé (PPP) paraît primordial.

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entions des Fonds communautaires doivent, dans la mesure du possible, attirant les investissements et le savoir-faire du secteur privé.

des pays candidats à l’Union européenne est marquée par des besoinsublics, notamment d’infrastructures dans les domaines des transports et

et déchets solides). La réalisation de ces infrastructures est indispensableoppement économique durable des pays candidats à l’adhésion. Leurra l’une des priorités de la politique régionale de l’Union européenne.

exte actuel d’ISPA, le PPP est appelé à jouer un rôle important dans less.

s à associer le secteur privé, tout en assurant une bonne application desen matière de marchés publics et d’aides d’Etat, j’ai demandé à mes guide «Guidelines for Successful Public-Private-Partnerships» quise des risques inhérents à ces types de financement ainsi que lestorités publiques et le secteur privé.

era utile pour tous les opérateurs publics et privés des Etats membres

esponsable de la politique régionaletutions


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EUROPEAN COMMISSIONDIRECTORATE-GENERALREGIONAL POLICY

Brussels, February 2003

Introduction

Recent years have seen a marked increase in cooperation between the public and private sectorsfor the development and operation of infrastructure for a wide range of economic activities. SuchPublic-Private Partnerships (PPP) arrangements were driven by limitations in public funds tocover investments needs but also by efforts to increase the quality and efficiency of publicservices.

PPPs have a long history in some Member States of the EU while being a more recentdevelopment in others. PPPs have received a boost in various countries undergoing process ofsignificant economic growth.

The efforts of the Accession Countries to reform and upgrade infrastructure and services couldpotentially benefit from the PPP approach. This is particularly true, given the enormous financingrequirements to bring these infrastructures up to the standards. The Commission has identifiedfour principal roles for the private sector in PPP schemes:

• to provide additional capital;

• to provide alternative management and implementation skills;

• to provide value added to the consumer and the public at large;

• to provide better identification of needs and optimal use of resources.

However, while PPPs can present a number of advantages, it must be remembered that theseschemes are also complex to design, implement and manage. They are by no means the only orthe preferred option and should only be considered if it can be demonstrated that they willachieve additional value compared with other approaches, if there is an effective implementationstructure and if the objectives of all parties can be met within the partnership.

The Services of the European Commission have a particular interest in PPPs within theframework of the grants that it provides, both within the context of Cohesion and StructuralFunds as well as ISPA. The use of grants in PPPs imposes constraints on projects, given theCommission’s, over-riding requirement to protect the public interest.


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In order to profit from the advantages of PPP all potential participants must enhance theirunderstanding of the different approaches and the optimal methods to structure sucharrangements. To this end, DG Regional Policy has undertaken a wide consultation processwithin the Commission, involving the EIB, EBRD, PPP units and task forces of the MemberStates and Candidate Countries. The Commission has attempted to integrate the views of allparties and will continue to draw upon their experience and skills in further promotingunderstanding and the development of PPP. This process has yielded valuable information on thestrengths and weaknesses of PPP and importantly on how to integrate grant financing while alsorespecting the requirements of EU and national legislation.

These Guidelines are designed as a practical tool for PPP practitioners in the public sector facedwith the opportunity of structuring a PPP scheme and of integrating grant financing. They do notattempt to provide a complete methodology or to define current or future policy. They should beregarded as a guide to the identification and development of key issues affecting the developmentof successful PPP schemes.

To this end, the Guidelines focus on four key topics:

• ensuring open market access and fair competition;

• protecting the public interest and maximising value added;

• defining the optimal level of grant financing both to realize a viable and sustainable projectbut also to avoid any opportunity for windfall profits from grants;

• assessing the most effective type of PPP for a given project.

The services of the European Commission recognize the evolving nature of the PPP concept butalso the need for further debate and above for the expansion of knowledge and implementationcapacity. The Guidelines could contribute positively to this process.

I hope that the Guidelines will assist public officials, financial institutions and the private sectorin our common efforts to better implement ISPA measures as well as those to be implemented inthe near future under the Cohesion and Structural Funds.

Guy CrauserDirector GeneralDG Regional Policy


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Executive Summary

Introduction

Recent years have seen a marked increase in cooperation between the public and privatesectors for the development and operation of environmental and transport infrastructure.In the European Member States this is a direct result of efforts to increase the quality andefficiency of public services, insufficient public sector financial resources to coverinvestment needs coupled with spending restrictions and a desire to access private sectorefficiencies.

A long experience of private participation in the road and water sector now exists andthere is a growing acceptance that Public – Private Partnerships (PPP) arrangements canbe used as an additional and complementary [to others] instrument to meet infrastructureand service needs in a wide range of sectors ranging from environmental services tohealth care provision or education.

PPPs present a number of recognized advantages for the public sector to exploit. Theseinclude the ability to raise additional finance in an environment of budgetary restrictions,make the best use of private sector operational efficiencies to reduce cost and increasequality to the public and the ability to speed up infrastructure development.

The positive characteristics of PPP arrangements in developing infrastructure appearparticularly attractive for the Candidate Countries (CCs) of Central Europe given theenormous financing requirements, the equally large funding shortfall, the need forefficient public services, growing market stability and privatization trends creating afavourable environment for private investment.

PPP arrangements come in many forms and are still an evolving concept which must beadapted to the individual needs and characteristics of each project and project partners.Successful PPPs require an effective legislative and control framework and for eachpartner to recognize the objectives and needs of the other. The European Commissionhas recognised the importance of PPPs and the need for an effective legal framework toensure the application of the rules and principles of the Treaty. For this reason it hasrecently issued a declaration to the Internal Market Council1 in line with the proposals tomodify procurement regulations and an Interpretative Communication on Concessions2.These Guidelines have been developed to integrate these important documents and arefully based on them.

While the benefits of partnering with the private sector in PPPs are clear, suchrelationships should not be seen as the only possible course of action and are indeedcomplex to design, implement and operate. Many alternative sources of financing areavailable, including “public-public” institutional arrangements which should not bediscounted in the hope that PPPs offer a miracle solution. Therefore PPPs should becarefully assessed in the context of the project, the public benefit and the relative gains tobe achieved under various approaches. Not least the national characteristics, individual

1 COM(2000)275 final2 JOCE C/121 of 29 April 2000


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macro-economic situations and the local policy framework must also allow and facilitatePPPs.

The European Commission has a particular interest in promoting and developing PPPswithin the framework of the grants that it provides. It has expressed its willingness toassist in the development and implementation of PPP projects and use grant financing toleverage such arrangements. However the use of grants will impose additionalconditionalities on projects particularly given the Commission’s financing objectives,constraints and over-riding requirement to protect the public interest.

The Guidelines are designed to assist the project designer to match the objectives of thepublic and private sectors.

These Guidelines seek to address the issue of developing successful PPP projects in theCC’s on a general level with specific reference to grant financing of transport andenvironmental infrastructure projects. They present a brief introduction to PPP concepts,discuss key conceptual issues and present a working guide to PPP development. Aboveall they are an attempt to bridge a perceived gap in our understanding of the practicalitiesof implementing PPPs in the Candidate Countries.

Scope and Purpose of the Guidelines

The Guidelines do not aim to provide a detailed guide to project design, appraisal andimplementation but rather to focus on a number of critical issues influencing thesuccessful integration of public grants, private funds, IFI loans (such as the EIB orEBRD) and European Commission financing. Reference is made to a number ofanalytical techniques which are well known and documented. These are not presentedwith the objective of promoting a standard methodology but rather in an attempt tohighlight areas in which particular care and analysis needs to be observed. TheGuidelines are not designed to provide an exhaustive list of PPP structures nor presentany structures as having the endorsement of the Commission.

The Guidelines present five thematic parts dealing in turn with:

• PPP structures, suitability and success factors• Legal and regulatory structures• Financial and economic Implications of PPPs• Integrating grant financing and PPP objectives• Conception, planning and implementation of PPPs

Part One “Alternative PPP Structures” presents four broad categories of PPP structureseach with increasing degrees of private sector involvement. It is stressed that while it isgenerally recognised that PPP presents an effective alternative to mobilising and usingfinancial resources and that there are private sector efficiencies to be harnessed, theyremain an evolving concept and do not represent the only or preferred solution to projectfinancing. Indeed the terminology debate surrounding the definition of PPP categoriesitself mirrors the evolution of PPP approaches and the evolving regulatory environmentdefining PPP in Member States. As such PPPs must be carefully matched to theindividual project characteristics. Guaranteeing benefit from PPP requires recognition ofthe relative strengths and weaknesses of each type of structure and the aims and


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objectives of each party. Of particular importance is the role of the public sector whichmay transform itself from a service provider to an overseer of service contracts.

Part Two “Legal and Regulatory Structures” defines the legal environment for PPPprojects. The importance of effective legal structures is stressed together with the factthat PPP implementation may require a review of existing legal provisions to ensurecompatibility. PPPs will operate in a complex legal environment characterised by theinteraction of the EU Acquis Communitaire, national, regional and municipal legislation,detailed project contractual documents and importantly, specific, procurementregulations. The legal situation in many CC’s is still evolving making careful legal duediligence an absolute requirement.

Part Three “Financial and Economic Implications of PPP” addresses the topic of riskmanagement and its financial impact on a project. As the prime responsibility of thepublic sector is to ensure value for money for society, several techniques andconsiderations are presented for determining and assessing value. Grant financing isrecognised as a useful tool in project financing but carries certain risks. Grants should becarefully matched to the actual needs of the project and beneficiary to minimise anynegative effects, ensure project viability and value for money.

Part Four “Integrating grant financing and PPP Characteristics” addresses the relativestrengths and weaknesses of grant financing and the opportunities offered. The ability touse grants in a PPP depends on the ability to meet the conditionalities attached and theability to provide sufficient safeguards to protect the grant providers’ objectives. Thissection will also include a specific discussion of integrating European Commission grantsinto PPPs.

Part Five “PPP Conception, Planning and Implementation” considers the PPP projectcycle with the objective of providing a detailed discussion of the issues encountered andpossible solutions. It does not aim to provide a comprehensive guide but rather to focuson key issues likely to impact on effective design and implementation. These issues areconsidered separately below.

Key PPP Issues

During the development of the Guidelines a number of key issues were identified asinfluencing the design of projects and their implementation. These are characteristic ofgrant financing in general and specific to cooperation with the European Commission.Their recognition and integration at an early stage is designed to facilitate both readierproject acceptance by the Commission and more effective implementation.

Ensuring open market access and competition. A key requirement of Commission financingand indeed as part of the Acquis Communitaire, is that PPPs should not impact negatively onthe operation of open markets nor on the clear and transparent rules of these markets. Thisissue is particularly relevant with respect to tendering and selection procedures for privatepartners, the use to which grants are put and the provisions made for renewing contracts(with special reference to the length of concession agreements). While regard must be takento ensuring that private parties are able to realise financial returns by guaranteeing sufficientopportunity to generate revenues, this must be matched with a concern to avoid the creationof non competitive or closed markets. An impact is clearly on the designed duration of


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concession contracts but also procurement procedures must respect the current body ofDirectives and above all the principles and rules of the Treaty setting out the need for openand fair competition, transparency and proportionality.

Protecting the public’s interest. The European Commission’s objective in developingcontrol mechanisms is foremost to protect the public’s interest. This manifests itself in manyforms and will impact on project design, scope and implementation. Most notablyCommission grants will require the adoption of European norms, quality and performancestandards together with effective monitoring and management systems in local public sectorpartners. There will also be a degree of reassurance obtained at the tender, evaluation andcontracting stages including the possibility for grant renegotiation particularly sensitive tosustainable local capacity if required. However there is also an important role for the publicto play and therefore the creation of independent consumer groups and associations acting as“watchdogs” will be encouraged.

Ensuring full compatibility between PPP arrangements and State Aid Rules. Provision ofgrant financing must be matched to the real need for grants. In particular care must be takenthat grants do not provide an unfair assistance to construction or operation therebyconstituting unacceptable State Aid under the EU’s interpretation.

Defining the right level of grant contribution. A particular concern of the EuropeanCommission is to ensure that its grants closely match real needs. This is not only to ensurefinancial efficiency but also that the maximum use is made of limited funds. A furtherconcern is to achieve an effective balance between the desire to facilitate project realisationand, in the public’s benefit, to limit the private sector’s ability to achieve undue profit fromgrants. This requires careful calculation of actual financing requirements to achieve projectviability. Consideration also needs to be given to avoiding the possibility that grantsconstitute incompatible state aid.

Selection of the most suitable PPP type. PPP arrangements should not be entered intomerely for the sake of undertaking a PPP project. A detailed review of the costs and benefitsof private sector involvement versus public alternatives must be undertaken to ensure that aPPP enhances the public benefit. The degree of private involvement needs to be carefullymatched to the objectives and needs of the project and the public. Appropriateness, cost, theability to effectively implement and manage should be the paramount considerations inselecting a PPP structure.

Success and constraint factors. The characteristics of projects, partners and implementationarrangements will create a series of constraints. These must be fully recognised andintegrated. A PPP must be regarded as an active partnership requiring a degree of flexibilityfrom each side. However the extent of flexibility must also be clearly defined to ensure thatproject boundaries are clearly known. The management of public grants imposes transparentrules on how private sector partners can be selected, how financing can be used and thebenefits which parties can expect from the project, together with performance and qualityrequirements. However the European Commission can also play a valuable role in assistingpublic beneficiaries to protect the interests of their public.


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Timing. Successful PPP design requires that all parties are brought together at an early stage.This is particularly important for the European Commission which, because of the need tocarefully justify its use of grants, must undertake careful analysis of proposed PPParrangements to ensure its objectives are met. Early Commission involvement and sharing offunctions is therefore crucial and preferable if a grant is foreseen. Four situations can beconsidered where timing is a crucial issue in relation to grant attribution, namely; where aPPP exists, where a PPP is already under negotiation but a grant is required to enable it,where a Commission grant is awarded and a PPP is entered into and finally where a PPP isdesired regardless of a grant. In each situation a Commission grant may be possible butcertain pre-conditions must be met allowing the Commission to satisfy its requirements.

Recognition of European Commission grant financing objectives and the best use of grantfinancing. Grant financing, while attractive, carries a number of constraints. Grants havespecific financing objectives, conditionalities and limitations. The project and its’ differentpartners must be able to effectively integrate and accept these and manage theirconsequences.

Future requirements. PPPs are a developing concept and in some cases have requiredsubstantial reform of legal and financial systems in Member States to make their applicationpossible. It can be expected that CCs will face similar difficulties in developing furthereffective frameworks within which PPPs can operate. This requires possibly actions todefine the role of the public sector, institutional capacity building at all levels including theallocation of qualified and motivated staff to specialised PPP units, reduction of market riskthrough user-oriented strategic approaches and development of private sector investmentfacilitation mechanisms. Additionally the ‘paying public’ i.e. the consumer must also beintegrated and given the power to influence PPP design and operation. This ‘bottom up’influence is crucial to the sustainability of the PPP approach and will require coordinationwith NGOs, consumer associations and the public.

These Guidelines aim to highlight some of the important issues that need to be consideredand addressed and will be supplemented with in-country training and further activities tostrengthen implementation capacity.

Relevant authorities in Candidate Countries and Member States have the final responsibilityfor deciding on whether to use PPP or other financing vehicles.


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INDEX

PART 1 ALTERNATIVE PPP APPROACHES....................................................................131 INTRODUCTION ...................................................................................................................132 WHY PPP...........................................................................................................................143 PPP STRUCTURES ...............................................................................................................16

3.1 Opportunities for Private Involvement in Traditionally Procured Projects...............193.2 Integrated Project Development and Operation Opportunities .................................213.3 Partnership Project Development and Investment Opportunities..............................23

4 THE SUITABILITY AND EFFECTIVENESS OF ALTERNATIVE PPP STRUCTURES...................264.1 Suitability to Transport Projects ................................................................................264.2 Suitability to Water Projects ......................................................................................294.3 Suitability to Waste Projects ......................................................................................29

5 REQUIREMENTS OF THE PPP PARTNERS.............................................................................316 ACHIEVING SUCCESSFUL PARTNERSHIPS...........................................................................34

PART 2 LEGAL AND REGULATORY STRUCTURES ...................................................36

1 INTRODUCTION ...................................................................................................................362 LEGAL HIERARCHY.............................................................................................................373 NATIONAL REGULATORY AND LEGISLATIVE ISSUES ..............................................384 PROJECT CONTRACTUAL ISSUES ........................................................................................395 PROCURING THE PRIVATE CONTRACTOR.............................................................................41

5.1 Choice of Procurement Procedure .............................................................................426 INSTITUTIONAL STRUCTURES.............................................................................................48

PART 3 FINANCIAL AND ECONOMIC IMPLICATIONS OF PPP ..............................501 INTRODUCTION ...................................................................................................................502 FINANCIAL IMPLICATIONS OF RISK ....................................................................................50

2.1 Revenue Risk...............................................................................................................512.2 Choice of Private Sector Partner ...............................................................................522.3 Construction Risk .......................................................................................................522.4 Foreign Exchange Risk...............................................................................................522.5 Regulatory / Contractual Risk ....................................................................................522.6 Political Risk ..............................................................................................................532.7 Environmental / Archeological Risk...........................................................................532.8 Latent Defect Risk.......................................................................................................532.9 Public Acceptance Risk ..............................................................................................542.10 Sustainability Risk ......................................................................................................542.11 Hidden Protectionism.................................................................................................54

3 ENSURING VALUE FOR MONEY IN A PPP ...........................................................................553.1 Factors Determining Value for Money.......................................................................553.2 Assessing Value for Money Potential .........................................................................553.3 Parameters for the Final VFM Assessment ................................................................563.4 Elements of the Value for Money Assessment ............................................................573.5 Parameters Required for the Non-Monetary Comparison .........................................593.6 Results of the Value for Money Assessment................................................................59

4 OPTIMISING THE GRANT CONTRIBUTION ...........................................................................59

PART 4 INTEGRATING GRANT FINANCING AND PPP CHARACTERISTICS ......631 INTRODUCTION ...................................................................................................................63


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2 JUSTIFYING GRANT FINANCING..........................................................................................632.1 Determining the Form of Grant Assistance................................................................65

3 COMMISSION FINANCING CHARACTERISTICS....................................................................653.1 Managing the Commission – PPP Relationship.........................................................67

4 LENGTH OF CONCESSIONS ..................................................................................................72

PART 5 PPP CONCEPTION, PLANNING & IMPLEMENTATION............................74

1 INTRODUCTION ...................................................................................................................742 PRACTICAL CONSIDERATIONS ............................................................................................753 IS A PPP FEASIBLE - IDENTIFICATION ................................................................................77

3.1 Obstacles and Constraints..........................................................................................773.2 Private Sector Interest ................................................................................................783.3 Is PPP the Best Delivery Method ...............................................................................78

4 SELECTING AN APPROPRIATE PPP STRUCTURE – PROJECT APPRAISAL ............................794.1 Needs Assessment .......................................................................................................794.2 Risk Allocation............................................................................................................794.3 Components of Service Delivery to Include in Public Private Partnerships..............804.4 Budget Refinement......................................................................................................814.5 Basic Conditions Expected in a Partnership ..............................................................82

5 PPP DESIGN & AGREEMENT ..............................................................................................825.1 Completion of Project Design ....................................................................................825.2 Contract Form Design................................................................................................885.3 Selection and Design of Procurement Process...........................................................89

6 IMPLEMENTATION CONDITIONS .........................................................................................906.1 Contract Management ................................................................................................90

ANNEX 1. BIBLIOGRAPHY..................................................................................................95

ANNEX 2. NOTES FROM THE WORKSHOP.....................................................................96


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PART 1 ALTERNATIVE PPP APPROACHES

PART 1 – SUMMARY

• PPP arrangements are growing in use and acceptance as an alternative and effectivemethod to mobilize additional financial resources and benefits from private sectorefficiencies

• PPP is not the only method to deliver project financing and realisation. It does notprovide a ‘miracle’ solution nor a quick fix and should only be used where appropriateand where it is able to deliver clear advantages and benefits.

• A multitude of PPP structures exist and must be selected according to project type,needs and sector. There is no single perfect model.

• Each type of PPP has inherent strengths and weaknesses which need to be recognizedand integrated into project design

• Each partner to a PPP has responsibilities. The Public sector must transform it’s rolefrom a service provider to manager / monitor of private contractors.

• Guaranteeing and enhancing public benefit from PPPs will depend to a large degree oneffective management and monitoring systems

• This Part will address:• PPP structures• Suitability of alternative structures• Requirements of PPP parties• Success factors for partnerships

1 INTRODUCTION

While the assumption that the public sectoris responsible for the delivery of basicservices remains deeply entrenched in manycountries, the methods by which theseservices are created, procured and deliveredare changing. This reflects a greater needand desire for the public sector to work withand harness the benefits of the privatesector.

There is a broad range of options forinvolving the private sector in the financing,physical development, and operation oftransport and environment projectstraditionally the domain of the public sector.As depicted in Figure 1, Public-PrivatePartnership (PPP) approaches are arrayedacross a spectrum. At one end, the publicsector retains all responsibility for financing,

constructing, operating and maintainingassets, together with the responsibility forassuming all associated risks. At the otherend, the private sector assumes all of theseresponsibilities. The vast majority of PPPapproaches fall in the middle of spectrum,with risks and responsibilities sharedbetween the public sector and its privatepartners according to their strengths andweaknesses.

The aim of this section is to provide anoverview of the variety of financing andoperational PPP structures that are currentlyused and which could be matched to theneeds of CCs and the use of Commissionfunding to leverage additional sources ofcapital that would not otherwise beavailable. This all-important phenomenonallows projects to be built with smallerlevels of support from both grant financing


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programmes and public resources inrecipient nations.

Waste Water Treatment Plant – Poland

The water and waste water sectors have gainedconsiderable experience in implementing PPP type

projects

By moving beyond pure grant financing andsupporting projects that limit privateparticipation to simple outsourcingagreements, the Commission candemonstrate the potential of PPPs in marketswhich have limited experience withpartnerships. In this context the EuropeanCommission can play an important role indemonstrating that when implemented underthe right conditions, PPPs encourageefficiency and provide access to new capitalfunds. By limiting the need for publicinvestment, PPPs can also help CandidateCountries (CCs) to implement much neededprojects sooner by avoiding the need to waitfor future government budget cycles forfunding.

It should be noted that while theseGuidelines refer to the specific situation ofCommission grant financing, many issuesare taken from general experience and areapplicable to a wide range of scenarios. It ishowever not the purpose of the Guidelines toprejudge any future activity or initiative ofthe Commission in the field of PPPdevelopment or the application of grantfinancing either within the Member States or

the CCs. Indeed the Commission has noted3

that “the issues relative to serviceconcessions and public private partnershipsmerit a detailed analysis in order to evaluatewhether specific legislation is required topermit more effective access to thesearrangements by economic operators and toguarantee to these operators to rightsafforded by the Treaty”. This is not thepurpose of these Guidelines.

2 WHY PPP

• PPP have developed in part due tofinancial shortages in the public sector

• PPPs have demonstrated the ability toharness additional financial resourcesand operating efficiencies inherent to theprivate sector

Recent years have seen a marked increase incooperation between the public and privatesectors for the development and operation ofenvironmental and transport infrastructure.In the European Member States this hasresulted, in part, from the privatisation ofutilities, the development of large multi-national utility operators and a generalreview of how public spending is undertakenincluding recent caps on spending limits tomeet the Maastricht criteria requiring adiversification of funding sources.

While initial projects have often been in thewater and road sector, with the constructionof toll roads (representing clearly definedfinancial returns); there is a growingacceptance that PPP arrangements can beused to meet infrastructure and service needsin a wide variety of sectors.

Success of PPP projects, the increasingavailability of private sector funds able toadopt a higher risk profile; and a generalisedglobal trend to privatise utilities has resultedin attempts to introduce the PPP concept inthe transforming economies of the Candidate

3 COM (2000) 275 final


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Countries (CCs) of Central Europe. This isbased on the existence of:

• An enormous financing requirement inthe environment and transport sectors toupgrade and extend networks in linewith the accession requirements andeffective service provision

• An equally large financial shortfall inavailable public funds and the ability ofinternational institutions to cover costs.This requires not only the identificationof additional funding sources but alsoattention to the more effective use ofpublic funds and to increasing theirimpact.

Additionally there is a growing realisationthat cooperation with the private sector, inPPP projects, is able to offer a number ofadvantages, including:

• Acceleration of infrastructureprovision - PPPs often allow the publicsector to translate upfront capitalexpenditure into a flow of ongoingservice payments. This enables projectsto proceed when the availability ofpublic capital may be constrained (eitherby public spending caps or annualbudgeting cycles), thus bringing forwardmuch needed investment.

• Faster implementation - the allocationof design and construction responsibilityto the private sector, combined withpayments linked to the availability of aservice, provides significant incentivesfor the private sector to deliver capitalprojects within shorter constructiontimeframes.

• Reduced whole life costs - PPP projectswhich require operational andmaintenance service provision providethe private sector with strong incentivesto minimise costs over the whole life ofa project, something that is inherentlydifficult to achieve within the

constraints of traditional public sectorbudgeting.

• Better risk allocation - a core principleof any PPP is the allocation of risk to theparty best able to manage it at least cost.The aim is to optimise rather thanmaximise risk transfer, to ensure thatbest value is achieved.

• Better incentives to perform - theallocation of project risk shouldincentivise a private sector contractor toimprove its management andperformance on any given project.Under most PPP projects, full paymentto the private sector contractor will onlyoccur if the required service standardsare being met on an ongoing basis.

• Improved quality of service -international experience suggests thatthe quality of service achieved under aPPP is often better than that achieved bytraditional procurement. This mayreflect the better integration of serviceswith supporting assets, improvedeconomies of scale, the introduction ofinnovation in service delivery, or theperformance incentives and penaltiestypically included within a PPP contract.

• Generation of additional revenues - theprivate sector may be able to generateadditional revenues from third parties,thereby reducing the cost of any publicsector subvention required. Additionalrevenue may be generated through theuse of spare capacity or the disposal ofsurplus assets.

• Enhanced public management - bytransferring responsibility for providingpublic services government officialswill act as regulators and will focusupon service planning and performancemonitoring instead of the managementof the day to day delivery of publicservices. In addition, by exposingpublic services to competition, PPPs


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enable the cost of public services to bebenchmarked against market standardsto ensure that the very best value formoney is being achieved.

International interest in PPPs is attributablegenerally to three main drivers:

• Investment in infrastructure -economic growth is highly dependent onthe development and enhancement ofinfrastructure, particularly in utilities(such as power, water andtelecommunications) and transportsystems. Furthermore, in manycountries there is an urgent need for newsocial infrastructure such as hospitalsand healthcare equipment, prisons,education facilities and housing. Formany governments this is seen as themost pressing area for private sectorinvolvement.

• Greater efficiency in the use ofresources - the experience ofprivatisation has shown that manyactivities, even those traditionallyundertaken by the public sector, can beundertaken more cost effectively withthe application of private sectormanagement disciplines andcompetencies.

• Generating commercial value frompublic sector assets - significantamounts of public resources are investedin the development of assets such asdefence technology and leading edgeinformation systems that are then oftenused for a narrow range of applicationswithin the public sector. Engagingprivate sector expertise to exploit theseassets in a wider range of applicationscan lead to the realisation of substantialincremental value for the public sector.

However while certain advantages do existand can be harnessed, PPP should not beregarded as representing a miracle cure norindeed a quick fix to infrastructure andservice development. PPP should be

regarded as an option amongst a range ofpossible tools to be applied only where thesituation and project characteristics permit itand where clear advantages and benefits canbe demonstrated. Indeed consideration ofPPP should not preclude other optionsincluding the traditional public – publicmodels.

3 PPP STRUCTURES

• Many forms of PPP exist and arecontinuously being developed to suitproject characteristics

• Main defining feature is the degreeof private control over andinvolvement in financing

• There is no unique model nor do theGuidelines suggest the developmentof one. Each project will define whatis suitable and what is required

The following, non-exhaustive, discussionsdescribe a number of possible PPPstructures. It should be understood,however, that the PPP process is extremelydynamic and that the particulars of mostarrangements are tailored to the specificcircumstances involved. At the same time,many of the individual components used todesign and structure specific partnerships(i.e. contract terms, in-kind contributions,financing facilities, or grants) can be usedwith a number of different PPP approaches.There can therefore be no one generic or‘best’ model of PPP structure, nor does theCommission make any recommendations asto the suitability of individual structures.

A PPP is a partnership between the publicsector and the private sector for the purposeof delivering a project or a servicetraditionally provided by the public sector.PPPs recognise that both parties have certainadvantages relative to the other in theperformance of specific tasks. By allowingeach sector to do what it does best, publicservices and infrastructure can be providedin the most economically efficient manner.


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The overall aim of PPPs is therefore tostructure the relationship between theparties, so that risks are borne by those bestable to control them and increased value isachieved through the exploitation of privatesector skills and competencies.

In order to work successfully with theprivate sector, public bodies need to be clearabout the fundamental principles andobjectives behind PPP. Under PPParrangements, private sector contractorsbecome long term providers of servicesrather than simply upfront asset builders,combining the responsibilities of designing,building, operating and possibly financingassets in order to deliver the services neededby the public sector. As a result, central andlocal government agencies becomeincreasingly involved as regulators andfocus resources on service planning,performance monitoring and contractmanagement rather than on the directmanagement and delivery of services. Theresult is that the public mission is deliveredthrough the private sector.

Designed appropriately, PPPs can generatesubstantial benefits for consumers andtaxpayers. The scope of potential benefitwill, however, depend on the type of projectbeing undertaken and the exact terms of thecontract governing the PPP. It is importantto note that public bodies have a critical roleto play in the management and regulation ofPPP during their design, construction andoperation. PPPs also require effectivecontract monitoring procedures to ensure

that contractual obligations continue to bemet in terms of both quality and timing.These issues are the subject of the followingsections.

It is also essential to recognize that thenomenclature used to describe thepartnership process has not beenstandardized. There are several terms oftenused interchangeably – turnkey and build-operate-transfer (BOT), for example. Thereare also single terms that are used looselyand can be applied to situations that arefundamentally different. For example, BOTcan be used to describe procurements thatinvolves private financing, as well as thosethat do not. As such, it is necessary for PPPpractitioners to delve beyond the terms andconcepts and become familiar with the wayin which the partnership process itselfworks. Indeed the terminology debatesurrounding the definition of PPP categoriesitself mirrors the evolution of PPPapproaches and the evolving regulatoryenvironment defining PPP in MemberStates.

�� A significant body of text nowexists describing PPP structures andtheir applicability. The bibliographypresents some of these including usefulcontact points for further information

The Channel Tunnel - linking France andBritain.

The Project, costing approximately Euro15 billion, met with considerable delay,cost overruns and financing problems. Ina major overhaul of project organization –increased responsibility was given to theprivate sector to manage the constructionand financing process.


18

Divestiture

Asset Capitalization

Figure 1

Project Procurement Options

PublicResponsibility

PrivateResponsibility

TraditionalPublic SectorProcurement

Design-Build-Finance-Operate(DBFO) Concession

Build-Own-Operate(BOO)

Public Owner/Operator/Financier

Engineer Contractor

PrivateConcessionaire

Private OwnerPublic Owner/

FinancierPublic Owner

Contractor Operator

Engineer

� EU� National Gov't� Local Gov't� IFI Debt� Commercial Debt

� EU� National Gov't� Local Gov't� IFI Debt� Commercial Debt� Private Equity

� EU� National Gov't� Local Gov't� IFI Debt� Commercial Debt

� IFI Debt� Commercial Debt� Private Equity

Contractor Operator

Engineer

� EU� National Gov't� Local Gov't

Contractor Operator

Engineer

Operator

Public Sector

Private Sector

Build-Operate-Transfer (BOT)

Turnkey Delivery

Design-Build-Operate-Transfer

Build-Own-Operate-Transfer

BOOT ConcessionMaintenance Concession

Design-bid-buildDesign-build


19

At present, Community Law does not have aspecific definition of PPP. Each type ofarrangement is defined by individualCommunity Legislation governingoperational structures and procurement.However the Commission’s InterpretativeCommunication on Concessions4 suggeststhat the principal criteria for distinguishingconcessions from other PPP type structuresis the extent of risk transfer to the privateparty. This criteria will then also allow eachtype of PPP to be defined and related to therelevant legislation and methods forselecting private parties. While the choiceof PPP structures is limitless in terms offinancial and legal forms, the Commission isof the view that all PPPs can be defined inrelation to the rules governing the choice ofprivate partners and the selection andapplication of public procurementprocedures. As a result PPPs, whether forworks and / or services, are:

• Covered under the detailed provisions ofPublic Procurement Directives

• Covered by the rules and principles ofthe Treaty as set out in the InterpretativeCommunication and jurisprudence.

While it is not possible at this stage to defineall possible types of PPPs according to theapplication of public procurement ofconcession rules, it is extremely importantfor PPP sponsors to develop a detailedunderstanding of the Commission’sperspective and to correctly categorise theirchoice of PPP structure before entering intocontractual arrangements.

The following sections present variousforms of PPP relationships moving fromminimal to maximal private sectorinvolvement. These definitions are based oninternationally recognized nomenclature butunlike a ‘legalistic’ definition of PPP orprocurement derived from the ProcurementDirectives, these are based on the extent ofrisk and responsibility transfer to the privateparty. 4 JOCE C/121 of 29 April 2000

�� Further assistance andclarification on the Commission’sinterpretation can be obtained directlyfrom DG Market and DG Competition.

3.1 Opportunities for PrivateInvolvement in TraditionallyProcured Projects

Traditionally, governments in most CCshave relied on public procurement todevelop their infrastructure systems. Withthis approach designated governmentagencies, such as a ministry or publicauthority are vested with responsibility fordeveloping certain types of infrastructure.These agencies typically elaborate masterplans prioritizing needs and then arrange thefinancing, design, and construction ofindividual projects. Once a project iscompleted it is then operated and maintainedby the agency, together with the other assetsunder its care.

Under the traditional public procurementmodel, government agencies can utilize theservices of the private sector for design andconstruction, with the award of individualcontracts made on a competitive basis.5However, private sector participation usuallydoes not extend beyond these functions.There are a number of ways in which greaterprivate sector participation can beintroduced as depicted in figure 2.

Three approaches for outsourcing formerpublic functions to the private sector aredescribed below. These mechanisms presentopportunities for the private sector toparticipate in varying degrees in themaintenance, operation and management ofinfrastructure improvements.

5 In certain cases in CCs design and constructionfunctions may have been fulfilled by publicly ownedcompanies, or directly by agency staff.


20

TraditionalPublic SectorProcurement withOutsourcing

Public Owner/Operator/Financier

Engineer Contractor

Operator

With Service Contracts

With Operating AgreementsWith Operating Leases

Contractor /Operator

Leasee

Public Sector

Private Sector

Figure 2Private ParticipationOptions with TraditionalPublic Sector Procurement

3.1.1 Service Contracts

Public agencies can enter into servicecontracts with private sector companies forthe completion of specific tasks. Servicecontracts are well suited to operationalrequirements and may often focus on theprocurement, operation and maintenance ofnew equipment. These tasks could includeareas such as toll collection, the installation,maintenance and reading of meters in thewater sector, waste collection or theprovision and maintenance of vehicles orother technical systems.

Service contracts are generally awarded on acompetitive basis and extend for shortperiods of time of a few months up to a fewyears. They allow public agencies to benefitfrom the particular technical expertise of theprivate sector, manage staffing issues, andachieve potential cost savings. Nonetheless,with service contracts management andinvestment responsibilities remain strictlywith the public sector. While they affordcertain benefits, service contracts cannotaddress underlying management or costissues affecting poorly run organizations.

3.1.2 Operation and ManagementContracts

Public operating agencies utilizemanagement contracts to transferresponsibility for asset operation andmanagement to the private sector. Thesecomprehensive agreements transfer involveboth service and management aspects andare often useful in encouraging enhancedefficiencies and technological sophistication.Management contracts tend to be short term,but often extend for longer periods thanservice agreements. Contractors can be paideither on a fixed fee basis, or on an incentivebasis where they receive premiums formeeting specified service levels orperformance targets.

Management contracts may be used as ameans to transfer responsibilities for aspecific plant, facility or service provided byan infrastructure owner. They may have amore broad reaching scope involving themanagement of a series of facilities.Nonetheless, responsibility for investmentdecisions remains with the public authority.


21

Operation and management contracts oftenprovide a good opportunity to encouragegreater private sector involvement in thefuture. They are particularly appropriate insectors undergoing transition from publicownership where existing regulatory andlegal frameworks may not allow greaterprivate participation. They can be helpful ingenerating trust between the public andprivate sectors in markets where there hasbeen little experience with PPPs. They alsoprovide a means for private companies totest the waters in potentially risky marketswith limited risk exposure. While operationand management contracts should beexpected to improve service quality, theycannot be expected to improve servicecoverage or encourage tariff reform.

3.1.3 Leasing

Leases provide a means for private firms topurchase the income streams generated bypublicly owned assets in exchange for afixed lease payment and the obligation tooperate and maintain the assets. Leasetransactions are different from operationsand management contracts in that theytransfer commercial risk to the private sectorpartner, as the lessor’s ability to derive aprofit is linked with its ability to reduceoperating costs, while still meetingdesignated service levels.

Leases are similar to operations andmanagement contracts in that theresponsibility for capital improvements andnetwork expansion remains with the publicsector owner. However, in certain cases thelessor may be responsible for specified typesof repairs and rehabilitation. Under the rightconditions, private companies entering intolease agreements might also make targeted

capital improvements in order to improveoperating efficiencies and profit levels.However, responsibility for planning andfinancing overall investment and expansionprograms remains with the public sectorowner. Lease agreements can be expectedto extend for a period of five to fifteen years.They are suitable only for infrastructuresystems that generate independent revenuestreams, and are often used in the publictransport and water sectors.

Traditional procurement can also be used tocover the design and build functions eitherbundled or separately. As with the examplesabove, ownership of assets remains with thepublic body and the private sector isresponsible only for well-defined tasksadopting limited responsibility.

3.2 Integrated Project Developmentand Operation Opportunities

The functions described above involveinstances where limited responsibilitiesnormally assumed by the public sector arepassed to private companies. However, thefunctions involved are at once discrete andrelatively isolated – a fact which limits thepotential benefits that the owner can derivefrom its partnership with the private sector.Integrated partnerships involve transferringresponsibility for the design, construction,and operation of a single facility or group ofassets to a private sector partner. Thisproject delivery approach is practiced byseveral governments around the world and isknown by a number of different names,including “turnkey” procurement and the“build-operate-transfer” (BOT) system.


22

P u b l i c O w n e r /F i n a n c i e r

C o n t r a c t o r O p e r a t o r

E n g i n e e r

� I S P A� N a t i o n a l G o v ' t� L o c a l G o v ' t� I F I D e b t� C o m m e r c i a l D e b t

B u i l d - O p e r a t e -T r a n s f e r e ( B O T )

T u rn k e y D e l iv e r y

D e s ig n - B u i ld - O p e r a t e - T ra n s f e r

The advantage of the BOT approach is thatit combines responsibility for usuallydisparate functions – design, construction,and maintenance – under one single entity.This allows the partners to take advantage ofa number of efficiencies. First of all, theproject design can be tailored to theconstruction equipment and materials thatwill be used. In addition, the contractor isalso required to establish a long-termmaintenance program up front, together withestimates of the associated costs. Thecontractor’s detailed knowledge of theproject design and the materials utilizedallows it to develop a tailored maintenanceplan over the project life that anticipates andaddresses needs as they occur, therebyreducing the risk that issues will gounnoticed or unattended and then deteriorateinto much more costly problems. Thebenefits of this “life cycle costing” areparticularly important as most infrastructure

owners spend more money maintaining thesystems than on development. In addition,the life-cycle approach removes importantmaintenance issues from the politicalvagaries affecting many public maintenancebudgets, with owners often not knowinghow much funding will be available to themfrom year to year. In such cases they areoften forced to spend what money the dohave on the most pressing maintenanceneeds rather than adopting a more rationaland cost effective preventive approach.

The public sector awards BOT contracts bycompetitive bid following a transparenttender process. Tenderers respond to thespecifications provided in the tenderdocuments and are usually required toprovide a single price for the design,construction and maintenance of the facilityfor whatever period of time is specified.6

6 Depending on the terms of the tender,Tenderers may be given some flexibility inpreparing payment schedules.


Tenderers are also required to submitdocumentation on their qualifications,thereby allowing evaluators to compare thecosts of the different offers as well as abilityof the Tenderers to meet their specifiedneeds.

While the potential exists to reap substantialrewards by utilizing the integrated BOTapproach, project sponsors not accustomedto this approach must take great care tospecify all standards to which they wanttheir facilities designed, constructed, andmaintained. With a BOT approach thepublic sector relinquishes much of thecontrol they typically possess with moretraditional project delivery, and unless needsare identified up front as overall projectspecifications, they will not generally bemet.

It should also be noted that an integratedBOT approach alone does not relieve publicsector owners of the burden of financing therelated infrastructure improvements. Fromdesign through operation, BOT contracts canextend for periods of up to twenty years ormore. They involve the construction and

operation of major infrastructure systems,such as wastewater treatment plants or masstransit systems.

3.3 Partnership Project Developmentand Investment Opportunities

The structures described above provide newopportunities for the private sector toperform tasks that would otherwise beundertaken by the public sector. However,PPP arrangements can also involve privatesector financing for projects that wouldotherwise be fully financed by the state.These types of PPP arrangements areparticularly attractive as they afford all theimplementation and operational efficienciesdescribed early, together with new sourcesof capital. Access to additional sources ofcapital allows owners to implementimportant projects sooner by avoiding theneed to wait for future government budgetcycles for funding.

The Vasco de Gama Bridge – Portugal

Portugal is considered a reference on how coordinated efforts can develop an economy. In particular experience of projectfinancing show the benefits of public and private partnerships as for example the financing of the Vasco de Gama Bridge

23


24

D esign-Build-Finance-O perate(D BFO ) C oncession

PrivateConcessionaire

Public O w ner

� IFI Debt� Commercial Debt� Private Equity

Contractor O perator

Engineer

� ISPA� National Gov't� Local Gov't

Build-Own-Operate-Transfer

BOOT Concession

Maintenance Concession

Divestiture

Asset Capitalization

Build-Own-Operate(BOO)

Private Owner

� ISPA� National Gov't� Local Gov't� IFI Debt� Commercial Debt� Private Equity

Contractor Operator

Engineer

3.3.1 Concessions

The primary vehicle for PPP opportunitiesinvolving direct private sector investment isthe design-build-finance-operate (DBFO)concession agreement. These agreementsenable a private investment partner tofinance, construct, and operate a revenuegenerating infrastructure improvement inexchange for the right to collect theassociated revenues for a specified period oftime. Concessions can be awarded for theconstruction of a new asset or for themodernization, upgrade, or expansion of anexisting facility.

Concessions often extend for a period of 25to 30 years, or even longer, and are awardedunder competitive bidding conditions.Under a concession approach the ownershipof all assets, both existing and new, remainswith the public sector. It is theirresponsibility to ensure that the assets areproperly used and maintained during theconcession period and that they are returnedin good condition when it is over.

Concessions are generally awarded based onfollowing criteria:

• The end price offered to users• The level of financial support required

from the government and other grantors• Ability to implement the project.


25

The Commission is currently reviewing itsdefinition and approach to concessions giventhe interest shown in their application in theMember States. This is addressed in greaterdetail in Part 2 particularly with respect tosafeguarding open market access and faircompetition;

Oversight of the award, implementation, andoperation of PPP concessions is a complextask. As such, it is often common practicefor governments to establish dedicated,stand-alone state agencies or special purposevehicles (SPV) with the sole responsibilityof overseeing PPP projects. Implementationagencies are likely to require staff withsophisticated financial and legal experiencethat goes beyond that of many publicinfrastructure owners. This is particularlyimportant for CCs where the infrastructureinvestment market is still considered riskydue in part to incomplete legislative andinstitutional structures, let alone the lack ofcomprehensive experience in projectfinancing, structuring and implementation.

3.3.2 Private Divestiture

Private divestiture involves the sale of assetsor shares of a state-owned entity to theprivate sector. Divestitures can beapproached in many different ways, and canbe either partial or complete. Divestiture isalso often an integral part of thetransformation of state-owned enterprises inCCs and can be used as a vehicle to transferthe ownership of assets from the centralgovernment to local governments and / or toprivate utility companies. The followingdiscussion on divesture addresses the sale ofassets to private investors only.

3.3.2.1 Complete Private Divestiture

In the case of a complete divestiture, theentire assets of a utility would be sold eitherto a single investor, a group of investors, orpossibly through a management buyout. In

certain cases a divestiture can also beaccomplished by making shares in thecompany available for purchase on thenational stock market. A completedivestiture is similar to a concession incertain ways, as it gives the private investorcomplete control over investment in, and theoperation and maintenance of whateverassets the company possesses. However,unlike concessions, divestiture also gives theprivate sector ownership of the assetsthemselves, and that ownership ispermanent. As such, the governmentrelinquishes further control with adivestiture approach, maintaining only aregulatory role, protecting consumers frommonopolistic pricing and, in some cases,perhaps requiring a minimum maintenanceand investment regimen.

Divestiture is likely to be particularlysensitive when it involves assets of nationalsignificance, such as a water resources orhighway networks. In addition toideological impediments, there may wellalso be constitutional and legislative issuesto be overcome. However, in cases wherelocal managerial capabilities are strong andwhere there are local investors who may beinterested in supporting such a venture,divestiture may provide a way to achieveprivate sector efficiency gains while keepingcontrol over the assets – and the revenuesthey generate – within the country. This hasproven an effective strategy with theprivatization of former state motorwayauthorities in Portugal and Italy, forexample, or water resources in Slovenia andEstonia.

3.3.2.2 Partial Private Divestiture

With a partial private divestiture, thegovernment would retain ownership of acertain portion of the former publiccompany’s assets. This is often a moreattractive alternative to those governmentsor authorities who wish to maintain a certainlevel of control in the management of theassets. In such cases, the interplay of


26

responsibilities between the public andprivate sectors is blended. A partialdivestiture is an excellent way for the publicsector to attract private capital andencouraging improvements in operationaland management efficiency, while alsoprotecting the public consumers as well asassets of national significance. Theindividual arrangements for sharingresponsibility for management andinvestment decisions depend on the divisionof assets, as well as the sharing of costs.Therefore, they would need to be establishedon an individual basis. It is likely that thepublic sector would transfer as much of thecosts as possible to its private partner.However, in order for a partial divestiture tobe attractive to private investors there wouldhave to be a reasonable scope for making afair profit on its investment.

4 THE SUITABILITY ANDEFFECTIVENESS OFALTERNATIVE PPPSTRUCTURES

• Each PPP structure has strengthsand weaknesses which must berecognized and integrated

• PPP does not provide a ‘quick fix’and should be applied only wheresuitable and when clear benefits andadvantages can be demonstrated

• PPP structures must be adapted tosectoral and project context

• Desired impacts and benefits willinfluence PPP selection and design

Table 1 summarises the advantages anddisadvantages of the four main groupings ofPPP relationships. It also providessuggested sectoral applications which arefurther discussed below. The selection of asuitable PPP arrangement is a complex taskand must be based on individual projectcharacteristics and needs (this is discussedfurther in Part 5).

�� Considerable experience has beengained in Member States with thedifferent PPP forms and in a broadrange of sectors. This experience canbe accessed directly from the MemberState PPP units details of which can befound in the reference section.

4.1 Suitability to Transport Projects

Some of the most important issues that willinfluence the selection of a preferred formof PPP for projects in the transport sector arethe size and scope of the project, the abilityto apply user tolls and the extent of risktransfer required. Major and minor roadsschemes or mass transit systems are wellsuited to traditional design and buildcontracts, as operating costs in a typicalscheme are low when compared to thecapital costs of construction.

Traditional procurement contracts areessentially an extension of the existingconventional approach, endeavouring totransfer design and construction risk to theprivate sector through fixed price contracts.In such instances responsibility formaintaining the infrastructure will remainwithin the Public sector. In some instances,the construction of, particularly, a majorroad scheme may be funded in part or inwhole by user tolls. For example, bridgesand tunnels are particularly suited to usertolling where there is a clear benefit to begained from choosing the tolled route over adifferent alternative route. In suchcircumstances, the public sector must decidewhether to transfer responsibility forfinancing the project and collecting tolls tothe private sector contractor.

Different types of PPP contracts are alreadybeing implemented in Europe. Tollmotorway concession contracts are suitablewhere the private sector contractor willfinance a major road scheme, collect usertolls and bear the risk associated with traffic


27

demand. BOT contracts are more suitablewhere the private sector will receive userfees paid by the public sector, but the publicsector will finance the project and accept therisk associated with demand. Shadow tollDBFO contracts are likely to be moresuitable where the private sector contractorwill accept some of the risk associated withtraffic demand, but user tolls are not applied.A number of major roads projects have beenundertaken in England, Finland, Scotland,Spain and Portugal on this basis and theprivate sector contractors are paid on thebasis of Shadow Tolls. However, there arealso a range of disadvantages associatedwith this approach including the greaterlevel of demand risk retained by the publicsector and the fact that as motorists do notpay for the economic cost of infrastructureprovision, infrastructure investment may notbe rationally allocated.

Minor projects are more suited to traditionaldesign and build contracts and are not likelyto be suitable for other forms of PPP unlessbundled together into a larger contract with asignificant operating element.


28

Table 1: Advantages and Disadvantages of PPP RelationshipsPPP Type Main Features Application Strengths Weaknesses

Contracting • Contract with Private party to design& build public facility

• Facility is financed & owned bypublic sector

• Key driver is the transfer of designand construction risk.

• Suited to capital projects with smalloperating requirement.

• Suited to capital projects where thepublic sector wishes to retain operatingresponsibility.

• Transfer of design and constructionrisk.

• Potential to accelerate constructionprogramme.

• Possible conflict between planningand environmental considerations.

• May increase operational risk.• Commissioning stage is critical.• Limited incentive for whole life

costing approach to design.• Does not attract private finance

BOT • Contract with a private sectorcontractor to design, build andoperate a public facility for adefined period, after which thefacility is handed back to the publicsector.

• The facility is financed by the publicsector and remains in publicownership throughout the contract.

• Key driver is the transfer ofoperating risk in addition to designand construction risk.

• Suited to projects that involve asignificant operating content.

• Particularly suited to water and wasteprojects.

• Transfer of design, construction andoperating risk

• Potential to accelerate construction• Risk transfer provides incentive for

adoption of whole life costing approach• Promotes private sector innovation and

improved value for money.• Improved quality of operation and

maintenance.• Contracts can be holistic• Government able to focus on core

public sector responsibilities.


• Contracts are more complex andtendering process can take longer

• Contract management andperformance monitoring systemsrequired.

• Cost of re-entering the business ifoperator proves unsatisfactory.

• Does not attract private financeand commits public sector toproviding long term finance.

DBFO • Contract with a private party todesign, build, operate and finance afacility for defined period, afterwhich the facility reverts to thepublic sector.

• The facility is owned by the privatesector for the contract period and itrecovers costs through publicsubvention.

• Key driver is the utilisation ofprivate finance and transfer ofdesign, construction & operatingrisk.

• Variant forms involve differentcombinations of the principleresponsibilities.

• Suited to projects that involve asignificant operating content.

• Particularly suited to roads, water andwaste projects.

• As for BOT plus:• Attracts private sector finance;• Attracts debt finance discipline;• Delivers more predictable and

consistent cost profile;• Greater potential for accelerated

construction programme; and• Increased risk transfer provides greater

incentive for private sector contractorto adopt a whole life costing approachto design.


• Contracts can be more complexand tendering process can takelonger than for BOT.

• Contract management andperformance monitoring systemsrequired.

• Cost of re-entering the business ifoperator proves unsatisfactory.

• Funding guarantees may berequired.

• Change management systemrequired.

Concession • As for DBFO except private partyrecovers costs from user charges.

• Key driver is the Polluter PaysPrinciple and utilising privatefinance and transferring design,construction and operating risk.

• Suited to projects that provide anopportunity for the introduction of usercharging.

• Particularly suited to roads, water (non-domestic) and waste projects.

• As for DBFO plus:• Facilitates implementation of the

Polluter Pays Principle; and• Increases level of demand risk transfer

and encourages generation of thirdparty revenue.

• As for DBFO plus:• May not be politically acceptable• Requires effective management of

alternatives / substitutes, egalternative transport routes;alternative waste disposal options)

4.2 Suitability to Water Projects

29

4.2 Suitability to Water Projects

Public Private Partnerships have existed inthe international water sector for a numberof years. For example, private sectorconcessions for the development andoperation of water supply and treatmentplants have been common place in Francefor at least forty years, leading to thegrowth of the large and diversified Frenchprivate sector utility companies. TheEuropean Union Drinking Water Directiveand the Urban Waste Water Directive haveresulted in a substantial change in publicsector responsibility within the waterindustry. In order to meet the requirementsof the Directives, many countries will haveto invest substantial amounts of capital innew water supply and waste watertreatment facilities. As a result, countriesthat have not yet involved the privatesector in water supply or waste watertreatment, are now considering thepotential to make use of private sectorskills and finance to satisfy therequirements of the Directives.

The considerations that will shape theselection of a preferred form of PPP forprojects in the water sector are similar tothose in the transport sector and includethe size and scope of the project (includingits operational content), the ability to applyuser charging and the extent of risktransfer required.

The construction of water supply or wastewater networks under PPP arrangements islikely to be linked to the level ofinformation available on the extent,composition and performance of existingnetworks. If information is not sufficienttraditional procurement arrangements maybe more suitable. On the other hand, watersupply and waste water facilities are likelyto be very suited to BOT and DBFOcontracts. They may also be suited toConcession contracts where there is anopportunity to introduce user charging.However, water supply and waste waterfacilities are considered to be less suited totraditional procurement design and buildcontracts as the public sector would retain

the risks associated with operatingincreasingly complex treatment processes,without having had a role in the design ofthose processes.

4.3 Suitability to Waste Projects

More recently, the use of PPPs has beenstimulated in sectors where there has beena significant increase in the burden oftraditional public sector responsibilitiesand this is particularly true with regard tothe disposal of municipal waste.Increasingly, for economic andenvironmental reasons, public authoritiesare reducing their reliance on landfillwhich has been the traditional means ofdisposing of waste. New methods of wastedisposal such as waste to energy schemesand recycling plants require substantialinvestment and specialised technicalknow-how.

The considerations that will shape theselection of a preferred form of PPP aresimilar to those for the transport and watersectors and include the size and scope ofthe project (including operational content),the ability to apply user charging and theextent of risk transfer required. Projects inthe waste sector are likely to be very suitedto the more developed forms of PPP wherea significant amount of operating risk canbe transferred to the private sector. Inaddition, under a Concession contract, theprivate sector can be asked to finance theproject, collect user charges (in accordancewith the Polluter Pays principle) andaccept the risk associated with wastevolumes. This is now being widelyapplied in the UK.

Table 2 summarizes the ability of the PPPstructures to meet a range of desirableperformance indicators. The various PPPstructures are arrayed in increasing orderof private participation from top to bottomon the table. It can be seen that as privatesector participation increases, so too doesthe potential for achieving a wide varietyof infrastructure goals. However, it alsoneeds to be recognized that greater privatesector participation in infrastructure

30

development also brings with it increasedimplementation constraints, particularlywhen private investment is involved.These constraints may well become further

complicated when Commission grantfunding is involved.

Table 2The Effectiveness of Alternative PPP structures

ImprovedService

EnhancedOperationalEfficiency

EnhancedRisk

Sharing

LifeCycle

Costing

AcceleratedImplement

ation

Leveragingof Public

Funds

Implementation

Constraints

Private OutsourcingService Contracts Possible Yes No No No No Low

ManagementContracts

Yes Yes No No No No Moderate

Leasing Possible Yes Some Possible No No ModerateIntegrated Private Development

BOT Yes Yes Some Yes HighPrivate Investment

DBFO Concessions Yes Yes Yes Yes Yes Yes Very High

As demonstrated, private outsourcingarrangements have the ability to affectservice improvements and gains inoperational efficiency. However, theirability to enhance risk sharing or capturemore important life cycle costingefficiencies is limited. These latterindicators can be somewhat enhanced withcertain types of leases, but the extent towhich this is possible depends both uponthe required service standards and theduration of the lease agreement. Giventhat they do not involve private sectorcapital investment, outsourcingpartnerships have no ability to accelerateproject implementation or leverage publicfunds. Therefore these approaches arebest suited to situations whereimprovements in operational efficiency aredesired, but where there is little need formajor capital improvements.

Like outsourcing, BOT arrangement canenhance both operational and serviceindicators. In addition they also bringabout extensive life cycle cost benefits.Although certain risk elements are shared,pure BOT structures do not involve privateinvestment and therefore cannot beexpected to leverage funds.

The BOT approach is appropriate whenowners need to embark on new capitalprojects and hope to achieve greateroperational efficiencies. They can alsostreamline both implementation costs andthe implementation process as a whole.BOT projects can prove a useful first stepin moving towards future partnershipsinvolving private investment, as theyprovide the opportunity to demonstrate thetypes of savings and efficiencies privatesector involvement can bring toinfrastructure development.

PPPs involving private investment providethe potential to achieve all the cost andoperational efficiencies associated with theBOT approach. In addition, the benefitsleveraging and accelerated projectimplementation are also added. As such,investment partnerships have the potentialto deliver maximum benefits to the publicsector. However, these arrangements alsointroduce legal and regulatory concerns,and require sophisticated management onthe part of the government to insure that itsrequirements are met. Therefore, in orderto justify the considerable effort involvedin resolving such issues, investmentpartnerships are often best suited to largerand more costly projects.

31

5 REQUIREMENTS OFTHE PPP PARTNERS

• PPP requires active participation of allpartners

• All partners must recognize andaddress the objectives andcharacteristics of each other

It is important to recognize that thedifferent participants in PPP projects havedistinct goals and requirements that mustbe met in order for them to be able toparticipate in an effective partnership.While certain goals are complimentary;others are not, and as the number ofplayers increases, so too will thecomplexity of establishing a fair playingground for the various participants.

Table 3 identifies the different players thatmay be involved in partnership projectsand arrays their likely requirements whenoperating under the partnership structuresdiscussed earlier. Predictably, as the levelof private sector participation increases, sodo the number of participants and therequirements of all partners, public andprivate alike.For private sector participants, the firstrequirement for any type of involvement isthe potential to derive a reasonable profit.In addition, in return for greater riskexposure, the private sector will alsorequire the potential for commensurateincreases in profit potential. Similarly,before committing its own capital in thedevelopment of projects, it will requireclear legal and regulatory structures, andwill want to see the potential for futureeconomic growth, together withreasonable levels of political support andstability.

While the public sector supports efficiencyimprovements, the private sector’smotivation for profit introduces conflictsof interest with beneficiary governments,which are committed to promoting equityand maximizing the well being of theircitizens. However, governments aregenerally willing to allow their private

partners to make a reasonable profit inexchange for improving service andefficiency, leveraging its own financialresources, expediting projectimplementation. Beneficiary governmentsmay also be concerned about the overallease of implementation when usingoutside or donor funds to supportpartnership projects.

It is also important to recognize that theCommission introduces its own set ofrequirement attached to its financing. Insuch cases, the improvements afforded bythe project will have to meet Europeanstandards and also provide other societalbenefits which may not always be easy toquantify in economic terms. Likebeneficiary governments, the Commissionis eager to achieve gains in efficiency andleverage existing financial resources, butas a donor of grant funds it is alsointerested in avoiding unfair private sectorprofit levels, as well as maintainingtransparency in the award of all contracts.Furthermore, the Commission also seeksto protect its grants by maintaining somecontrol of the funds after they have beenreleased to the beneficiary.

Finally, partnerships involving privateinvestment are also likely to require loansand guarantees provided by internationalfinancial institutions (IFIs), such as theEIB (see box) and commercial banks.Such institutions will require rigorous andconservative financial analysis inexchange for their participation. They willalso need clear proof regarding thecertainty of outside and State funding, aswell any equity contributions to be madeby the private sector. Lenders will alsoneed proof of the technical ability of theprivate operator, as well as the beneficiarygovernment’s ability to oversee theimplementation and operation of theproject. In addition, lenders will requirethat clear regulatory and legal structures bein place to govern investment partnerships,and they will also be interested in thegeneral stability of the politicalenvironment in the beneficiary nation. Itshould be recognized that as regularparticipants in PPP infrastructurepartnerships, IFIs and commercial banks

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are well versed in the potential pitfalls andin turn have developed comprehensivefinancial modeling and due diligencepractices that will have to be satisfied

before their participation can be assured.Examples of the different requirements ofthe parties in various PPP arrangementsare set out in table 3.

The EIB (European Investment Bank) has supported the development of about 100PPPs to-date in most EU countries for a total amount of signed loans over EUR 15billion. On the basis of its multi-sectoral know-how, geographical spread and PPP-deal making experience, EIB is well positioned to assist both public authorities andprivate investors in the CEEC to successfully implement PPP projects. In doing so,it seeks to provide significant added value to all interested parties by sharing itsexperience, applying best practice and offering long-term funding on attractiveterms. In this way, the Bank not only aims to bring about the successful financing ofPPPs but also to ensure value-for–money to the public sector as a whole.


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Table 3. Requirements of PPP Partners under Different PPP ArrangementsPrivate Sector Requirements Service

ContractsManagement

ContractsLeases BOT

AgreementsDBFO

ConcessionsPartial

DivestitureFull Divestiture

Fair Profit Required Required Required Required Required Required Required Reward for Risk Mitigation – – Desirable Desirable Required Required Automatic Clear Legal / Regulatory Structure – – Required Required Required Required Required Growth Potential – – Desirable – Desirable Desirable Desirable Political Support – – Desirable Desirable Required Required Required Political Stability – – – Desirable Desirable Desirable Desirable

Beneficiary Government Requirements Leveraging Funding – – – Yes Important Important Important Accelerating Project Implementation – – – – Important Important Important Improving Service Levels Yes Yes Yes Yes Yes Yes Yes Improving Service Coverage – – – Important Yes Yes Yes Efficiency Gains Important Important Important Important Important Important Important Ease of Implementation – – Desirable Desirable Desirable Desirable Desirable

Commission Requirements Attaining European Standards – – – Relevant Relevant Relevant Relevant Maximizing Societal Benefits Relevant Relevant Relevant Important Important Important Important Transparency / Open Competition Relevant Relevant Relevant Important Important Important Important Reasonable Control of Grant Funds – – – Required Required Required Required Avoiding Undue Private Profit – – – Required Required Required Required Efficiency Gains Desirable Desirable Desirable Important Important Important Important Leveraging Private Funds – – – – Yes Yes Yes

Lender Requirements Rigorous Financial Analysis – – – – Required Required Required

Conservative Cost/Revenue Assumptions – – – – Required Required Required

Certainty of Grant and State funding – – – – Required Required Required

Clear Legal regulator structure – – – – Required Required Required

Technical Ability of Owner/Operator – – – – Required Required Required

Political Stability – – – – Desirable Desirable Desirable

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6 ACHIEVINGSUCCESSFULPARTNERSHIPS7

• Successful implementation dependson recognition of partner’sobjectives

• PPPs require careful considerationof control and management systemsthrough project agreements

What are the necessary elements toachieve successful partnerships in theinfrastructure arena? First, it is essential torecognize exactly what a partnership is. Apartnership is an agreement between twoor more parties to work together towards acommon goal. Partners share joint rightsand joint responsibilities, and when theseare not met partnerships do not work.Partnerships require the will of all partiesinvolved to work together. They also relyon clear and carefully crafted agreementsdefining the rights and obligations of theparties involved and establish a frameworkfor responding to new situations as theyarise. Concession agreements must alsobe tailored to the laws and regulationsgoverning the award. As such, it isessential for governments to develop clearlegal and regulatory formats that identifythe various steps in the process, togetherwith rights and obligations of all involved.In CCs, as has been the experience inMember States, this may well involve thepromulgation of new laws.

Similarly, effective user fee policies arealso essential components of thepartnership process. In certain casesutility fees may have been subsidized inthe past and infrastructure PPPs may beundertaken in conjunction with theliberalization of tariffs. If this is the case,proposed tariff structures will requirecareful review in terms of their overallaffordability, their ability to gain publicand political support, and their ability to 7 This section draws on Achieving Public-Private Partnership in the Transport Sector,Benjamin G. Perez, Diebold Institute forPublic Policy Studies: New York City, 2002.

finance the needed improvements. Theestablishment of a reasonable tariff level isa delicate task at best and involves closeinterplay between expected utilisationslevels, public acceptability, marketconditions, and government support.

Efficient organization and streamlineddecision making are also critical to theability of beneficiary governments tolaunch successful PPP projects. One ofthe most effective steps beneficiarygovernments can take to supportsuccessful infrastructure partnerships is theestablishment of special-purposeauthorities charged with overseeing theirimplementation. Such authorities usuallywork with consultants to organize andexecute planning and feasibility studies,conceptual design work, and in manycases establish financial demand model.Special purpose authorities can assumeresponsibility for liaison with all parties,as well other government departments.Often these agencies also negotiate withdevelopment banks and other potentialfunders. Once individual projects havebeen identified, the authority procuresthem on behalf of the government and thenoversees their construction and operation.While the presence of a developmentauthority can never guarantee success, itdoes streamline and organize governmentinvolvement, helps develop governmentexpertise, and encourage consistent policy.

Successful concessions rely on a series ofchecks and balances. A well-craftedagreement uses checks and balances tocreate co-dependence and transparency,while enabling all the parties involved toachieve their goals. Without theparticipation of any one of these actors itwould not be possible to develop theseprojects on a partnership basis. Thisreality forces all of the participants to bereceptive to the needs of its fellow partnersand to work together towards a jointsolution and work through new issues asthey arise. This dynamic may be furtherreinforced when IFIs are involved.

Partnership is achieved by providingcredibility for the private partner riskingits money and legitimacy for the

35

government sponsoring the project.Legitimacy is achieved by ensuring thatpartnership projects meet the needs of thepaying public, produce desiredadditionalities, and reinforce widerfinancing goals. It is also achieved byrewarding for the successful negotiation ofrisk and providing the private partner witha reasonable return on its investment.However, if the rewards are too high thenthat legitimacy is undermined. Legitimacyis also undermined when investors aremore interested in the profits derived fromlucrative construction contracts rather thanthe successful operation of a concessionitself once it is built. As an independentgrantor, the Commission can be used tofoster credible and legitimate relationshipsbetween beneficiary government andprivate investment partners, both throughits direct participation and through theobjectives and conditionalities attached togrants.

Achieving partnership also requires strongpolitical support. Traditionally when therehas consensus that an infrastructure projectshould be built, governments haveallocated the necessary resources toprocure it themselves. When governmentslook to the private sector for funding thismay be a signal of lackluster support.However, because of the risks involved,the un-conventionality of the approach andthe need to maintain legitimacy,partnership projects are likely to requirestronger political and government support.Moreover, as risks and challengesincrease, so to must the government’ssupport and commitment. In addition toproviding financial resources, theCommission can play an important role inmaintaining critical government supportfor PPP projects in beneficiary nations.

Toll Station on Hungarian Motorway

Successful implementation of motorway toll schemesdepends not only on demand for services but effectivepartnering of all parties, comprehensive projectagreements and a commitment to project success

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PART 2 LEGAL AND REGULATORY STRUCTURES

PART 2 - Summary

• PPP are defined and governed by a complex interaction of national and municipallegislation and regulation and project contractual documents

• Commission grants and the accession process add the EU Acquis Communitaire andgrant conditionalities to the legal environment

• While cooperation with the private sector is welcomed the Commission must fulfillits objective of safeguarding the public interest and the correct use of funds. Thisimplies contractual and implementation conditionalities

• The legal situation in CC’s is still evolving therefore full legal due diligence andcareful contract design are crucial for all parties

• An effective and sustainable institutional structure is essential for promoting andfostering successful PPPs

• This Part will address:• The legal hierarchy• National legislative and regulatory issues• Project contractual issues• Procurement specific issues• Institutional requirements

1 INTRODUCTION

The objective of this section is to identifyand define the relevant statutory,regulatory and contractual issues affectingsuccessful PPP relationships. Adistinction is made between EU, nationaland project specific issues in order tocapture both statutory and contractualmatters. In all instances a key requirementfor successful PPPs is that sufficientclarity, continuity and security is providedto safeguard the interests of all parties,including the Commission.

Although on individual projects theCommission will be a contractual partyonly to a designated National Authority asin the case of ISPA the NIC and theNational Fund (through respectively theFinancing Memorandum and theMemorandum of Understanding) itdirectly influences both the national legalstructures through the AcquisCommunitaire and the individual project

contracts through conditionalities itimposes. Additionally; and through itsassociation with the accession process, itwill have a wider indirect policy impact ona broad set of legal and regulatory criteria.For this reason it is imperative to theeffectiveness of PPP development thatregard is taken to the impact ofCommission conditionalities.

As stated in the ISPA Manual, “Theinvolvement of private finance in thedevelopment of infrastructure is animportant objective of Communitypolicy…The use of ISPA resources in apublic-private partnership requiresverification of the existence of anappropriate legal framework and ofappropriate regulatory conditions for thispartnership, including the followingaspects:

• Equal opportunity for all relevantcompanies in the same sector;

• Respect of competition rules inawarding concession;

• Respect of competition rules inawarding the investment contracts;

• Respect of conditions of theconcession (service to consumers,maintenance, etc.);

• Absence of disproportionateremuneration on capital.

Additionally ISPA characteristics imply:

• That while, the Commission it is aproject funder it does not necessarilyenjoy the same rights as other,notably private sector financiers.Grant financing implies a lack ofequity participation or ownership ofassets and hence a lower status ofdebtor (unless provided forcontractually).

• The Commission continues to requireex-ante control of projects (under theISPA programme) and the use ofspecific procurement procedures.This imposes certain restrictions onhow projects can be implemented andpossibly on how private operators /investors can be selected andintegrated integrated.

• Conditionalites on contractualarrangements must be matched withsufficient flexibility to allow thepossibilities of private sectorinvolvement.

On top of these considerations theevolving (and incomplete) nature ofregulatory systems in CCs needs to be

accounted for both in terms of riskgeneration and effective PPP management.

Bearing this in mind two checklists can bedeveloped to ensure national and projectlevel issues are effectively identified andaddressed.

2 LEGAL HIERARCHY

• Development of PPP inCandidate Countries requiresthe integration of a complex legalhierarchy involving EU,national, municipal andcontractual issues

PPP investments are influenced by ahierarchy of legal regimes as depicted bydiagram 1 below. Each must be accountedfor when developing a PPP both toguarantee the ability to access funds butalso to ensure the long-term legality andviability of the project. The followingchapters investigate each and will stressthat the legal environment in many CCs iscurrently such, with the continuing reformand harmonisation process, that particularattention must be given to ensuring thatlegal risks are properly identified,accounted for and attributed. Additionallygiven the long term nature of PPP projects,the requirements of the EU AcquisCommunitaire must also be integrated.

Project ContractualIssues

InclPubTranPubCon

Body of EU Acquis

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PPPPROJECT

Municipal / RegionalRegulations & Statutes

National Legislationuding (amongst others):lic Health Environmentalsport Procurement

lic Finance Labourtract Tax / Accounting

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3 NATIONALREGULATORY ANDLEGISLATIVE ISSUES

• Successful PPPs depend on theeffectiveness of the national andmunicipal legislative and regulatorystructures

• Legal due diligence is required todefine the constraints to PPPimplementation and to define projectscope

• EU Directives must be integrated

The effectiveness and impact of a PPPdepends, to a large extend, on theregulatory mechanisms used to influenceand guide the parties and in particular theprivate sector decision making process.Because of these critical interactions it ispreferable to ensure the development ofeffective legislative and regulatoryprovisions before developing PPPrelationships. In this area theCommission, can provide valuable policycontributions particularly in the currentsituation of regulatory transition associatedwith the accession process and reform oflegal and operating structures in the CCs.

The analysis of a national and sectoralregulatory framework has four mainpurposes:

1. to identify elements that could impedeprivate sector participation, affect

viability or distort advantages to begained

2. to consider the need for restructuringof current operators ahead of a PPPwith respect to their legal status andthe flexibility of their mandate andarticles of association

3. to identify the need for and designsector specific regulation makingprivate sector participation possibleand effective including thedevelopment of institutional structuresto oversee and regulate privateoperators

4. to identify which regulations need tobe incorporated into PPP contracts, toidentify their impact and to identify ifsafeguards against regulatory risk needto be included

While the accession process and exposureto Commission financing has meant thedevelopment of certain statutory andregulatory structures to accommodate theAcquis, these are not necessarily sufficientor appropriate for a PPP relationship. Itshould be noted that all Member Stateshave had to, or are undertaking legislativereform to ensure their ability to use PPParrangements. The Commission also isundertaking review of its approachtowards PPPs as demonstrated by theCommission InterpretativeCommunication on Concessions UnderCommunity Law (2000/C 121/02) and itsdesire to reform procurement procedures.In particular the following issues must beinvestigated:

• Legal capacity of parties and legal requirement ofthe State to provide services

• General legislation allowing or restricting privatesector involvement particularly by foreigncompanies

• Existence and legal basis of cost recoverymechanisms

• Ability to provide guarantees• Property issues of land and infrastructure• EIA requirements• Land acquisition• Planning permission requirements• Licenses• Need for project specific statutory requirements• Potential conflict with EU Directives• Transparency of laws

• Administrative coordination• Dispute settlement provisions• Forms of possible state financial support• Competition and antitrust regulations• Potential impact of employment and social security

laws• Currency and profit repatriation rules• Public sector borrowing restrictions• Tax and accounting liabilities• Adequacy of selection and procurement procedures• Legislation governing project agreements and

operational issues• Property law• Intellectual property law• Transfer of know-how and technologies• Adequacy of oversight and monitoring provisions

and authority to regulate services

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National legislative structures will notalways be conducive to PPP arrangements,but certain methods can be adopted tofacilitate their introduction, including:

• choosing a private sector arrangementthat reduces risks associated with thedeficiencies of the legislativestructure, for example using a feebased management contract fordistribution or BOTs for bulk supply,if collection performance orrequirements for providing subsidisedservices pose unacceptable revenuerisk to the private partner

• choosing a private partner best able tomanage legislative / regulatory risk,for example in the case of adverseforeign currency or profit repatriationrules then contracting local companiesmay be more viable

• incorporate explicit safeguards incontracts

• encourage the development ofeffective regulatory and watchdogmechanisms

Experience has shown that earlydevelopment of conducive and consistentnational legislative and regulatorystructures greatly facilitates theidentification, development andimplementation of PPPs. A particularrequirement is to establish the roles andresponsibilities of all parties and ensurethat effective systems are in place toregulate and monitor PPPs to derive thedesired value for money and necessarytransparency in implementation.

When designing and evaluating PPPprojects particular attention needs to begiven to the integration of the uncertaintiescaused by an evolving national legislativeand regulatory structure and the reformprocess affecting many of the CCs, as forexample the privatisation of utilityoperators. Focus should be placedparticularly on:

• the impact of legislation on the abilityto guarantee open and fair competitionparticularly with respect to theselection of utility operators. It is

often the case that reform orprivatisation will impose an operatoror partner, which has not been selectedon a competitive basis nor perhapsidentified at the project design stage

• the potential change in legal status andrights and obligations of parties. Thisincludes consideration of potentialchanges in the ownership of assets

• the extent and effectiveness of publicsector oversight and monitoringregulations and systems in ensuringcompliance with contract conditions

4 PROJECTCONTRACTUAL ISSUES

• Contracts will define theparameters of the PPP relationshipand limit the activities of allparties.

• Contracts need to providesufficient flexibility and control toensure objectives of all parties aremet and that differences can beresolved to the benefit of theproject

• Keeping things simple is oftenmore effective than being overprescriptive

• The Commission will directlyinfluence the design of contractualdocuments despite the fact that it isnot a party to individual projectcontracts

A PPP will involve numerous parties andtherefore a corresponding number ofcontractual arrangements. While thenomenclature may change, the maincontractual documents include:

• Project Agreement – this is the mainlegal document setting out the rightsand obligations of the ContractingAuthority and the Contractor. Manymodel contracts exist but changes willneed to be made to account fornational and project specificrequirements.

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• Performance Specifications – thesewill include all of the technical,financial and service requirements ofthe Contracting Authority and must bespecifically referred to in the ProjectAgreement as constituting an integralpart and defining the partiesobligations in relation to them.

• Collateral Warranties – these providefor direct links between theContracting Authority and theindividual sub-contractors appointedby the Contractor. Their main purposeis to give the Contracting Authoritythe benefit of an independentobligation in relation to the workcarried out by sub-contractors. Theywill also allow for step-in rights.

• Direct Agreements – these regulate therelationship between the ContractingAuthority and outside fundersincluding the Commission through theFinancing Memorandum.

Other contractual documents ofimportance include; construction andoperating contracts and financial securityand guarantee arrangements. It is crucialthat these documents are prepared in atransparent manner and that clauses arefully understood by concerned parties.

The following discussion is meant toprovide a brief understanding of the issueswhich contracting parties will benegotiating . This section is not designedto provide a model contract.

Heading DetailGeneral provisions of the agreement • Legislative approaches

• Governing law• Conclusion of the project agreement

Organisation of the concessionaire • Legal form• Capital• Applicable accounting standards

Project site, access and easement • Ownership of project assets• Land acquisition for the purposes of the project• Easement and transit arrangements

Financial arrangements • Financial obligations of the concessionaire• Tariff setting and tariff control, including

o concessionaire’s authority to collect tariffso tariff control methods, ie rate-of-return method, price-cap methodo policy considerations on tariff control

• Financial obligations of the contracting authority, includingo direct paymentso purchase commitments

Security interests • security interests in physical assets• security interests in intangible assets• security interests in trade receivables• security interests in the project company

Assignment of the concessionTransfer of controlling interest in the projectcompanyConstruction works • review and approval of construction plans

• variation of project terms• monitoring powers of the contracting authority• guarantee period

Operation of infrastructure • performance standards• extension of services• continuity of services• equal treatment of customers or users• interconnection and access to infrastructure networks• disclosure requirements• enforcement powers of the concessionaire

General contractual arrangements • subcontracting• liability with respect to users and third parties• performance guarantees and insurance• changes in conditions• exempting impediments, force majeur• breach and remedies

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�� Substantial work has beencarried out by a number oforganisations to develop modelcontract forms. The bibliographyprovides a number of contact points.In all cases it must be rememberedthat generic documents must beadapted to the characteristics of theactual situation

Although the Commission will not be adirect party to a contract between projectbeneficiaries and the private sector,funding being supplied directly to aNational Authority, interaction with theCommission and the ISPA regulations are,currently, such that approval of an ISPAgrant will be conditional on satisfactoryarrangements being made to safeguardCommission interests. While theCommission recognises the continuingevolution of the PPP concept and the needfor a degree of flexibility; to safeguard itsinterests, scrutiny of contractualdocuments should aim to:

• safeguard the public interest.Commission sponsored projects mustbe designed to provide effective publicservices and contractual arrangementsshould guarantee the continuation ofservices in a manner which addressesthe public’s need.

• ensure contract fairness. The contractneeds to produce conditions of‘fairness’ amongst the parties whichincludes an equal distribution risks andbenefits. In particular price settingmechanisms need to be transparentand equitable, the private sectorshould not benefit from unreasonableprofits, as a result of the grantcontribution, and dispute resolutionneeds to be effective.

• promote effective regulation andmonitoring. This is an overridingrequirement to ensure that contractterms are respected and the interests ofall parties maintained.

• ensure contractual flexibility to meetchanged circumstances. This iscovered particularly by Article 8 of the

ISPA Financing Memorandum inwhich the grant conditions may bechanged if substantial changes to thestatus of the project occur within thefirst 5 years. This covers in particularthe transfer of assets from the public tothe private sector and hence asignificant change in the financialconditions of the project.

Additionally it is crucial that theCommission be involved early on in theproject preparation process to ensure that itis able to identify its requirements andintegrate them into the project designprocess.

5 PROCURING THEPRIVATE CONTRACTOR

• Procurement conditionalities ofgrant providers often representthe main cause for projectcollapse

• A degree of flexibility is requiredbut the Commission’s objectivesunder procurement policy needto be respected

• Procurement options will changewith accession

The field of procurement is often the onewith the greatest scope for conflict andPPP relationship failure, particularly ifpublic bodies and IFIs with separateprocurement procedures are involved.This is notably the case of the Commissionwhich requires the adoption of specificprocurement procedures for the use of itsgrants but which are not necessarily bestsuited to complex multi-party PPParrangements. While these Guidelinestreat the specific situation of Commissiongrants, some procurement issues arecommon to all funding institutions.Particular attention also needs to be givento the adoption of the correct Communityprocurement and contracting regime withreference to differentiation betweenconcession and public procurementapproaches.

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This situation is further affected by theevolving legal and regulatory state in CC’swhich leads to uncertainty both in how tostructure procurement procedures and whois responsible for what. The implicationsof the accession process will lend greaterclarity to public procurement once CCs areobliged to adopt the EU ProcurementDirectives. However until such a time thedevelopment of PPPs (using Commissiongrants) must be adapted to the currentprocurement regulations and nationallegislation.

Above all it is necessary to remember thatthe PPP process aims to attract privatesector finance and know-how and, in orderto maximise the benefits of PPPs, toinclude this at the earliest possible stage ofa project. In this respect traditionalprocurement rules present a conflict as theprivate sector, to compensate for earlyinvolvement, will require assurances or aprivileged position in the implementationstage. This creates public sector concernbased on the arguments that:

• any alternative procurementprocedures will leave the public sectoropen to allegations of corruption, lackof transparency or unfair competition;

• the regulatory environment does notallow procurement other than thatbased on competitive bidding;

• the public sector does not want to beforced into an early relationship whenall technical and financial parametersare not know;

• the private sector may deriveunreasonable profits.

Current procurement rules (especiallythose of the Commission) are designed toensure transparency, open participationand cost effective solutions based on fullyspecified tender conditions. However forcomplex PPP arrangements (particularcomplex DBFO and concession projects)this may not prove to be the best option as:

• these procedures are usually designedto operate under conditions ofcertainty;

• they prohibit extensive informalconsultation and communicationbetween the parties (which is essentialto the development of partnerships);

• they are focused on lowest pricewhereas PPPs may also target otherfactors;

• they force tender specifications to becomplete and therefore leave littleroom for variations.

Several procurement alternatives are beingdeveloped8 which have minimum criteriabased on:

• tender specifications which state thedesired end goal but leave the biddersto propose solutions;

• strict performance criteria andmonitoring systems which bindcontractors to their bids;

• compensation for private sectorparticipation in bids to those notselected;

• provisions to renegotiate contractterms over the contract life.

Until such time as the Commissiondevelops a unified approach, the selectionof procurement procedures with particularreference to the selection of privatecontractors, must be based on a clearseparation of contracts which are coveredby the ‘specific’ provisions of the publicprocurement Directives and those coveredby the rules and principles of the Treaty(as defined by the recent InterpretativeCommunication on Concessions).

5.1 Choice of Procurement Procedure

The choice of procurement procedure mustbe completed at an early stage of theproject and must be agreed to by the mainparties in particular the funders; and ifinvolved, notably the Commission.

This section will set out two types ofprocurement procedures based on pre andpost accession of CCs. This distinction is

8 Refer to the UNDP Joint Venture PPP forUrban Environmental Services Project or theFIDIC Silver Book

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The FIDIC suite of Contracting Books

important as currently grants canincorporate only those procurementprocedures authorised by the PracticalGuide to Contract Procedures9. Uponaccession CCs will adopt the EUProcurement Directives and will face adifferent set of issues. To account for thelong lead times in project developmentboth situations are described. This sectionfocuses particularly on the need to:

• respect procurement regulations toensure effective grant allocation

• provide sufficiently flexibility inprocurement to maximise the benefitsof a PPP relationship

• integrate the characteristics ofdifferent types of PPP relationshipsand seek to adapt procurement to theunderlying needs of the relationshipand the project

5.1.1 Pre-accession Phase

Procurement procedures are currentlydefined by the ISPA Regulations, thePractical Guide to Contract Proceduresand Title IX of External Aid Regulations.These must be used for the application ofISPA grants with little scope forderogation even if PPP schemes are

9 These Guidelines are based on the currentlyavailable Practical Guide but note the on-goingrevision of the Guide

considered. According to the ISPAManual “Commission sources of financecan be integrated into private financingschemes…… Their integration must,however, not restrict the procurement ofworks, services or supplies during projectimplementation.”

Two aspects must be considered. The firstconcerns the selection by CCs of privateparties before the involvement of theEuropean Commission, as for example thecontracting of a private concessionaire foroperations (whether through tender orprivatisation). While this is obviously nota consequence of a Commission financedproject, the selection and capacity of theprivate party will be of consequence to theapproval of a Grant. As a result, NationalAuthorities should aim, as a minimum, tofully integrate and be able to demonstratethe conditions of:• Equal opportunity for all relevant

companies in the same sector;• Respect of competition rules in

awarding concession;• Respect of competition rules in

awarding the investment contracts;• Respect of conditions of the

concession (service to consumers,maintenance, etc.);

• Absence of disproportionateremuneration on capital.

It is further recommended that an earlyadoption of the principles and proceduresof the EU Procurement Directives,including the recent InterpretativeCommunication on Concessions UnderCommunity Law (2000/C 121/02) isdesirable to demonstrating the fulfillmentof these conditions (these are set out in thefollowing Post-accession section).

The second aspect concerns procurementwith a Commission Grant. It should benoted that the Commission currentlyrestricts the use of grants to theprocurement of supplies, services andworks and therefore does not envisage theapplication of grants in the form of otherfinancial instruments. As a result a grantwill be used to directly facilitate therealisation of physical infrastructure which

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must be procured, according to thePractical Guide, using Open or RestrictedProcurement Procedures (according totender type and amount).

It is argued that the Open and Restrictedtender procedures limit the development ofPPPs in two ways:

• The prospect of competitive tendering,and hence the cost and uncertainty ofcontract award, reduces the incentiveto the private sector to participate.

• The requirement of Open andRestricted procedures is to provide afully specified project output againstwhich tenderers compete, principallyon price. It is argued that this limitsthe ability to seek innovative solutionsbased on a private sector approach andpotential efficiency gains that thiswould entail.

The first argument is valid to a degree butcan be qualified with respect to the type ofPPP relationship targeted. Indeed it is rareto have a situation where some form ofcompetitive tendering is not involved andis usually only found where a PPP projectis being promoted by a private sectorparty. The uncertainty surroundingcompetitive tendering can be managed byproviding up-front information on thescale of the tender, the scope of evaluationcriteria and performance requirements.This can provide an effective guidance tocompanies on whether tendering is in theirinterest.

In order to avoid a too limited number ofTenderers, a degree of market soundingand informal consultation can beundertaken in order to ensure that theplanned tender and project will attractsufficient interest. Should this not be thecase, this should in itself be an importantindicator for project design and appraisaland may require a re-assessment of projectparameters.

It has been suggested10 that the cost oftendering, particularly for large complexprojects, could be partially covered by 10 Notably by the UNDP PPPUE

Contracting Authority in order to share therisk associated with the tender process. Itis believed that this should be consideredonly for very large projects wheresubstantial conceptual work is required byTenderers. However Tenderers should begiven a measure of intellectual propertyprotection, in that the materials developedin their tenders will not be exploited byany other party.

The argument that Open and Restrictedtender procedures limit the ability to seekprivate sector innovations is valid if therequirement to provide completelyspecified projects at the tender stage isabsolute. This limits competition to thefinancial considerations. However anumber of important innovations arepossible, within the procedures, toovercome this but require a preliminaryidentification of what the importantdesired values and benefits of the PPPrelationship are. Possible innovations,including:

• If the project must meet certaintechnical standards (including EUstandards) which limit the possibilityfor substantial technical innovations tobe gained, the real value of a PPP willlie in financial considerationsincluding cost structures, the degree ofservice provision and how risks arepriced and managed. This thereforeassumes that a fully technicallyspecified project will be evaluated(after technical compliance)principally on the financial offer. Inother words this will entail evaluationof, amongst others:• How costs are structured• In the case of concession type

contracts, how revenues arestructured

• How risks are priced• What is the value of the private

sector contribution andrequirement of additionalfinancing (including ISPA grant)

This in effect requires a detailed valuefor money assessment including some

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form of financial comparator. Theseare discussed further in Part 3.

• If there is the potential for bothtechnical and financial innovation andvalue added from the private sector itis recommended to allow Tenderers tosubmit Variant Solutions. Thisrequires that they submit a tendermeeting the original conditions and atender which proposes their alternativeapproach. It should be noted howeverthat the evaluation of variant solutionsmust comply with strict guidelines andshould be against a set of minimumstandards required by the project.

In both cases the emphasis is to remainwithin the boundaries of existingprocedures but to develop morecomprehensive evaluation techniques thatin effect allow Tenderers some flexibilityand the project to harness private sectorinnovations and efficiencies.

5.1.2 Post Accession Phase

On adoption of the European Acquis theprocurement process is governed by aseries of Directives. The first step entailsdeciding which Procurement Directivesare applicable. Current Directives andtheir amendments, relate to four regimes:

• Works (Council Directive 93/37/EEC);• Supplies (Council Directive 93/36/EEC);• Services (Council Directive 92/50/EEC);• Utilities (Council Directive 93/38/EEC).

The first three Directives are commonlyreferred to as the “Classic Directives”. Ofimportance is also the recent CommissionInterpretative Communication onConcessions Under Community Law(2000/C 121/02). The first step inselecting the relevant Directive is to assesswhether the project concerns the ClassicDirectives or the Utilities Directive. TheClassic Directives cover the followingcategories:

• Works - this category covers the fullrange of building and civilengineering, contracts including the

supplies and services necessary tocarry them out;

• Supplies - this category covers theprocurement of products whetherfinanced through purchase, lease,rental or hire purchase, including thesupply, delivery, installation andoperation of equipment andmachinery; and

• Services - this category covers theprovision of services includingengineering, architectural and otherprofessional services. It specificallyincludes sewage and refuse disposalservices, sanitation and similarservices.

Each Directive has contract valuethresholds and prohibits the splitting ofcontracts to circumvent these. It should benoted that some uncertainty has existed asto the categorisation of projects into worksor services. The main interpretationoffered by the Commission and EuropeanCourt of Justice is that if works areincidental to the services provided then theService Directive is applicable. Incidentalcan be defined with respect to the mainobject of the contract or the predominantvalue of the component. It is suggested,based on jurisprudence, that the EuropeanCourt of Justice favours the latterdefinition.

Concession contracts pose a similarinterpretative issue. The EuropeanCommission has stated that if the recoveryof costs is guaranteed by the contractingauthority without the risk involved in themanagement of the construction, then thecontract will be a works contract ratherthan a concession.

5.1.2.1 Procurement Procedures

The Procurement Directives allow for anumber of different procurementprocedures, including:

• Open Procedure – whereby anyinterested party can tender.

• Restricted Procedure – whereby anyinterested party may submit a request

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for pre-qualification and may tender ifsuccessfully pre-qualified.

• Negotiated Procedure – which issimilar to the restricted procedure butopens the possibility for post-tendernegotiations on contract specifications.This procedure can also be used forthe selection of concession contracts.

The open procedure is generally notconsidered suitable for PPP due to scaleand complexity issues. Generally if acontract is a works or services concession,or alternatively falls within the UtilitiesDirective, the negotiated procedure isavailable but subject to the provisions ofthe Treaty of Rome and nationalregulations. In all other instances adecision between restricted and negotiatedprocedures must be made.

The Works and Services Directivesrespectively set out specific circumstancesin which the negotiated procedure can beused and go on to state that "in all othercases, the Contracting Authority shallaward their public works (services)contracts by the open procedure or by therestricted procedure". Whilst there are anumber of grounds set out in theDirectives for commencing a procurementusing the negotiated procedure, there areonly two potentially relevant bases forcommencing a procurement with thenegotiated procedure in the context of aPPP.

The first is "in exceptional cases, when thenature of the works (services) or the risksattaching thereto do not permit prioroverall pricing". The second applies onlyin the context of the Services Directive"when the nature of the services to beprocured is such that contractspecifications cannot be established withsufficient precision to permit the award ofthe contract by selecting the best tenderaccording to the rules governing open orrestricted procedures". It should be notedthat the validity of such cases only applieswithin the strict scope of the Directives.

The European Court of Justice has statedthat the use of the negotiated procedure is

a derogation permitted by the Directivesand as a consequence the onus will be onthe Contracting Authority to show that thecircumstances justifying its use apply.Additionally Contracting Authorities usingthe negotiated procedure or any other nonspecified procedure will need todemonstrate that the rules and principles ofthe Treaty have been respected.Internationally, the main drivers behindthe use of the negotiated procedure havebeen the ability to:

• secure the best value for money;• secure the optimum allocation of risk;• encourage innovative solutions; and• reduce tender or bid costs.

The practical reasons why the negotiatedprocedure is favoured for PPP projects areclear. Indeed, the European Commissionhas recognised the difficulties associatedwith using the restricted procedure. In aCommunication of 1998 the EuropeanCommission stated that:

"especially in the case of particularlycomplex contracts in areas that areconstantly changing, such as hightechnology, purchasers are aware of theirneeds but do not know in advance what isthe best technical solution for satisfyingthose needs.Discussion of the contract and dialoguebetween the purchasers and suppliers aretherefore necessary in such cases. But thestandard procedures laid down by thetraditional Directives leave very littlescope for discussion during the award ofcontracts and are therefore regarded aslacking in flexibility in situations of thistype".

If a negotiated procedure is permitted theContracting Authority must ensure that thefollowing principles are clearly adhered to:

• equality of treatment – this appliesthroughout the procurement process tothe conclusion of a contract andtherefore places limitations on theextent of possible negotiations.

• transparency – notably in thedefinition of procedures and

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publication of tenders in the OfficialJournal or adequate alternatives.

• proportionality

In choosing the appropriate procedure, aContracting Authority will have regard toa number of factors. These include:

• the scope and nature of the project;• the degree of precedent available for

reference and use;• the degree of risk transfer proposed

(particularly as regards statutoryprocess risk);

• the role and influence of third partyfunders.

In a Design and Build or BOT contract,the case for the use of the negotiatedprocedure is difficult to make. There isample precedent for using the restrictedprocedure successfully; there will usuallybe adequate project definition and thenature of the works or the risks attachingto them will usually permit overall pricing.

In addition, there is nothing to prevent aContracting Authority from seeking theviews of tenderers. Examples of issues onwhich the views of Tenderers should besought include force-majeure, intellectualproperty rights, payment mechanisms andlimitations on liability. Thus, even wherea greater degree of risk transfer isproposed than in previous projects, theContracting Authority is not necessarilyleft only with the option of using thenegotiated procedure.

In the case of a DBFO contract, theContracting Authority will be seekingoptimal risk transfer in the context of theintroduction of private finance. Where therestricted procedure is followed in DBFOprojects, it may lead to the pricing ofprojects based on private sector costs ofequity and debt without sufficient scopefor innovation and an efficient allocationof risk to the private sector. A ContractingAuthority can improve its judgment on theappropriate allocation of risk throughregular and structured market sounding ofprivate sector appetite for various types ofproject and the spectrum of risks and

rewards they represent. Some of the riskswhich may be difficult to specify inadvance in contract terms are:

• demand or volume risk;• elements of the statutory process risk;• payment structures and mechanisms;• maintenance costs impacted by

demand or volume usage;• financing proposals;• compensation and termination clauses;

and• change of law risks.

Where the negotiated procedure is used,serious consideration should be given tolimiting the areas or scope for negotiationthereby helping to reduce tender costs andthe time expended leading to contractaward. Efforts should be made to deviseprocedures that relate as closely aspracticable to the restricted procedure,allowing the necessary flexibility tonegotiate only on the key issues.

In summary, a Contracting Authority mustgive very careful consideration to thequestion of the procurement procedure tobe used and take appropriate legal advice.It is permitted to commence a procurementusing the negotiated procedure but only invery limited circumstances and its use willbe reviewed very strictly in the event of achallenge. However, the factors whichinfluence a decision in favour of the use ofthe negotiated procedure tend to exist inthose projects where it is intended toutilise private finance or to achieve agreater degree of risk transfer than isnormally anticipated. Where privatefinance is involved, the use of thenegotiated procedure is likely to beappropriate for major projects so thatoptimal value for money proposals arereceived.

The European Commission is consideringthe introduction of a greater flexibilitywith the introduction of a CompetitiveDialogue procurement procedure. Thisproposal is being developed in response tothe criticism sometimes leveled at theexisting system to the effect thatprocedures are excessively rigid and

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formalistic and, where complied withstrictly, can lead to malfunctioning in theaward of contracts. To that end, it haspublished a draft proposal for a EuropeanParliament and Council Directive toamend the Classic Directives proposingamendments with a view to makingprocedures more flexible. Additionally theCommission has made proposals tomodify the classic Directives.

6 INSTITUTIONALSTRUCTURES

Effective legal, regulatory and contractualconditions are crucial to PPP success butcan only exist if supported by an efficientinstitutional structure which bothfacilitates PPP development and providesclear boundaries to protect the interests ofall parties. Most Member States haverealised that PPP development requiresmajor institutional changes not leastbecause the role and responsibilities of thepublic sector change from direct serviceprovision to management and monitoring.However a further role is sponsor anddeveloper of the PPP concept. To this endseveral Member States developedspecialised PPP task forces.

Two principal models of interventionexist. The decentralised approach, asadopted by France, places responsibility atthe regional level and within the concernedline Ministries. Other countries, such asthe UK and Ireland, have selected a morecentralise approach by creating onededicated national PPP unit. In both casescountries have realised the importance ofsourcing high calibre experts to create anucleus able to drive the process. At thebeginning such units focus particularly ondeveloping capability, required legal andregulatory structures, market interest andpilot projects in order to test anddemonstrate the value of PPPs. Asexperience is gained the role of such unitschanges to focus on assisting the selectionof PPP opportunities, counselling,ensuring value for money, investorattraction and above all maintainingpolitical support.

Such units and the public sector in general,have a key role to play in creating trustwhich in turn allows a reduction in riskand therefore cost, but importantly also thedevelopment of effective and sustainablepartnerships. Trust must include the openexchange of information, the possibility tohave non-conflictual dispute resolutionand respect for the objectives of all parties.

Trust also implies a strong level ofpolitical commitment which must bedeveloped, sustained and communicatedby the necessary institutional structures.To this end, experience has shown thevalue in identifying a ‘political champion’of PPPs able to provide an effective linkbetween political priorities andinstitutional structures. Political supportshould be realistic and practical aboutwhat PPP can achieve and how it is to beimplemented. There will be occasionswhere projects must be stopped (andindeed the public sector must play anactive role in identifying these situations),but likewise a reasoned approach isrequired to identify when projects presentgreater long term interest as opposed toshort term political gain. This requiresinstitutional structures able and willing toeffectively negotiate with the privatesector. This includes taking the necessarytime to correctly structure deals and wherenecessary to show willingness torenegotiate contracts to enhance benefitsfairly for all parties.

An institutional framework is required toallow the public sector to change frombeing a direct service provider to anindependent regulator, manager andmonitor. Additionally it must provide therole of project promoter. All functionsrequire an in-depth understanding of themotives of the private sector and thereforehow a balance a can be achieved betweenthese and the objective of safeguarding thepublics’ interest. Sustainable success ofPPPs can be enhanced by including civilsociety in the monitoring / oversightstructures. Implementation of PPPs as analternative financing and service provisionmodel must be seen to provide anddemonstrate value for money and qualityservice provision. The public, as paying

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consumers, are therefore a criticalbarometer of performance and suitabilityof PPP implementation and should beintegrated into the monitoring process.This implies that PPPs are influenced bothfrom the top down but also from thebottom up.

Example of Civil Action Against aPlanned Incinerator – Source BBC – 3November 2001

“Incinerator protesters marchagain”

Hull City Council - Protestors claim councillorshave not consulted them

A campaign is underway to prevent theconstruction of a waste incinerator in thecentre of Hull.

Hull City Council and East Riding of YorkshireCouncil have signed a 25-year contractallowing the Waste Recycling Group (WRG) toburn 165,000 tonnes of rubbish a year in thenew incinerator.

Hundreds of protestors who are concernedabout the alledged health risks associated withincinerators are marching to the city councilbuildings to object to the plan.

WRG insists that the incinerator, proposed forStoneferry in Hull, would be perfectly safe.

'Highest standards'

Clive Carr, managing director for thecompany's eastern division, told BBC NewsOnline: "We would operate this plant to thevery highest standards currently available inthe UK and even in Europe.

"I believe those standards are high enough.

"The land it would be built on is derelictcontaminated land, which would be cleaned upas a part of the construction process."

Under the 25-year contract Hull City Counciland the East Riding of Yorkshire Council wouldpay WRG to take the waste, which would

produce electricity to be sold onto the NationalGrid.

'Profit making'

Campaigner Eric Wedge, 59, from the group"Hull Against the Incinerator", told BBC NewsOnline: "People need to be aware about thelack of consultation which goes into theseprofit-making projects.

"Who picks up the tab with all the healthproblems I do not suppose they care.

"We have thrown down a challenge to thecouncillors who signed the contract.

"We want them to meet us on the Guild Hallsteps on Saturday... we have collected 25,000signatures, which is the largest petition evergot up in the city of Hull."

Academic studies

The protest group says academic studiessupport their viewpoint.

"We are about the only country in the westernworld that is advocating incinerators - othercountries are stopping building them - Francehas closed 80% of its down, and America hasnot built one for five years."

Mr Carr said: "The UK Department of Healthcarried out a seven-year study into 14 millionpeople and 72 incinerators, and found that ifthere was any cancer risk from incinerators itwas so small that it wasn't measurable.

"The level of emissions that would beproduced are equivalent to the levels ofdioxins in urban soils.

The dioxins released on bonfire night areequivalent to that released from all the UK'sincinerators in one year."

In August, 400 people attended a protestMarch against the incinerator proposals, anddemonstrators entered Hull City Councilwearing gas masks.

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PART 3 FINANCIAL AND ECONOMIC IMPLICATIONS OF PPP

PART 3 - Summary

• PPP projects present a different risk profile to conventional projects• Risk has a direct financial impact on the project as it is translated into financial

terms by the private party• Risk should be transferred to the party best able to manage it in the most cost

effective manner• A prime responsibility of the public sector is to ensure value for money in PPPs• Several techniques exist to determine value for money – their use should be carefully

evaluated against need• Grant financing carries certain risks. The level of grant financing should be

carefully matched to ensure that public benefit is maximized and adverse impact onprivate sector profits is minimsed

• This Part will address:• Financial implications of risk and risk types• Ensuring value for money in a PPP• Optimizing grant contributions

1 INTRODUCTION

The primary focus of this Part is to addressthe financial and economic implications ofPPP relationships. It will focus primarilyon three areas, being:

• The financial implications of risk in aPPP relationship

• Ensuring value for money from a PPPat the design and evaluation stages

• The optimization of grantcontributions.

It is not intended to explain the differenttechniques of financial and economicanalysis which are well known andintegrated into accepted projectpreparation processes. Instead this Partwill present additional issues to include inthe analysis of projects which arecharacteristic of PPP relationships.

2 FINANCIALIMPLICATIONS OF RISK

• Risks are directly translated intofinancial implications

• Risk should be transferred to theparty best able to manage it in themost cost effective manner

• Risk should not be transferred forthe sake of doing so

A risk is defined as any factor, event orinfluence that threatens the successfulcompletion of a project in terms of time,cost or quality. A key principle of PPPs isthat risk should be allocated to the partybest able to manage it. The effectiveallocation of risk has a direct financialimpact on the project as it will result inlower overall project costs and willtherefore provide enhanced value formoney if compared to traditionalprocurement methods.

The direct relationship between risk andfinancial impact lies also in the fact thatthe degree of risk transfer to the private

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sector will influence the overall cost of theproject to the public sector as all risk willbe associated with a price premium.Therefore the objective must be to achievecost effective risk transfer not simply riskallocation for its own sake.

The objectives of risk transfer include:

• To reduce long term cost of a projectby allocating risk to the party best ableto manage it in a most cost effectivemanner

• To provide incentives to the contractorto deliver projects on time, to requiredstandard and within the budget

• To improve the quality of service andincrease revenue through moreefficient operation

• To provide a more consistent andpredictable profile of expenditure

The following discussions address riskcategories and allocation.

2.1 Revenue Risk

Revenue risk is the most fundamental ofall unknown factors involved in PPPprojects. Revenues flows are generallydetermined by two factors: utilisationlevels, and tariffs. The availability ofreliable historic information documentingdemand and price elasticity levels variesamong different sectors. In the watersector, for instance, a great deal ofinformation is likely to be available.However, the cost of providing water maywell have been subsidized in the past,making it more difficult to determine howconsumers would behave in the face ofunsubsidized pricing.

In the case of road projects, even withextensive investigation of past traffictrends, forecasts of future growthpotential, and surveys of people’swillingness to pay tolls, there is always asignificant residual risk on the trafficlevels that projects will actually attract.This risk is only reduced after a number ofyears of operation. In order to arrangeproject financing, certain assumptions

regarding usage and revenue levels mustbe made. While these calculations areusually intended to be conservative,overstatements are not uncommon.Moreover, unforeseen future events canalso have dramatic impacts, such as the oilshocks of the 1970s, which were a majorfactor in the failure of the three privateconcessions in France.

Traffic risks are also amplified in CCs,where assumptions regarding economicgrowth and automobile ownership take ongreater importance. Moreover, incountries, where automobile ownershipand income levels are lower, and motoristsoften opt to drive on slower parallel routesrather than paying expensive tolls.11

For road projects, the adequate level trafficrisks to be transferred to the private sectorshould be carefully analysed. Shadow tollor availability payment mechanismsshould be considered instead of realtolling, which usually does not yieldenough revenue to cover a significantpercentage of investment costs.

1

EIP

French toll-road tempts investors with asmile

BBC - March 12 2002

France is trying to lure investors to the 2.8 billion($A4.7 billion) initial public offering of Autoroutesdu Sud de la France. ASF had 1.9 billion in saleslast year, mainly from its 2794 kilometres ofhighways that run along the Mediterranean coast.Meantime, ASF's network is attracting interestfrom other European highway companies.

ASF plans to add 318 kilometres of toll roads by2009, according to information on its website. Itstwo main concessions run until 2026 and 2032. Thecompany is allowed to raise tolls by 30 per centmore than inflation through 2006, says a recentreport by Standard & Poor's.Traffic on the existing network has grown at anannual rate of 5.7 per cent between 1997 and 2001,according to the company. ASF's 8.3 billion ofdebt may hinder expansion plans, even though thecompany would raise about 800 million from theoffering, said S&P, which rates the company AA-

1 András Timár, “Road Projects in Transitionurope,” Transportation Equipment and

nfrastructure Review, Chapter 5, Euromoneyublications, Essex, UK, 1998, p. 19.

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2.2 Choice of Private Sector Partner

Inherent risk is associated with forming apartnership with unknown partners. Thisis accentuated through a publicprocurement process which does notfacilitate extended negotiation periodsallowing a degree of knowledge andconfidence to be established. Theprinciple risks are that the private partyproves insufficiently competent and / or isnot able to deliver the services to the initialspecifications. This can be because of abadly researched tender or because tenderswere designed to win the contract in thehope of recovering costs at a later stage.In both instances the tender evaluationmust aim to identify such situations.

A common concern of public bodies is thatby granting a PPP contract they may becreating a monopoly situation for a privatecompany or at least creating a situation ofunfair competition or market access. Thispotentially impacts both on project costsbut also the ability to introduce innovationinto service provision.

EU Procurement rules stipulate open andfair competition. While this presents acommercial risk to the private sector, amore serious risk occurs with the existenceof corruption and market and/or pricefixing. This can only lead to financial lossfor the public and unsuccessful bidders butalso a long term reduction in marketinterest by the private sector if suchpractices are thought too prevalent.

2.3 Construction Risk

The capital construction cost of anyproject is one of the fundamental factorsupon which financing is based, and whencost overruns are incurred, the financialfeasibility of a concession can bejeopardized. Poor project definition,unknown geological conditions, or looselydefined safety specifications can havedramatic affects on capital constructioncosts. However, these potential problemscan be mitigated with the completion ofcareful engineering studies before a

concession contract is actually signed.Construction delays also have detrimentaleffects on capital costs. While somedelays can be minimized through carefulconstruction management, they still havethe potential to arise. Other externalfactors, such as timely delivery of right-of-way, for example, are more difficult tomanage. External forces such as inflation,economic policy, embargoes, and politicalconflicts also have the potential to havedramatic affects on capital costs.Construction risk is nearly alwaysassigned to the private party, which in turnis likely to include strong incentives foron-time completion of works in itsconstruction contract.

2.4 Foreign Exchange Risk

Debt is a defining characteristic of nearlyall concessions and, when money isborrowed abroad, foreign exchangefluctuations can threaten project viability.This risk can be exacerbated whengovernments require that concessionairesobtain a certain portion of their financingfrom foreign sources. Foreign exchangerisk is greatest when weak currencies areinvolved, putting projects in emergingeconomies at greater risk. Whileaccession to the EU and the ultimateadoption of the Euro will limit foreignexchange risk in most CCs, the dangers ofcurrency fluctuations remains a seriousdetracting factor for PPPs in the CCs. Incertain cases, foreign currency risk can beassumed by sovereign governments,export credit agencies, or internationalfinancial institutions in order to makeconcession projects more attractive toprivate investors.

2.5 Regulatory / Contractual Risk

Although governments negotiate contractterms and conditions with theirconcessionaires, they are not alwayssuccessful in maintaining theircommitments. This is particularly true oftolls and other user fees, which tend to bepolitically sensitive. This was the case in

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France in the 1970’s, for example, whenthe government reneged on itscommitment to allow privateconcessionaires to set toll rates. Thisfactor was critical to the demise of threeout of the four private motorway operatorsin France. More recently a lawsuitsponsored by the Hungary AutomobileClub was successful in its charge that theservice on the M1/M5 Motorway was notcommensurate with the high tolls charged,and the court of first insistence ordered a50 percent reduction in toll prices.12 Thisdecision lead to an immediate suspensionof disbursements by the European Bankfor Reconstruction and Development anddelayed construction for seven months.

These risks are more common than manyproject finance proponents like to admit.They can have substantial effects onexisting concession agreements, and alsoweaken interest in future projects.Regulatory risk is exacerbated in countrieswhere new and untested laws govern PPPprojects, which is often the case in CCs.Such risks can be expected to be greatestin countries with comparatively littleexperience in project finance.

2.6 Political Risk

Assessments of the inherent strength andstability of local political institutions arecommon in the investment field and arereflected in bond ratings prepared byinternationally recognized rating agencies.As political risk increases, so does the costof obtaining financing. The long durationof most concession agreements and thecommon aversion to user fee increases,make PPP projects especially susceptibleto political risk. This is exacerbated whennew governments oversee unpopularprojects instigated by previousadministrations. Political risks are oftenassumed by host governments, but such anassignment can prove less than optimal inthe face of lackluster political support for 12 John D. Crothers, “Project financing of tollmotorways in central and Eastern Europe: asignpost for transition?” Law in Transition,Spring 1997, pp. 6-11.

an infrastructure partnership. IFIs andmultilateral organizations such as theCommission can use their influence tohelp to counter political risk. Bilateralagencies such as export-import banks havealso been known to provide political riskguarantees to private concessionaires fromaligned countries.

2.7 Environmental / ArcheologicalRisk

Infrastructure projects have the potential toprovoke environmental concern, andgovernments and citizen groups arebecoming increasingly vigilant in theirefforts to mitigate potential impacts.Unforeseen environmental issues can

Public protest can severely disrupt projectimplementation. However constructive public

participation should be encouraged to optimize design,minimize protest and enhance public oversight.

increase capital costs considerably andresult in serious delays. Environmentalrisk is usually assumed by the privateparty. For this reasons, most would-beinvestors undertake thoroughenvironmental assessments and identifylikely mitigation programs before enteringinto a concession agreement.

2.8 Latent Defect Risk

It is now increasingly common forgovernments to provide contractors /concessionaires with the right to pre-existing infrastructure systems as a way tohelp finance the construction of newinfrastructure. In many cases, newprojects may also involve upgrading andexpanding existing systems. In exchange,concessionaires usually assume

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responsibility for the maintenance of thesefacilities for the duration of their contracts.While seemingly attractive, thismechanism can be costly forconcessionaires if the facilities they inherithave unknown structural faults. The riskof encountering unpleasant surprises canbe minimized when thorough and well-documented inspections of the facilities tobe transferred are completed beforeconcession contracts are formalized.

2.9 Public Acceptance Risk

Infrastructure projects have the potential toprovoke vociferous protests among localcommunities; a fact which can prove fatalto private concessions. There are severalnotable examples of public acceptance riskin Europe. The Lyon Périphérique Nordconcession was ultimately canceled due towide spread public opposition, boycotts,and protests aimed at the project’s hightoll levels. Controversy has alsosurrounded routing of the A2 Motorwaythrough greater Warsaw in Poland, andpublic protests to toll increases in Lisbonassociated with the new Vasco da GamaBridge concession brought traffic to a halton Portugal’s most heavily traveledroadway link, while images of the angryprotests were broadcast around the world.The government quickly acquiesced to theprotestors’ wishes, reduced the tolls, andpaid the concessionaire the differenceusing public funds. One protestor in theUK stopped construction on the NewburyBypass single-handedly by lying in ahand-dug tunnel under the constructionsite for five days. These experiencesdemonstrate the very real threat that publicacceptance risk can pose. Prudentinvestors need to make carefulassessments of the approvals required fortheir projects, as well as public sentimenttowards the projects before deciding toinvest.

2.10 Sustainability Risk

A principle objective of the public sectoris to protect the public interest and ensure

delivery of value for money. Publiclyprocured and operated projects provide thetax paying public with the ability tocontrol the quality through votes andtaxes. The introduction of privateoperators may reduce this control ifeffective control or oversight systems arenot developed. Along with thedevelopment of an effective public sectormanagement and monitoring capability itis necessary to promote the developmentof consumer “watchdog” associations andallow for public consultation. This notonly creates a direct link with the privateoperator but also develops a strong senseof consumer ownership or participation inPPP projects.

2.11 Hidden Protectionism

Infrastructure provision is generallyperceived to be within the domain of thepublic sector, and the public can beskeptical when private actors are involved.Such skepticism can be exacerbated wheninvestors are from an outside and moreaffluent country and have the potential tomake a profit on their investment. Whensuch a reaction occurs among thepopulace, it can also have repercussions inthe political arena, making it more difficultfor foreign investors and their hostgovernments to resolve conflicts. Foreigninvestors would be negligent if theyignored this issue, and should investigatethe experiences of other outside investorsin the countries where they are consideringdoing business. It can be argued, forexample, that this dynamic had negativerepercussions on the now defunct M1/M15motorway concession in Hungary. Thisrisk is borne by the concessionaire and it isbest countered by consistent governmentsupport. It is however ironic to note theoften inconsistent approach of publicbodies to foreign participation.Particularly there is often less objection toarrangements developed through directagreements than when public procurementis involved. It is through the latter thatnationality and foreign participation mostoften becomes an issue.

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Detailed methodology to analyse risk ispresented in Part 5. It is important to notehere that although the full quantification ofall risk facilitates analysis it is not alwayspossible, effective nor desirable. Riskquantification often involves complicatedand costly models based on questionableassumptions. This is particularly the casewhere data is not complete or risks do nothave a direct impact. In such cases thecost of risk quantification and the likelyvalue / accuracy of data should be matchedagainst the importance and likelihood ofthe risk occurring. As such it isrecommended to firstly undertake aqualitative assessment of risk focusing onimpact and likelihood of occurrence. Thisshould permit the prioritization of risksand hence the quantification of the mostimportant ones. Part 5 discussed somecommon analytical methodologies.

The allocation of risk should reflect thespecific characteristics of the project andthe strengths of each party. However thecost of risk transfer must not be neglectedas, given the nature of PPPs, theachievement of value for money will oftendepend on the level and cost of risktransferred to the private sector. It is alsogood practice to investigate the extent ofrisk transfer (and the financialimplications) in other associated contracts.Given the interdependence betweenproject components and contracts it islikely that a significant transfer in aseparate component can have a financialimpact on others and hence should beidentified and accounted for.

3 ENSURING VALUE FORMONEY IN A PPP

• PPPs should be used only if theyprovide better value for moneythan traditional methods

• Value for money assessmenttechniques are complicated andrequire quality data and shouldbe used after careful reflection

• However value for money mustbe a primary objective inmaintaining the public interest

PPPs should only be adopted as aprocurement and implementation option ifthey are reasonably expected to deliverenhanced value for money over traditionalmethods. Value for Money Assessment(VFM) is therefore crucial to deciding thesuitability of a PPP, in general, and thesuitability of a particular project design.Additionally, as discussed in Part 2, givencertain restrictions on procurementprocedures, the evaluation stage of atender becomes crucial in deciding whichtenderer is able to offer the best solution,which is a function of value for moneyprovided.

3.1 Factors Determining Value forMoney

Factors determining value for money willobviously vary from project to project andbetween sectors. Generally, however, PPPwill generate value improvements in anumber of areas including:

• Reduced life cycle costs• Better allocation of risk• Faster implementation• Improved service quality• Generation of additional revenue

A recent survey commissioned by the UKTreasury Taskforce on PPP identified that froma public sector perspective, there are 6 keydrivers of value for money in PPP projectsincluding: risk transfer, long term nature ofcontracts, the use of output based specification,competition, performance measurement andincentives and private sector managementskills.

The average percentage saving in net presentcost terms of using PPPs was estimated at 17%over the contract duration.

3.2 Assessing Value for MoneyPotential

Value for money (VFM) generationpotential should be investigated withparticular reference to:

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• The scope of the project including thebalance between asset provision andservice delivery

• The potential for cost effective risktransfer particularly with respect todemand and residual value risk

• The scope for user charges, third partyrevenues and alternative asset usagethat might reduce project costs

Traditionally this type of information isgathered from market analysis andreference to previous projects andhistorical data. However if these sourcesprove insufficient or substantial concernsexist it may be necessary to undertake ashadow bid. This can be done in one oftwo ways:• Estimating the cost savings required –

this involves adding the additionalcosts of a PPP approach (including thecost of private finance, profit margins,tendering costs and the cost of publicsector regulation) to a financialcomparator (defined as the comparisonof the cost of the preferred PPP tenderwith the cost of delivering the projectthrough traditional public sectorprocurement methods) and thenmaking a valued judgement on thepotential of the private sector toeliminate these additional costs

• Actual Bid – this involves developingan actual bid for the PPP project andcomparing it to the estimated cost oftraditional public sector procurementcosts.

It should be noted that the above concernsassessment for the potential of a PPP togenerate value for money. Actualassessment can only take place at the endof the procurement stage but should bedone before the conclusion of contractualarrangements.

3.3 Parameters for the Final VFMAssessment

The achievement of value for money in aPublic Private Partnership procurement is,in part, evidenced through effectivecompetition between potential suppliers

and, on projects that involve publicmoney, through a value for moneyassessment of the costs and benefits of thepreferred PPP tender.

The nature of the value for moneyassessment undertaken at the end of theprocurement process depends on whetherthe PPP project is financially freestanding, generates the majority of itsrevenues from third parties, or is reliant onpublic finance. The nature of the value formoney assessment for each type of projectis summarised below.

3.3.1 Financially Free-Standing Projects

Financially free-standing projects requirethe Contractor to recover all costs throughcharges on the final users of the service.The public sector plays a facilitating rolebut no public money is involved. It istherefore the responsibility of theContractor to determine whether theproject is commercially viable and suitablefor investment.

The Contracting Authority should satisfyitself through project appraisal that aConcession contract is the preferred formof PPP for the project, and that theapplication of user charges is appropriate.The Contracting Authority shoulddetermine its preferred approach to thesetting of user charges, and develop apayment mechanism that will delivergovernment policy, the objectives of theproject and protect the public interest.Value for money is achieved through thecompetitive tendering process which isbased on the economically mostadvantageous offer principle.

3.3.2 Concession Contracts with PublicGrants

The issues set out above for financiallyfree-standing projects also apply to thoseprojects where the public sector providesgrant financing and / or subventions butthe revenues come principally from user

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charges (ie the public sector is a minorityfunder).

However, such projects do involve theinvestment of public money and there istherefore a need to ensure that the projectrepresents the best use of the public funds.For this reason the benefit gained fromapplying the funds to the PPP projectshould be compared with the benefitgained from applying them to analternative project that would otherwisenot proceed. Policy priorities will be animportant consideration in this regard.Public subvention could take a number offorms, including capital grant and revenuesupport.

3.3.3 Projects where the Public Sector isthe Main Financial Contributor

In the case of projects where the publicsector is the sole or main funder a detailedvalue for money assessment isrecommended at the end of theprocurement. The assessment shouldcompare the costs and benefits (inmonetary and non-monetary terms) of thepreferred PPP tender with the costs andbenefits of traditional procurement, orunder certain circumstances, with othercomparable measures.

3.4 Elements of the Value for MoneyAssessment

A value for money assessment comprisestwo key elements:

• Monetary comparison - comparison ofthe cost of the preferred PPP tender,with the cost of traditional publicsector procurement, expressed in termsof discounted cashflows over the lifeof the PPP contract (the FinancialComparator). Under certaincircumstances other quantifiablemeasures may be used as the basis fora Financial Comparator; and

• Non-monetary comparison -comparison of all the factors that aredifficult to quantify in monetary terms,

but their value to government and thewider public is significant. Examplesinclude speed of project delivery,quality of service, and security ofsupply.

3.4.1 Parameters Required for theMonetary Comparison

The monetary comparison could take oneof four forms depending on thecharacteristics of the project The fourforms of monetary comparison can besummarised as follows:

• Financial Comparator - involving acomparison of the cost of the preferredPPP tender with the cost of deliveringthe project (to the standards set out inthe initial output specification)through traditional public sectorprocurement;

• Best available alternative - for projectswhere the cost of traditional publicsector procurement is difficult todetermine, the cost of the preferredPPP tender should be compared withthe best available alternative costing;

• Price benchmarks - involving acomparison of the preferred PPPtender with reliable, comparable andindependent price benchmarks or unitcosts (for example, standard costs pervolume); and

• Comparable PPP projects - involving acomparison of the preferred PPPtender with the cost of othercomparable existing PPP projects.

3.4.2 Financial Comparator

The Financial Comparator is a techniquesemployed particularly by the UK PrivateFinance Initiative to assess the value formoney provided by a preferred PPP optionand selected tenderer. It is developedbased on the preferred PPP option toprovide a fully costed estimate ofdelivering the project (to the standards setout in the initial output specification)through traditional public sectorprocurement, presented in terms of a

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discounted cashflow analysis. In practice,if the preferred PPP option results in thetransfer to the private sector of all servicesincluded in the preferred option arisingfrom the Project Appraisal, then thedifferences between the FinancialComparator and the preferred option willbe limited.

The Comparator is based on a hypotheticalproject contract in which the public sectorundertakes all functions (design, buildoperate etc) based on actual costs incurredon similar projects. It should include allrisks and the value of any assets to madeavailable to the project. Care needs to betaken to avoid double accountingparticularly with respect to public sectorcosts that would not be part of a PPPcontract.

The costs expressed in the assessmentshould be presented in real terms in a

discounted cashflow analysis and over arange of applicable discount rates. TheNet Present Value (NPV) of the publicsector project is compared with the NPVof the PPP option. If the difference inNPVs is positive then the PPP alternativeis considered attractive. A furtherrefinement entails making the cash flowcalculations stochastic through the use ofranges instead of mean values and theapplication of Monte Carlo analysis. Theresult is a probability distribution of theNPV of the PPP option as compared to thepublic procurement option. Thisdistribution would also indicate thepossible spread in the output and again apositive value means the PPP is the moreattractive option.

A suggested layout of the model isprovided below:

Example of Financial Comparator Model

Item / Year 0 1 N+1Opportunity Costs• LandCapital Costs• Construction• Etc• Residual ValuesRecurring Costs• Structural maintenance• Operational costs• EtcNet Cost Before Risk

NPV of Capital and Opportunity CostNPV of Recurring CostsNPV of Total Costs (without risk)Equivalent Annual Cost

Risk Analysis• Design risk• etcNet Cost After Risk

NPV of Total CostsEquivalent Annual Cost

It should be noted that developing afinancial comparator is often a timeconsuming and expensive task and theresults are only as good as the baselineinformation provided. While it isundoubtedly a useful tool a careful

assessment needs to be made as to its needgiven project scale, available information,cost and the usefulness of alternativemethods.

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3.4.3 Best Available Alternative

Ideally, the Financial Comparator shouldbe based on the same services and servicelevels as the preferred PPP option.However, for projects where there is notrack record of public sector procurement,the cost of the public sector providing theservice levels defined in the outputspecification may be difficult to determineand subject to a high level of uncertainty.

In such circumstances, the FinancialComparator should be based on the bestavailable alternative costing, which willmost likely relate to the provision ofservices to a lower or alternative standard.The best available alternative may relate tothe cost of current provision.

It is essential that the service levelsassumed by the Financial Comparator areclearly recorded in the PPP Assessment sothat, at the end of the procurement process,the differences between the preferredprivate sector tender and the FinancialComparator can be understood andevaluated.

3.4.4 Benchmarking and Comparison

A Financial Comparator may not berequired for projects that involve theprovision of services for which there is awell established market. In suchcircumstances, the financial comparisoncould simply involve a comparison ofprivate sector bids against reliable,comparable and independent pricebenchmarks or unit costs (for example,standard costs per volume). The use ofprice benchmarks or unit costs is likely tobe most applicable to outsourcing typecontracts.

3.5 Parameters Required for the Non-Monetary Comparison

The monetary comparison will not takeinto consideration all of the factors thatcontribute to value for money. Manyfactors will be difficult to quantify in

monetary terms, but their value togovernment and the wider public issignificant. Examples include speed ofproject delivery, quality of service,security of supply and equity issues suchas the accessibility of services.Consequently, the monetary comparisonshould not be approached as a pass failtest, and should be complemented with avalue for money assessment of the costsand benefits of the preferred tender in non-monetary terms.

The costs and benefits of the preferredtender may be usefully compared with thecosts and benefits of traditionalprocurement in non-monetary termsthrough the use of impact statements or aweighting and scoring matrix.

3.6 Results of the Value for MoneyAssessment

The results of the value for moneyassessment that is undertaken at the end ofthe procurement process determinewhether establishing a PPP with thepreferred Contractor will deliver improvedvalue for money compared with traditionalprocurement, or indeed other Tenderers.The value for money assessment istherefore the fundamental tool in decidingwhether or not to proceed with a PPPcontract.

4 OPTIMISING THEGRANT CONTRIBUTION

• Grant financing can have positiveand negative impacts

• Grants, like the entire projectfinancing package, should bematched to actual needs

• A compromise has to be reachedbetween permitting projectrealization, enhancing private sectorprofit levels and maximizing socialbenefit

An inherent characteristic of grantfinancing is that beneficiaries have little

60

incentive to optimise the amount theyrequest. Additionally in the specific caseof the ISPA application process introducesa certain element of rigidity in that thegrant amount is determined at the projectdesign and application stage and isapproved before procurement. Thistogether with procurement procedures thatdo not facilitate price negotiations make itdifficult to adapt grants to realrequirements unless an effectivenegotiation phase is foreseen.

Grant financing has two principal impacts,namely:• an immediate impact on project

financial viability by reducing costs(or increasing revenues)

• an impact on Local Authority (ieMunicipal) budgets by reducingdemand on funds and allowing budgettransfers to other requirements

• an impact on the private sectorcontractor’s perception of projectviability

Assessing the level of required grantfinancing is complex and must give regardto the objectives of and impact on each ofthe parties in a PPP, not simply ‘theproject’ itself. A basic principle should beto provide grants only up to that amountwhich allows the project to be realised andoperated in a sustainable manner. Thisassumes that a range of financing optionsare considered for realisation and that theproject is considered over its usefulfinancial life.

The overriding consideration must be tomatch grants to real project needs therebyavoiding the potential for a “Ferrarisyndrome” in which over ambitiousdesigns are financed and implemented.The ISPA Programme currently bases thecalculation of a grant on the revenuegenerating capacity of the project withregard to an equitable tariff policy, nounreasonable profits to the private partyand the maximisation of co-financingopportunities. A Discounted CashflowAnalysis is used to assess the projects’ability to generate revenue to cover costswithout a grant and specifically what, ifany, percentage of capital costs can becovered. The grant represents the‘financing gap’ between forecastedrevenue generation and required revenuegeneration.

An alternative has been to calculate theInternal Rate of Return if this is below anacceptable level then the grantcontribution should represent that amountrequired to raise the IRR to an acceptablelevel.

Both approaches are well known.However both represent a certain numberof difficulties not least of which is thedefinition of an acceptable IRR and thelevel of affordability to sustain requireduser charges and tariffs.

Alternative methods include:

• the Commission has also made adistinction between project types andhas assigned fixed rates of grantassistance to each. This obviouslyprovides no incentive to optimisegrants or undertake financialengineering

• an holistic approach to financingwould look at the financial analysis ofthe project but also the financialsituation and in particular the debtabsorption capacity of the projectbeneficiary. This would allow a moreprecise assumption on the amount ofdebt that a project can assume bothwith respect to the projects viabilityand the ability of the project

Is the scale of investment matched to actualneeds ?

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beneficiary to finance debt. As aresult grants are set to a level whichallows realisation of the project butassumes that the first priority offinancial engineering will be toassume the maximum [efficient] levelof debt. In this approach soft loaninvestment funds have often beensuccessfully used which blendcommercial loans and grants toprovide soft loans thereby promotingdebt financing but neverthelessreducing the overall debt burden.

• greater emphasis can be placed ondetermining more accurate estimationsof the IRR and ability to pay. Both,currently, suffer from a lack ofconsistent and reliable data in the CCswhich makes benchmarking thefigures very difficult. This is a resultboth of insufficient availability of dataand inconsistencies in analysis as isoften witnessed in project appraisalwork. This situation can be expectedto improve with greater experience ofproject implementation andapplication of user charges, howeverfor the moment greater expenditure onproject financial analysis would seemto be the only alternative.

• a facility that is not sufficientlyexploited at this time, due to restrictiveprocurement procedures, is to allowthe private sector Tenderers define therequired level of grant assistance.This is a useful benchmark whereflexibility is given to Tenderers tosuggest their optimum approach andwhere they are encouraged, throughthe tender conditions, to minimisetheir demand for grant financing.

A further element to consider whenanalysing the amount of effective grant toprovide is the potential for conflict withEU policy and directives on State Aid(rules on State Aid are now applicable inCCs). Where a grant contribution to a PPPconcerns payment to an economic operatorfor the provision of “services of generaleconomic interest” (such as water andwaste services but not the provision oftransport infrastructure, which is regarded

as a general, not selective measure) andwhere the public is charged for theservices, any financial compensation fromstate resources for the provision of suchservices could be interpreted asconstituting state aid. The precise limits ofthis restriction are still being defined bycase law and awaiting a final ruling by theCourt of Justice. The Commission hashowever published a recent report13 whichsuggests that state aid rules are notbreached (that is, any state aid iscompatible) as long as grant contributionsare correctly calculated and only serve toallow the operator to function and providethe services in a situation of "economicequilibrium". This would seem to supportthe absolute need to ensure both that, nounjustifiable excess profit is created bygrant financing and that the project couldnot operate viably without the grantcontribution. Additionally anyrenegotiation of grant contributions withprivate operators would need to follow thesame logic. This situation is still evolvingand the expect decision from the CourtJustice will need to be integrated intofuture grant design.

In all cases the prime objective of theCommission in protecting the publicinterest, should be to optimise the grantallocation in such a manner that the projectis realised, is financially viable,sustainable and generates the maximumsocial benefit but which also limits[resulting] private sector profits toreasonable levels. This can be representedgraphically in the following diagram.

13 Report to the Seville European Council onthe Status of Work on the Guidelines for StateAid and Services of General Economic Interest14 COMP.A3/AA/D(2002) 293

The gr

On the

0 � YY � X

On the

0 � AA � BB � C

C � D

Point 1Point 2Point 3

Points

A C

Private Sector Profit &Repayment of Capital

Social Benefit (VFM to

X

Y

Effect of Re-Negotiation

Real Impact ofNew OperationalAsset (With Grant)

Impact ofAssociatingPrivate Expertise/ Capital

5

E

Trade–off Private Sector Profit – Social Benefit

O

aphic can be defined as follow

Vertical - Private Sector Pr

Private sector operating prIncrease in private sector oefficiency of an operative Reduction from X towardsfrom grant financing) to enmargins as a result of re-ne

Horizontal - Social Benefit a

social benefit arising fincrease in social benemarginal increase in socontribution

or E increase in social beneprofit resulting from g

represents a project fi represents a project fi represents a project fi

contribution4 & 5 represent a desired ou

maximising social bemargins resulting from

B

1

s:

of

ofp

as Yhg

x

rofic

fira

nanana

tcne

2

62

it axis:

it without grant coerating profit with set (resulting from = the redistributi

anced social benefotiation

is:

m a purely public t arising from privaial benefit from pr

t as a result of re-nnt financing

nced purely from nced from privatenced under a PPP

ome for the grant fit while limiting tgrant financing.

3

ntributiongrant financ grant financon of pure opit and “fair”

sector projecte sector pa

oject realisat

egotiation of

public sourc sources with arrangemen

provider in the impact on

4

D

ing and increaseding)erating profit (resultingprivate sector profit

trticipationion and grant financing

redistribution of pure

es public funds

t with a grant

heir objective of private sector profit

the Collectivity)

63

PART 4 INTEGRATING GRANT FINANCING AND PPPCHARACTERISTICS

PART 4 – Summary

• Grant financing has strengths and weaknesses which must be integrated into theproject.

• Grants should be used when required and matched to actual project needs• Grants can be delivered in a number of methods depending on required impacts• Grants have a strong conditionalities which may limit their application• The ability to use grants in a PPP depends on the ability to meet conditionalities or

provide sufficient safeguards to protect the Commission’s interests• The length of concession contracts is of particular interest to the Commission and

must correspond to the spirit of the Procurement Directives• This Part will address:

• Justifications for grant financing• European Commission financing characteristics• Length of concessions

1 INTRODUCTION

The section will address the specific issuesof integrating grant financing into a PPPpackage and more specifically how Grantobjectives and conditionalities can beaddressed.

The section will:

• Identify the pertinent characteristicsof grant financing and offer solutionson what to finance (the issue ofoptimal grant size has been treated inPart 3)

• Identify the characteristics andbenefits of PPP approaches and howthese can be exploited underEuropean Commission projects

2 JUSTIFYING GRANTFINANCING

• The impact of including grants inproject financing needs to becarefully evaluated against theirstrengths and weaknesses

• Grants can impact positively onproject viability but their use mustalso be justified in terms of real need

Grant financing has traditionally beenemployed by the public sector to realiseinfrastructure requirements which are notfinancially viable to other sources offinancing (due to risk, viability or scaleissues), or which present particular socialcharacteristics requiring them to remain inthe public domain. As a result grants mayhave different financing objectives andimplementation procedures to classicalcommercial sources which in turn createsperceived barriers to successfulcooperation between the two.

Due to the decreasing amounts of availablepublic finance there has been considerablepressure to integrate grants into more

64

commercially orientated forms offinancing and hence PPP relationships.These developments has been augmentedby the trend of privatisation in utilityservice provision and the increasedavailability and application of privatefinance. These developments have forceda review of how grants are best used andparticularly how the advantages of freefunds can best contribute to an overallfinancial package.

Deriving the maximum benefit from grantfinancing requires an identification of theirrelative strengths and weaknesses. Thefollowing discussion presents a number ofthese but it should be borne in mind that,as with Commission funds, grants usuallyhave conditionalities attached which donot necessarily relate to market (iefinancial) necessities and therefore such ananalysis must go wider than a simple cost– benefit analysis of financing instruments.

The most commonly cited advantage ofgrants is the ability to finance projectswhich would / could not otherwise befinanced by commercial sources alone.This is most often the case with ‘social’infrastructure which does not usuallyprovide sufficient financial viability forcommercial financing. This argument isvalid provided that the investment coststogether with operational and maintenancecosts are included and therefore that theinvestment is sustainable over its useful(financial) life and provides a real socialbenefit.

The use of grants is, arguably, mostvaluable in co-financing applicationswhere its objective is to increase thefinancial viability of a project to a levelallowing the application of commercialfinancing. This leveraging function entailsthe use of grants to reduce the overall costof the project or to enhance the value ofthe revenue stream. It is in this field thatgrants can be applied most intelligently toderive the maximum benefit and differentmethods of doing so are presented later.

The presence of grants, and by associationa public or international body, often alsoassists in reducing certain types of project

risks and therefore project cost. Grantscan be used directly to finance riskcoverage or used as a guaranteemechanism. However the presence of thegrant giving body and the willingness tocommit public funds, additionally providesthe private sector with a certain assuranceregarding the seriousness of the projectand sponsors.

The above two strengths are associatedwith the ‘leveraging’ effect of grantsmeaning that the availability of grants isusually conditional upon or enhances theavailability of co-financing or is afacilitator to identifying other sources offunding. In this case grants have animportant and complimentary role to playin PPPs as both tools aim to increase thevalue and volume of financing.

As stated above, conditionalities areusually attached to grants which are oftenwider than financial conditions. This canhave the advantage of accounting for orrealising socio-economic externalitiesparticularly if these impinge on projectviability and grants pay for them.

However grant financing also has anumber of weaknesses which must berecognised if they are to be successfullyintegrated into PPP’s. Most importantlygrants, in themselves, provide littleincentive to efficiency enhancementsusually associated with the pressures ofcommercial financing. Additionally theavailability of free funds can cause adegree of dependency and ‘crowding out’of alternative sources. This has been seenin the CC’s where a, natural, reaction hasbeen to focus on free grants and nationalfunds before considering other sources tothe point of delaying investments orrefusing to consider alternative financialsources.

A common complaint has also been thedifficulty and cost of implementing grantswhich are usually subject to more lengthyand bureaucratic procedures. This hasmade their integration into commercialfinancing packages difficult. However itmust be remembered that grants areusually public funds and therefore imply

65

stringent public accountabilityrequirements.

2.1 Determining the Form of GrantAssistance

Grant financing usually focuses on theprovision of services, supplies and worksfor the realisation of physicalinfrastructure. They therefore intervenedirectly on the capital costs side of aproject by reducing costs and / orenhancing revenue streams.

Grant financing can be used in a numberof different ways with the objective ofoptimising their impact. This objective isdriven in part by the fact that theavailability of grants is often limited, as isthe case of the Commission budget relativeto overall financing needs, and that grantsshould not be seen as an alternative toother sources of financing but rather as aconstituent part of a financing package.As a result project designers must ask thequestion ‘where, and in what form, will agrant have the most impact relative to theneeds of the project’ and ‘how muchfunding should the grant provide’ (this istreated in Part 3).

Alternative applications of grants include(but are not limited to) the following:

• Provision of regular, subsidy,payments to operational costs. Thiscan be particularly useful in the firstyears of operation when cashflow isstill developing but is not sufficient tocover all costs, particularly the cost ofcapital.

• Coverage of financial costs. This caninclude:• Reducing the cost of borrowing by

effectively ‘softening’ loans• Providing loan guarantees• Financing risk elements• Subsidising taxation payments• Covering exchange rate losses

• Subsidising revenue flows. This isparticularly useful if a policy objectiveis to keep user charges low. Howeverthis should not be considered a

permanent arrangement due to theintroduction of inefficiencies.

• Financing the public sector’scontribution in-kind.

• Assisting the financing of the publicsector’s financial incentives to theprivate sector.

Additionally the restrictions placed ongrant financing by the potential tocontravene State Aid rules as discussed inPart 3 chapter 4 must be integrated.

In all cases it is crucial to assess the realneed for grants and to optimise the grantamount relative to this. While grants havemany positive contributions, the negativeimpacts of grants on a project and publicfinancing should not be forgotten.

3 COMMISSIONFINANCINGCHARACTERISTICS

• Grant conditionalities influencethe entire project cycle but aredesigned primarily to safeguardthe public interest and guaranteethe correct use of funds

• Of particular concern is thedevelopment of PPPrelationships and procurementand hence at what stage theCommission becomes involved

The ISPA objectives and implementationprocedures are a good example of theconditionalities often attached to grants.Although focus is placed on technical andfinancial viability and sustainabilitycriteria, nevertheless grant recipients mustalso fulfill numerous wider conditions.The recognition of their implications iscrucial to the successful integration ofGrants into PPP’s.

ISPA has been designed as an instrumentto assist the development and realisation ofenvironmental and transport infrastructurewith the specific recognition that itoperates in economies which do not have

66

the financial means or investment climatesto finance them themselves. It should benoted however that it was not designed toundertake the financing of theseinvestments itself and indeed insists bothon co-financing and encourages thepossibility of using a diverse range offunding sources and mechanisms.

It is also important to note that theCommission is not directly a contractualpartner with the project beneficiary butinstead channels its funds through anational structure which is responsible forensuring that the conditions of financingare respected. There is however animportant difference with other EU fundsin that ISPA [currently] maintains ex antecontrol over implementation. This resultsin a situation in which while ISPA is notdirectly [contractually] related to theproject implementers it neverthelessexercises an enormous influence on thedesign and implementation of the project.While ISPA provides majority financingthis situation can be justified but would

become less tenable if ISPA grants presenta smaller minority of total funds.The main characteristics, over and abovethe technical and financial projectcharacteristics, defining ISPA financing(and hence potential cooperation withprivate sector partners) include the needfor a project to enter into a defined list offinancing objectives and priorities, theadoption of financing rules andCommission approved procurementprocedures and ex-ante control ofimplementation. Additionally theCommission has certain needs which mustbe met in all projects including;transparency in implementationparticularly with respect to procurement,early involvement, clear demonstration ofpublic benefit and value for moneyincluding that grants are not unfairlybenefiting the private sector and evidencethat European standards are adopted indesign criteria. The factors influencing aCommission grant to a PPP can besummarised in the following diagram.

The Fundamental Commission – PPP Interactions

OPEN MARKET &PUBLIC

PROCUREMENT

RESPECT OFSTATE AID

REGULATIONSPROTECTINGTHE PUBLICINTEREST

EFFICIENT GRANTALLOCATIONS

COMMISSION –PPP

INTERACTION

These influences derive from theprinciples of the European Union asenshrined in the Treaty and Acquis andfrom the objectives associated withCommission grant financing. They can besummarised as:

• Ensuring Open Market Access – thisincludes:• Fair and open participation of

parties receiving equality oftreatment

• Application of transparent publicprocurement procedures

• Application of the PublicProcurement Directives

• Adherence to the principles governingState Aid – this includes:• Ensuring there is no over-

compensation for servicesrendered

• Grants matched to real needs

• Protection of the public’s interest –this includes:• Ensuring PPPs and grants deliver

quality of service• Value for money must be

demonstrated• Public participation in the

oversight function should beincluded for sustainability

• Windfall profits to contractorsmust be avoided

• Re-negotiation of contracts shouldbe undertaken where required tore-balance contracts

• Implementation of PPP should notdiminish focus on andresponsibility for socialconsequences includingemployment and socio-economicdevelopment

• Defining the optimal level of grantfinancing – this includes:• Grants to be matched to real needs• Maximise use of limited funds• Do not distort market operation• Maximise leverage potential of

grants• PPP are not to be treated as an

accounting tool to move publicexpenditure ‘of balance sheet’.

3.1 Managing the Commission – PPPRelationship

PPP relationships function when theconcept of a partnership between parties isfully recognised. This requires both jointcooperation and an understanding andintegration of the aims and objectives ofall parties. As such if the characteristics ofone party are not addressed the partnershipis unlikely to proceed effectively. Thisinterdependency can be demonstrated by atripod whereby if one leg is removed thestructure collapses:

The PPP Relationship

The Project

Public Sector – aim torealise cost effectiveinfrastructure & publicservices

Commission – aim

to assist accession

67

Private Partner – aim torealise profit and operationalobjectives

68

This section will deal with the problematicof integrating Commission objectives andconditionalities into a PPP relationship(the following section will address thespecific issue of how to structure a grant).It is assumed that the problematic ofintegration lies in operating with theprivate sector as the Commission alreadyhas experience of joint or co-financingwith other IFI’s. Commission exposure tocooperation with the Private Sector willchange with the increasing pace ofprivatisation of utility operators and theneed to rely on private funding sources tocomplement limited public funds. As aresult the Commission is already facingthe existence of both local and foreignprivate operators. Although theirintervention is predominately in the formof service contracts, the Commission isnevertheless increasingly finding itself

included in simple PPP relationships. Thishas raised the issues of:

• how will or was the private partyselected and is this in-line with EUprocurement Directives andprocurement policy and henceacceptable

• what will be the impact of grants onthe private sector financial balance

• is the continued viability andsustainability of the investmentguaranteed

• will the EU’s standards be fulfilled• who will retain ownership of assets• is public benefit assured

The main issues can be summarized asfollows:

PPPRelationship

Issues RequiredActivities

Outcomes Risks

A PPP exists • selection process ofprivate party

• suitability &competency ofprivate party

• financial status ofparties

• what is to be grantfinanced

• financial & legalreview of PPPcontracts

• due diligence ofprivate party

• justify lack ofopen competition

• develop safeguardclauses under Art 8

• grant only forspecific targetedapplications

• clearly definedimpacts and outcomes

• effectivemonitoring

• renegotiation asrequired

• unfair competition• misuse of funds• generation of undue

profit• reduced grant impact• reduced social

benefit

A PPP is underpreparation and aGrant is requested

• as above• existence of open

and fair competition• expected private

sector profit margins

• as above• influence selection

process• develop penalty

clauses• match grant to

need

• harmonization ofPPP and grantapproaches

• competitivetendering

• grantconditionalities andmonitoring

• as above• loss of private

partner if no matchwith Commissionconditionalities

A grant has beenawarded and a PPP isentered into

• as above• potential conflict

with the Commissionconditionalities

• safeguarding publicinterest

• Invoke Art 8 ifrequired

• Renegotiate grant

• Revoke grant orrenegotiated grant

• Misuse of funds

• As above• Revocation of

grant• Project

unsustainable

A PPP is desiredregardless of Grantaward

• is grant necessary• can public benefit

be enhanced• are EU Directives

respected

• Cost benefitanalysis of project

• Assess publicbenefit

• Project impactnot maximized

• Over reliance onprivate sector

• Private sectorexploitation

• Reduce socialbenefit

• Lack ofcompetition

It should be noted that these issues areusually raised at the beginning of a projectbut also during project implementationparticularly with the current trend ofprivatisation. Methods must be developed

allowing the effective integration ofCommission grants into the PPP processfocusing particularly on changes tocontractual terms between parties, forISPA notably through the Financing

69

Memorandum; and changes to selectionand procurement procedures. Thisrequires recognition of the fact that as thecomplexity of PPP relationships increases,the Commission may find itself no longerin the position of majority financier andtherefore imposing its currentconditionalities may create inefficientbarriers to project realisation.Additionally, as discussed in the followingsection, the use of grants may also changein terms of what is financed therebyfurther removing the Commission fromphysical project implementation.

In order to define such methods, each ofthe 4 categories of PPP relationships(defined in Part 1) will be analysed interms of changes required to ensure:

• that no undue financial benefit accruesto the private sector as a result of grantfinancing

• that there are clear justifications forthe application of grants in particularwith respect to demonstrating valuefor money

• that there is transparency and fairnessin selection and procurementprocedures

• that the Commission is able to benefitfrom an early involvement in projectdesign and implementation

• that effective monitoring systems andprocedures are available

3.1.1 Traditional Public SectorProcurement

This basic type of PPP relationshipessentially involves service contracting forwell defined tasks with ownership ofassets and the management of financingremaining in public hands. As such thereshould be no conflict with current ISPAregulations and indeed the Commission isalready commonly involved in theserelationships.

Two issues remain outstanding:

• given the increased private sectorinterest in providing services in CC

markets it is questionable whethergreater attention should be paid to thesize of grants in relation to possiblecommercial financing which in turn isrelative to the debt capacity of theproject and the beneficiary. Attentionshould be placed to avoid crowdingout commercial / alternative financingsources. Related is the issue ofwhether grants could not also be usedto directly finance the application ofcommercial loans to projectimplementation.

• increasingly projects are faced withchanging circumstances in terms ofownership, privatisation, projectconditions. It is obviously theCommission’s interest to maintain thevalue of conditionalities it imposes.The Financing Memorandum, Article8, makes provision for changedcircumstances during the first 5 yearsof the project. With increasing privatesector participation it is howeverimportant to ensure that potentialbenefits from changed circumstancesare not lost.

3.1.2 BOT Projects

The pertinent feature of this group of PPPrelationships is that while ownership ofassets and responsibility for fundingmanagement remains with a public body,the assets have a private operator whoderives financial returns from theiroperation and hence (direct or indirect)charging of users. As a result the concernsof undue financial gain and value formoney are particularly relevant.

While the procurement process canessentially remain the same, the advantageof these relationships is gained through thegrouping of contracting, engineering andoperational functions to derive life cyclecost benefits. The real issue thereforebecomes one of how to designprocurement and particularly evaluation,procedures to ensure that all efficiencies ofthe BOT approach are captured. Part 2demonstrated that given the restrictions ofthe current ISPA procedures, some

70

flexibility can nevertheless be introducedeither by allowing variant solutions intenders and / or by placing more emphasison evaluation techniques which identifythe full range of costs and benefits.

This approach allows project beneficiaryto organise a tender which takes advantageof life cycle cost benefits resulting fromthe tender competition while alsorespecting the need for presenting fulltechnical specifications. This wouldassume that the Commission is satisfiedwith:

• Technical and financial performancecriteria

• Evaluation methodology and criteria• A minimum number of participants in

the tendering process• Adequate transparency and openness

in the procedures.

To further ensure that the project meetsimplementation criteria, the Commissionshould play an active role in thedevelopment of the evaluation criteria(which in itself is a useful analytical toolfor project design).

Given the time difference between grantapproval and project implementation, suchevaluation criteria will also better definethe need for grant financing. It is thereforerecommended that the results of theevaluation process be integrated into theFinancing Memorandum and the grantadjusted accordingly. This could providea mechanism to more accurately matchgrant contributions to actual need.

Concerns of undue financial gain toprivate parties can be addressed bystipulating the expected financial returnsto operations either by defining paymentsto contractors or setting maximum user feecharges. Indeed it is now commonpractice to limit user charges and build inincentives for additional profits to beraised through efficiency gains therebyreducing the burden on fees. This shouldbe supported by flexibility in the FM toreduce overall grant contributions should

financial projections prove better thaninitially forecasted.

The monitoring function is particularlyimportant in this relationship as the publicbody changes from being an operator to amanager and must therefore developadequate monitoring and oversightcapabilities to ensure that the contractordelivers against contract specification.The existence of these capabilities wouldallows the Commission to ensure its valuefor money, public benefit and monitoringrequirements. Two further functions canbe introduced. The Commission should bepresent at the evaluation of the privatecontractor to ensure the fairness of theprocedure against specifications.Additionally the current role of ISPAsupervising engineer could be transformedto an independent monitor of the BOTcontract until such time as the nationalmonitoring structures are able toeffectively adopt this function.

A number of further issues have beenraised as a result of recent experiences,these include:

• The need to investigate the ownershipstructure of all assets and whethertransfer of assets is envisaged in anypart of the infrastructure chain. This isimportant as ownership or leasingarrangements of one piece of relatedinfrastructure can cross – subsidies theoperations of a private concessionaireand can therefore impact on thefinancial conditions of the project

• An holistic approach needs to be takento the investigation of Municipalfinances both to analyse the overalldebt capacity, ensure that finances aresustainable and that the grant is notbeing used as a transfer payment

• The selection of privateconcessionaires prior to the ISPAproject remains an important issue.Justification for selection should beassisted if local authorities respect thespirit of EU Procurement Directivesand make specific reference to therequirements of the Treaty of Rome intheir selection. This is not always the

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case and the Commission may berequired to undertake a separateanalysis of the arrangements and thevalue for money provided by theconcessionaire. It is thereforeadvisable to include the Commissionat an early stage of any procedures if agrant is to be applied for.

3.1.3 DBFO and ConcessionAgreements

The comments relative to BOTrelationships are also relevant for DBFOand concessions as the public sectorentrusts operations to a private party butadditionally the financing responsibility isshared in that the private concessionairebrings an equity participation and / orprivately identified financing sources.Asset ownership however remains(ultimately) with the public sector. Giventhe high degree of interest in concessioncontracts in the Member States, theCommission is currently investigatingthese to ensure there are no possibilitiesfor infringing competition and marketrules. It’s Interpretative Communicationsets out its argumentation as discussed inPart 2.

A DBFO must demonstrate the ability tomake sufficient financial returns towarrant private financing in a qualifiedrisk environment. This raises the questionof the best role for grant financing beingeither in the realisation of infrastructure orthe realisation / facilitation / leveraging ofa financing package (see next section).

Even more so than with BOT schemes,there are efficiencies to be gained byensuring that funds are pooled andmanaged by the concessionaire. Becauseof the implied derogation of responsibilityan even greater degree of preparation isrequired with particular attention to thedefinition of performance criteria whichwill both ensure that conditionalities aremet but which do not stifle private sectorinitiatives to enhance efficiencies. Theanswer to this apparent contradiction maylie in the use of more effective evaluation

techniques, notably the application of apublic / financial comparator at projectdesign and procurement evaluation.

Additional issues include:

• Undue profit concerns can beaddressed by setting financial returnguidelines in the tender specificationsand limiting the extent of user feesalthough this may be difficult inconcession arrangements where theprivate party assumes majorityfinancing. As with BOT schemesopportunities for additional profitshould be included as incentives forefficiency gains.

• Value for money must be addressedthrough the minimum performancecriteria and standards to beimplemented.

• Transparency is addressed through theselection procedure, agreed uponbeforehand with the Commission andthrough the application of a publiccomparator to assess the bids.

• Effective monitoring systems areparticularly crucial as the public sectoris normally further removed fromoperations than under BOT schemes.The FM must include provisions forchanging the terms of the grant inrelation to the regular findings of themonitoring process. This ensures thatan additional performance guarantee isplaced on the private party.

�� As a general rule, Municipalitieswishing to integrate ISPA financinginto a proposed PPP are advised toinclude the Commission at theearliest possible stage to ensure thatconditionalities can be fullyintegrated with minimal disruption tothe project.

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4 LENGTH OFCONCESSIONS

• The length of contracts is ofmajor concern to theCommission in its desire toachieve open and faircompetition

An issue which impacts both on privatesector participation in projects and theCommission’s ability to approve PPParrangements is the duration of concessionagreements. Private operators willnaturally aim to maximise the length ofconcessions to safeguard their cashflowand the viability of their investment. TheCommission on the other hand aims topromote open competition and fair marketaccess, reduce the possibility ofmonopolies and ensure the public benefit.These objectives would suggest shorterconcession agreements.

These issues have been addressed recentlyby the Commission in its InterpretativeCommunication on Concessions UnderCommunity Law (2000/C 121/02) whichresults from the growth of concessionarrangements in the EU Member Statesand the potential for conflict with faircompetition / open market Directives.

A number of considerations can be takeninto account when designing concessionagreements both when the Commission isdirectly or indirectly involved, including:

• At the tender evaluation stage theremust firstly be a clear demonstrationof value for money from a concessionarrangement which should be apriority factor in approving it. It isargued that currently not enough effortis placed in identifying value formoney and where further efficiencygains or cost savings can be achieved.

• A common complaint of the privatesector concerns the perception offairness of concession tenders. Inother words is the tender fair enoughto warrant the investment indeveloping a tender. This can be

overcome, in part, by increased effortsto publicise the purpose andorganisation of tenders and to ensuregreater openness and transparency inprocedures. This should also includehighlighting cases of private sectorcorruption. It is therefore argued thata perception of fairness will creategreater interest in concession tendersand facilitate their organisation on amore regular basis.

• As a general rule the lower the amountof risk assumed by the private partyand the lower their financialcontribution, the shorter should be theconcession period.

• A common tool is to impose amaximum cap on user charges but tosupport the concessionaires cashflowwith subsidies (or shadow charges).While this does not promote theimplementation of effective tariffsystems or the polluter pays principleit does allow social considerations tobe integrated into the financialimplications of concession duration.

• Another common tool is to separatethe concessionaires revenue streambetween user charges and an incentivepayment relate to cost savings realisedthrough increases in operationalefficiency. This allows greaterjustification for longer concessionsbecause the concessionaire isincentivised to take a long termoperational approach to meet hisrevenue targets.

• Several countries, particularly in thesolid waste sector, have taken theapproach that where the former publicutility has been privatised and hasbeen awarded the first concession, theperiod of the first concession shouldbe very short (in the region of 5 yearsmaximum) to reflect the fact that therehas been an unfair competitiveadvantage and that the concessionaireprobably received the concession at avery low price. This gives sufficienttime for the private sector to analyse

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the concession and prepare for thenext tender and for the former publicutility to restructure itself sufficientlyto compete in a fair market.

These considerations recognise that theduration of concessions can be reducedprovided that sufficient knowledge isavailable on the ability to meet areasonable cashflow to the private sectorand that tender conditions are recognisedto be fair and open thereby stimulatingprivate sector interest.

Heavy commuter traffic crossing the river in Bratislavameans that the four existing bridges cannot adequatelycope. The new Košická Bridge is expected to meet 18%of traffic crossing the river, and ease congestion.On 10 September 2001, the European Investment Bank(EIB) and METRO Bratislava signed an agreement ona EUR 45 EIB loan for the new bridge. METRO is aspecial-purpose company owned by the City ofBratislava and the Slovak Republic.The loan agreement fixes the financing parameters andreduces uncertainties for all parties involved. Itcontains concrete commitments and may serve as aroadmap for the planners. The conditions in theagreement have furthermore facilitated the terms ofreference for studies and the formulation of tenderdocuments for the works themselves. Disbursement of the funds remains subject to thesuccessful completion of an ongoing EnvironmentalImpact Assessment, including identification ofmitigation measures, adequate public consultation andpublic tendering procedures in line with internationalstandards. The tender process has now started and,subject to completion of remaining actions on the EIA,works are expected to begin in Spring 2002.

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PART 5 PPP CONCEPTION, PLANNING & IMPLEMENTATION

PART 5 – Summary

• PPP project require careful design, effective support structures and a goodunderstanding between partners

• Previous Parts have discussed thematic issues. This Part presents a guide for thedevelopment of PPP projects with a grant financing element

• Particular focus is placed on addressing 8 key PPP issues, namely:o What are the objectives of grant financing and what is their best useo Selection of the most suitable PPP typeo Success and constraint factorso Ensuring open market access and competitiono Timing – including when the Commission should be involvedo Defining the right level of grant contributiono Protecting the public’s interesto Future requirements

• This Part will address:• Project identification• Project appraisal• Design & agreement• Procurement• Implementation

1 INTRODUCTION

Based on the previous thematic Parts,current Commission objectives andprocedures and best practice examples,this section presents a detailed guide for :• Deciding whether a PPP relationship is

feasible for a particular project• Selecting an appropriate PPP structure• Designing the PPP relationship• Implementing a PPP project

Such a guide, by necessity, includes manyaspects of the PPP process which are notdirectly relevant to the function andresponsibilities of all concerned parties /PPP practitioners. However these areincluded to ensure that, through theirdetailed knowledge, Commission staff areable to effectively stimulate the PPPprocess and influence the process, wherenecessary, to ensure the inclusion ofCommission objectives in the design andtherefore facilitate early approval. This is

also in-line with the Commission’s desireto be involved early on in the PPP processdevelopment and design.

It is important to stress that there is notone method to analyse PPP’s, rather thisguide will present a logical progressionbased on the project cycle with suggestedmethodologies to structure thought andanalysis for decision making. Again theCommission will, in most cases, not berequired to undertake detailed projectanalysis as this is normally theresponsibility of project sponsors orconsultants. They should however beaware of the different methodologies usedbehind presented information or tostimulate the required studies.

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2 PRACTICALCONSIDERATIONS

The development of a successful PPPrequires attention to a large variety ofissues. As PPP is a developing conceptthe first stage must be to create asupporting institutional structure able todevelop, guide and manage PPPs on behalfof the public sector. This will entail thedevelopment of supporting national andlocal legislation and regulations enablingPPPs, the development of institutionalcapabilities and importantly the creation ofeffective management and oversightstructures.

Practical issues associated with PPPdevelopment include the following:

• selection of the most suitable PPPstructure for the local setting andproject characteristics

• developing systems and structureswhich reduce complexity andwherever standardise the approach

• ensuring that the structures aremanageable both in terms of size andcomplexity

• ensuring that a full understanding ofthe timing is achieved

• the public sector should be realisticabout the skills and experience it has

to develop and implement PPP –integrate private sector expertise ifrequired

• PPPs must demonstrate additionalvalue for money over and abovetraditional procurement systems andmust be designed to maximise benefitsto all parties according to theirobjectives

• All parties must recognise andunderstand their objectives. Thepublic sector has wider concerns thanthe private sector who will not deliver“free gifts” through the PPP process

• Effective institutional and regulatorystructures must be developed tomanage and monitor PPPs. The Publicsector should be clear that somecontrol must be given to the privatesector

• The paying public should be integratedinto the monitoring / oversightfunction

• Trust must be established between allparties if a partnership is to be created

The following roadmap can be envisagedto the development of an effectiveenabling framework for PPPimplementation. This is followed by thecritical path to practical PPP developmentwhich forms the basis of this chapter.

Roadmap to Successful PPP Development

CAN PPP BEIMPLEMENTED

• What are the objectives• What are the cabailities

and capacities needed• Is there private sector

interest

ENSURE YOU ARE READYBEFORE STARTING

WHAT IS TO BEPROVIDED

• Whatinfrastructure –services are needed

• What are the risks– who takes them

• What are the costsand benefits

• What type of PPPis suitable

KEEP IT SIMPLEAND MATCHED TO

REAL NEEDS

WILL A PPPDELIVER VALUEFOR MONEY ANDTHE BEST USE OF

RESOURCES

ONLY USE A PPP IFREAL BENEFIT ISDEMONSTRATED

AND ACHIEVABLE

Guidelines For Successful Public – Private Partnerships

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Project Appraisal

PPP Project CycleTime Line

Stages

• Preparation ofNational and locallegislative andregulatorystructures

• SuitabilityAssessment

• Selection of PPPtype

• Define PPPstructure

• PPP D• Procu

proceand d

• AgreeNatioAuthofunde

Requirements

• Legal context• Institutional

capacity• National policy• Integration of

projects into EUharmonisation andpriority fundingstrategies

• Needs assessment• Risk allocation• PPP components• Budgeting• Expectations of a

PPP

• Integrinto d

• Procuproceselect

• Funderequir

• Finansocio-appra

• Desired gains• Obstacles and

constraints• Private sector

interest• True cost of

services• Cost and benefits

of PPP

Project Identification Design & APreliminary Stage Project Appraisal

EVALUATION

esremss sesigmenalritrs

atiesiremdurionrsemciaecoisal

gr

ignentelectionnnt of

ies and

• Tender• Evaluation• Negotiation• Contracting

• Construction• Operation• Monitoring• Contract

management• Evaluation

on of PPPgnent

e & design

entsl andnomic

• Open andtransparentprocess

• Detailedrecordings

• Effectiveimplmentationstructures

• Effective workingrelationship

eement Procurement Implementation

MONITORING

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3 IS A PPP FEASIBLE -IDENTIFICATION

• Effective PPP development requireseffective regulatory and strategicstructures to be in place

• The suitability of a PPP approach toproject realisation should firstly beassessed given the capability andcapacity of the public sector toimplement PPPs and derive benefit

• Suitability of PPP approach includeswhether there is sufficient privatesector interest and whether PPP is thebest delivery method

Prior to the decision process a number ofpreconditions must exist within national /local authorities as defined in thePreliminary Preparation Stage. Theseinclude:

• Identification of who is responsible forPPP and who has authority andresponsibility including for ultimatedecision making and regulation.

• Developing (whether in-house oraccessing externally) the necessaryexpertise to design, tender, evaluate,implement and monitor PPP.

• Establishing policies to guide decisionmaking including ensuring that thenecessary legal and regulatorystructures are in place to allow PPP.

• Establishing procedures that enablesthe effective evaluation and deliveryof PPP services.

• Developing a policy for PPP in currentand future services in order tointroduce a coherent planning processwhich encourages early identificationof PPP opportunities.

• Integrating projects into EUharmonisation and priority fundingstrategies.

The Commission has a valuable role toplay in this process particularly in aspects

of institutional strengthening and ensuringthe effective development of PPPs.

The objective of this phase is to assesswhether a PPP approach is suitable for aparticular project. The responsibility forthis assessment and final decision shouldlie with the National Authority as projectbeneficiary and project sponsor (forconvenience in this Part the term “NationalAuthority” is assumed to imply therelevant national body responsible foridentifying, developing and implementingPPPs whether this be on a national or locallevel). However the private sector willneed to be considered in that a basis forviable PPP relationships is that the privatesector finds an interest in the project.Additionally the Commission as apromoter of the PPP approach has avaluable role to play in encouraging thisassessment, which is still often neglectedin CC’s.

The potential for applying PPPs willreflect local authority policy, expectationsand openness to cooperating with theprivate sector. This in turn will determinethe criteria to be applied and to theirrespective weightings. This first stage willassess the desirability and suitability ofprocuring a project as a PPP. Essentialquestions that must be asked include:

• What are the potential obstacles andconstraints to PPP opportunities

• Would the private sector be interestedin the opportunities

• Is PPP the best method to deliver therequired services / infrastructure

3.1 Obstacles and Constraints

Potential PPPs can be hindered by severalconstraints and obstacles which must beconsidered by National Authorities. Themain ones include:

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FACTOR COMMENTLocal and nationalgovernment policy

• Does the policy environment favour PPP application andthe different components required for a PPP

• Is PPP consistent with other government policies ie landuse, social policies etc

Extent of legislativeauthority

• Is there a or sufficient legislative authority for enteringinto PPPs

• Is there sufficient legislation to support the managementand supervisory role of the public sector in a PPP

• Are there sufficient authorisations and what are the limitsto enter into debt agreements

Taxation framework • What is the tax status of a PPP• What are the possibilities to offer tax exemptions to

private partiesReporting and accountingrequirements

• How are PPPs treated in national authority accounts• What are public disclosure requirements

Financial issues • Can private sector financing compete with publicfinancing

• What is the effective cost of borrowing• Is the project financial self sufficient or can become so• What financial support mechanisms are available

Technical and organisationalissues

• Is there sufficient data to allow design and preparation• Can competitive tendering be assured• What quality control mechanisms exist

Political and socialconsiderations

• Is the national authority regarded as creditworthy• Is there strong political commitment to the PPP approach• Will a PPP be socially acceptable

Ability to integrate differentforms of funding

• Will a PPP be acceptable to existing sources of financingie Commission and what factors are likely to have to beintegrated into designs ie procurement rules

3.2 Private Sector Interest

The private sector will be interested insome projects more than others based notonly on purely financial considerations.National authorities have a major role toplay in adding to the value of a project.Generally the private sector will givepriority to projects which demonstrate:

• Sufficient demand• Revenue generating and development

potential• Strong viability• Strong political commitment• Meet internal development criteria

A crucial issue, which must be addressedby the national authority, is themanagement of risk. While considering

the principal that the party best able tomanage a risk should adopt it, it shouldalso be remembered that the degree of risktransfer to the private sector will determinethe extent of return required by the privatesector.

Various market factors will need to beanalysed including existing and futuredemand. Various techniques are used todetermine financial viability but at thisstage a simple cash flow analysis may besufficient to determine whether privateinterest is possible.

3.3 Is PPP the Best Delivery Method

Crucial to the selection process of a PPP iswhether it will provide value for money

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and above all additional value thantraditional public procurement methods.Two considerations are important:

• The national authority should establishthe true cost of providing a servicewith the purpose of benchmarking orshadow biding potential private costs

• The benefits and costs should besystematically analysed consideringboth quantifiable and non quantifiableitems

The factors determining value for moneywill change between projects. A numberof common methods for PPPs to generatebetter value for money exist including:

• Reduced life cycle costs• Better allocation of risk• Faster implementation• Improved service quality• Generation of additional revenue

Other project specific factors will usuallybe identified by considering the experienceof similar projects and quantifying projectspecific characteristics.

It should be noted that this, preliminary,value for money assessment can onlyprovide an understanding of the potentialvalue of using a PPP approach. Finalassessment can only be made at the end ofthe procurement process.

4 SELECTING ANAPPROPRIATE PPPSTRUCTURE – PROJECTAPPRAISAL

• Selection of a PPP requires assessmentof what deliverables are actuallyrequired

• Risk allocation will be affected by thetype of PPP selected

• A decision is required as to what partsof the project to include in a PPP

There is no one method for deciding whichtype of PPP approach will best serve theneeds of a project as this depends on the

project characteristics and publicperception of the need for PPP. It ishowever important that the selection of anappropriate PPP form be undertaken at anearly stage to facilitate effective projectdesign and achieve early buy-in of theparties.

Part 1 presented the main types of PPPrelationships with their respectiveadvantages and disadvantages. Selectionof the most appropriate type will require,as a minimum, consideration of thefollowing items.

4.1 Needs Assessment

The main focus in a needs assessment is todefine the service needs and to determinethe objectives to be achieved through thePPP. These objectives must bequantifiable, measurable and specific inorder to assist in analysis and the futurepreparation of the procurement process.For this purpose and for future monitoringafter the completion of the project, it isextremely important that the nationalauthority’s needs and objectives areclearly stated.

4.2 Risk Allocation

A major component of any PPP is riskallocation. Who will assume risks in thedelivery of a service or in the construction,operation and maintenance ofinfrastructure is often the central questionin a PPP. The national authority shouldattempt to reduce risks but it should alsobe aware that risks are inherent in mostprojects and servicing initiatives.

There is some debate as to how much riskshould be transferred from the public tothe private sector. Generally, the morerisk transferred to the private sectorpartner, the more financial reward theprivate partner will demand. Risk shouldbe allocated to the party who can bestassume it in the most cost effectivemanner.

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From the standpoint of the nationalauthority, there are several political risksthat need to be addressed. These include:

• loss of control in the provision ofinfrastructure or in the delivery of aservice

• potential reduced service quality forservice users

There are also a number of other risksinherent with infrastructure or servicedelivery projects that need to be analyzedand understood by both public andprivate sector partners. Examples includerisk associated with:

• fire, flood, etc.• changes in financing costs• reduced demand for service or failure of

demand to increase as projected• design errors• construction-related problems, including

failure to meet the schedule and/or qualityissues

• ownership transfer• environmental liability• non-compliance with regulations and permits,

or changes in regulations• value of assets at end of partnership, change

of ownership

• employment practices and changes in labourlegislation

• performance monitoring• technology issues (failure of existing

technology, inappropriate choice oftechnology)

• force majeure (that is, dealing with majorchange arising beyond the control of eitherparty, including acts of God, natural disasters,court orders, war)

• insolvency of private sector partner• inflation/currency strength

4.3 Components of Service Deliveryto Include in Public PrivatePartnerships

The national authority must decide whichcomponents of a servicing initiative arebest addressed through a PPP and whichare best kept in the public domaine.Consideration should be given to thefollowing questions:

• Project design - Can the privatesector bring more innovation andefficiency to the design process thanthe public sector? This is an importantconsideration. The objective shouldbe to develop designs that providevalue for money and lower overalllife-cycle costs of the project, not onlythe capital cost.

• Procurement and construction -Who can secure goods and servicesrequired for the project or servicinginitiative most quickly andcompetitively? Who is in the bestposition to construct the facility?

• Financing - Who can secure the mostcompetitive financing?

• Ownership - Who should own thefacility or service? Do the benefits ofpublic ownership outweigh thebenefits of private ownership?

• Operations and maintenance - Whois in the position to operate the servicecheaper and more efficiently? Will theinclusion of operations or maintenanceas part of the public privatepartnership enhance the originalobjectives of the national authority?

• Marketing - Who would do a betterjob promoting the use of the service?

Many of the components of servicedelivery are logically bundled together,such as design-construction, ownership-financing, and operations andmaintenance. It is important to considerbundling to determine whether combiningvarious components leads to greater valuefor money than providing individualcomponents. The choice of whichcomponents of service delivery should be

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provided will determine the form of PPPto be used. In selecting the preferred form,it is always important for the nationalauthority to confirm that the approach isconsistent with the overall national andlocal policies relating particularly to:

• ownership of services and facilities• impact on local government staff and

public sector employees• risk management• financial policies (e.g., debt)• economic development

4.4 Budget Refinement

Before a tender is issued, the nationalauthority needs to determine or refine theproject’s budget. In many cases, this iscompleted by determining what the projectwould cost if it were built strictly by thepublic sector. This process is used for anumber of reasons:

• It will determine if a PPP will actuallysave money for the public sector.Unless a proponent’s solution isinnovative and would result in asignificant improvement in service orcost savings, it is unlikely that anational authority will participate in aPPP arrangement.

• It will provide potential partners witha “benchmark” on which they need to

improve in their proposals. Again, ifthe proposal comes in at a higher costthan proposed by the nationalauthority, the expectation is that theprivate partner will provide animprovement in quality ofinfrastructure or service for users.

• It will determine if the nationalauthority can afford to be involved. Ifit cannot build a much-needed projecton its own, assistance from the privatesector may be required.

Costs are not the only consideration. Thenational authority must also benchmarkquality of service, technology andimplementation time. The preparation of a“shadow bid” will allow the nationalauthority to evaluate and compareproposals from potential private partnerson a fair and equitable basis. More oftenthan not, national authorities do not makea full accounting of the cost involved inproviding a service. Administration,overhead and maintenance costs can oftenbe separate budget items. These costs arethen not directly attributed to the servicesthat create them.

When the true or actual cost of aninfrastructure project or a service is beinganalyzed for benchmarking, the followingcomponents need to be examined in detail:

• Program-associated capital costs• Salaries and benefits of all employees

directly involved in the provision of theservice

• Allocation of the salaries and benefits paid toadministrators, accountants and humanresources employees who deal with thespecific service

• Telephone, fax, courier, Internet, computernetwork costs

• Training• Utilities

• office equipment• postal costs/courier expenses• cost of office supplies used• advertising and promotion costs• public relations costs• travel, meals and accommodation allowances• cost of outside consulting contracts

proportion of overhead incurred by theservice through space needed in the localgovernment building, use of a centralaccounting system, payroll, engineeringdepartment, procurement, clerical staff

In infrastructure projects, both capital andoperating costs must be considered indeveloping a benchmark cost.

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4.5 Basic Conditions Expected in aPartnership

The basic conditions expected in apartnership must be included in the futuretender document. They will form one ofthe building blocks on which bidders willbuild their submissions. The nationalauthority should consider the followingaspects of the proposed PPP and establishtheir requirements:

• preferred length of the partnership• ownership of assets during and after

the partnership• treatment of public employees who

may be displaced by the partnership• performance specifications, standards

and expectations, including the rolesand responsibilities of both partners

• how both partners’ performance willbe measured

• a definition of an “adequate rate ofreturn”

• profit and cost sharing provisions• performance bond requirements

It is important for the national authority tokeep in mind that these conditions are notset in stone. Rather, they are subject tochange in the negotiation process with thepreferred partner. These conditionsprovide an indication to prospectivepartners of what the national authority isseeking in the partnership arrangement.

5 PPP DESIGN &AGREEMENT

• PPP design must consider the needsof all parties and how best to achievedelivery

• Particular attention is required forthe design of procurementprocedures and contractmanagement / monitoring systems

The previous sections aimed to determinewhether a PPP is feasible and what form itshould take. The detailed design willfocus on what will be achieved and how.This discussion will be limited to the

design analysis relative to PPPrelationships and will not treat basicproject technical and financial design.Sequential steps will be considered,including:

• completion of project design relativeto PPP structure selected, including:o technical performance standardso financial assessment to ensure

viabilityo design of future contract forms

• selection and design of tenderingprocess, including:o type of tender processo tender procedureso evaluation procedureso negotiation procedureso contract award procedures

• implementation conditions, including:o monitoring and oversight

conditionso redress and re-negotiation

• integrating the Commission,including:o consultation and approval

requirements

The majority of these tasks should becompleted by the National Authorities.However it is considered crucial that theCommission be consulted and included inthe process as it is at this stage that thegrant eligibility criteria need to beintegrated into the project and that thefuture approval of projects is pre-determined.

5.1 Completion of Project Design

Project preparation must ensure that itaddresses the specific needs of PPPrelationships.

5.1.1 Technical Design

The main considerations to be integratedinclude:

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• is the private sector able to deliver thetechnical standards set for the project

• is the private sector in a position tointroduce technical innovations andimprovements for the project

• what tender process is best able toprovide the technical standards (seefollowing section on procurementprocess design)

• what are the minimum technicalstandards to be used for tenderevaluation and performancemonitoring

• how will performance monitoring beundertaken

• what are the operation andmaintenance arrangements includingupgrading and emergency serviceprovision

5.1.2 Financial Design

This component entails three headings:

• risk assessment and allocation• financial appraisal• socio-economic appraisal

5.1.2.1 Risk Assessment

Risk assessment and allocation is core to aPPP relationship. Each party will valuerisk differently with the private partyapplying higher discount rates andtherefore more weight on costs andbenefits. It is essential that there is acommon understanding on the scope andimplication of risks between the parties inorder to properly cost the project. This

section is based on the presentation of riskin Part 3. Risk assessment is based onthree steps:

Risk Identification

The principal risks will have already beenidentified during the preliminary stagesand can be categorized as described in Part3.

A common error in risk identification is toinadvertently duplicate risk. For exampleto risk of failure to deliver a service maynot be independent of other risks such asprocess design deficiency or of inadequateresourcing or skill levels. Risks may beinter-related and have a common result.

Risk Assessment

It is common to assume that all risks canbe or should be quantified. While thismay be possible it often requiresconsiderable effort which does notnecessarily produce results with a highdegree of certainty nor is in proportionwith the risk or size of a project. As aresult it is recommended to undertake apreliminary qualitative risk assessment.

This enables the potential significance orimpact of risk to be considered andprioritized. This should be conducted intwo stages:• assessment of the potential impact of a

risk – this is a subjective measure ofhow sensitive the project is to aparticular risk, classified (for example)into high, medium and low impact asdemonstrated in the following table:

Assessment of the Potential Impact of Risk

Scale of Impact Description Value (% of Project Cost)High Critical to continued service > 50%Medium Serious impact 5% - 50%Low Small impact < 5%

• assessment of the probability of occurrence – this is a subjective indication of how likely the risk isto occur, classified, for example, into high, medium and low probability as demonstrated in thefollowing table:

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Assessment of the Probability of Occurrence

Probability Description Value (% of Project Cost)High Likely to occur > 10%Medium Occasionally occurs 1% - 10%Low Unlikely but possible < 1%

The probability and impact of each risk can be combines in a single matrix to provide a measure of thequalitative value of each risk as follows:

Assessment of the Significance of Risk

ProbabilityH M L

H 1 1 2M 1 2 3

Impa

ct

L 2 3 3

1 = greatest significance / impact

This method allows a qualitative assessment and indication of the most important risks that are likely torequire quantification

Risk quantification will express the potential impact of a risk in financial terms and will allow theidentification of a cost effective risk allocation and management strategy. This is also required topermit the functioning of comparative analysis during the evaluation process. As discussed above thetime and effort devoted to risk quantification should reflect:

• project size and complexity• the number of significant project risks• the need for a financial comparator• the type of procurement process

A number of methods exist to quantify risk involving increasingly rigorous analysis as presented in thefollowing table:

Risk Quantification Approaches

Method of RiskQuantification

Method ofAnalysis

Suitable Projects

Range of values forselected risk factors(eg min and maxdemand)

• sensitivityanalysis forindividual risks

• scenarioanalysis forcombinations ofrisk

• projects where there is no data to facilitate more detailedanalysis

• projects for which there is no flexibility in how risks aremanaged

• projects which will go ahead regardless of the risk analysis

Point estimates • root squaremethods

• projects for which rough estimates of the probability andvalue of risk is known and risks are independent andfollow normal distributions

Consider full range ofoutcomes

• Monte Carloanalysis

• Projects for which there is a reasonable understanding ofthe likely probability and value of risk

• Monte Carlo analysis is the most suitable method where arational cost contingency needs to be estimated, where thelikelihood of various outcomes needs to be understood,where several ways of managing risk need to be comparedor where risks combine in complex ways

• It is recommended for large complex projects

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Risk Allocation

The guiding principle of risk allocation isthat risk should be allocated to the partybest able to manage it. However, theremay be cases where the price charged by aContractor for taking on a exceeds thevalue to the Contracting Authority oftransferring the risk. Cost effectiveallocation of risk between a ContractingAuthority and the Contractor will result inlower costs of construction and operationfor infrastructure projects, and will provideenhanced value for money when comparedto traditional procurement. However, ifrisks are transferred inappropriately to theappointed Contractor, value for moneywill decline as the premium demanded bythe Contractor for managing the risk willoutweigh the benefit to the ContractingAuthority.

At the design stage, the price charged by aContractor for taking on a risk will not beknown. The risk assessment shouldtherefore focus on determining, inprinciple, whether the Contracting

Authority or the Contractor is best able tomanage the risk, or whether the risk shouldbe shared. In considering the mostappropriate allocation of risk, thefollowing issues should be taken intoaccount:

• the capacity of the ContractingAuthority to manage the risk and itsability to control it;

• the capacity of private sectorcontractors to manage the risk andtheir ability to control it; and

• the preferred allocation of risk, givenany public interest issues.

The preliminary allocation of risk shouldreflect the specific characteristics of theproject and the underlying strengths andcapacities of each party. The degree ofrisk transfer to the private sector will varyon a project by project basis and will beinformed by the precedent reviews andanalysis and the selected PPP relationshipas demonstrated by the following table.

Typical Allocation of Risk

Risk Category Allocation CommentPlanning Risk May be retained by Contracting

Authority for pilot projects. However, theremay be occasions when transfer in whole orpart is appropriate or unavoidable

Design andConstruction Risk

Transferred to Contractor throughpayment mechanism

Contractor bears risk of cost and timeoverruns. Contracting Authority retainsrisk of changes to Output Specification

Operating Risk Transferred to Contractor under DBO, DBFOand Concession contracts through paymentmechanism.

Deductions are made from payments forfailure to meet service requirements

Demand Risk Often retained by Contracting Authority orshared. May be transferred under DBOF andConcession contracts where the Contractor cancontrol demand andforecast revenues with reasonablecertainty.

An example of demand risk transfer iswhen the Contractor recovers its coststhrough user charges (e.g. road tolls).

Residual ValueRisk

Retained under DB and DBO contracts Maybe transferred under DBFO and Concessioncontracts to ensure fitness for purposethroughout the duration of the contract

Contractor carries residual value risk ifasset not automatically transferred toContracting Authority at end of contract

Other FinancialRisk

Other financial risk Often transferred (orshared) under DBFO and Concessioncontracts

An indexation mechanism may be used

Legislative Risk Legislative risk Often retained (or shared).Government is often best placed to controlregulatory and legislative risks

Key issue is whether the regulatory orlegislative change is discriminatory inrespect of the specific project or sector

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One of the areas in which risk transfer ismost problematic is statutory process. Asa general rule, the Contracting Authority isbest placed to manage the statutoryprocess by virtue of its legislative basis,experience and resources. In general,private sector parties internationally haveindicated an unwillingness to acceptplanning risk, especially in the roadssector, identifying the followingdifficulties:

• a lack of familiarity with the statutoryprocesses and procedures;

• uncertainty regarding the cost andtimescale of such processes and theirability to manage this;

• the reluctance of funders to finance thecosts and risks associated with thestatutory process; and

• the need for price adjustment and/ornegotiation to cater for changes arisingduring the statutory process.

Notwithstanding these reservations, therewill be occasions when transfer ofstatutory process in whole or in part willbe appropriate or unavoidable.

5.1.2.2 Financial Appraisal

The active involvement of the privatesector markedly changes the importanceand nature of financial appraisal, relativeto schemes that are undertaken solely inthe public sector. While both public andprivate sectors have reason to beconcerned about the outcome of thefinancial assessment, their perspectiveswill usually be different. This will causethem to focus on different aspects of theprocess, giving more emphasis to someand less to others and possibly usingdifferent model parameters. The key areasof concern for both groups may besummarised as:

• Financial viability.• Distribution of revenues.• Assessment of risk.

While the financial viability is clearly amajor concern for private sector

participants in a PPP, it is also significantfor the public perspective. If the project isfinancially non-viable and has to beabandoned or significantly amended,attaining the social objectives of the publicsector may be compromised. The winnersand losers in financial terms are also anissue for both sectors. Significantredistribution of financial wealth may beseen as socially unacceptable, or mayprompt active lobbying to amend orabandon a proposal. Each of these is apublic as well as a private concern, forexample, if a road PPP may seriouslyundermine the financial health of railwayoperators. Finally, the involvement of theprivate sector boosts substantially theimportance of understanding andresponding to the risk profile of a project,but again is not solely a private sectorconcern.

Financial Viability

The principals of financial analysis arewell known and fully integrated into thegrant application process so will not bereproduced here. It must be stressed thatthe financial viability of a project must beclearly demonstrable to potential investorsand all lending organisations. The projectmust have clear and defined revenues thatwill be sufficient to service principal andinterest payments on the project debt overthe term of the loans and to provide areturn on equity which is commensuratewith development and long term projectrisk taken by equity investors. It istherefore important to realise that thefinancial plan may have a greater impacton the terms of a project than thephysical design or construction costs.

PPPs are often characterized by morecomplicated financial engineering in thesourcing and combination of differentfinancing types. In structuring a financialloan package a number of aspects could betaken into consideration to reduce (future)financial uncertainties as much as possible.These include:

• Maximisation of long term debt ;• Maximisation of fixed rate financing;

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• Minimisation of refinancing risk.

Distribution of Revenues

Another very important further dimensionthat is of concern to many private sectorcompanies is the timing of the cash flowsderiving from a project. While this is inpart a reflection of aversion to risk it isalso a legitimate additional concern that,where a project is very large relative to thefinancial base of the company undertakingit, the company may literally run out ofmoney before the inward cash flows fromthe project start to materialise. Thecompany’s capacity to borrow may not beenough to bridge the gap betweenexpenditure and revenue generation.

In project financing it is the future cashflow that is the basis for raising privatefinance. Project financial appraisalshould therefore be thought of as acontinuous process that takes placethroughout the early stages of a projectright from the emergence of the need forthe project and up to the point when thedecision to sanction or abandon the projectis made.

While it should be stressed that it wouldnot normally be the public sector’sresponsibility to undertake this continuousmonitoring of a project’s financialviability, it is in the public sector’s interestto ensure that private sector partners aredoing so and to create an environment inwhich, should potential problems beidentified, early discussion and resolutioncan take place. At the early stages of aproject it is important that the significantrisks are identified and their effect on theproject considered. Thus goodmanagement of a project by the privatesector should:

• achieve the triple constraints ofspecification, budget and schedule;

• be able to manage the liquidity (cashflow) of a project, and not consideronly long-term profitability;

• involved in a continuous assessment ofproject risks;

• perform continuous monitoring ofproject’s financial viability, involvingan interactive process with the publicsector.

Assessment of Risk

Risk assessment was presented in theprevious section. In this section only theissues necessary for the financial analysisare highlighted. Generally whenconsidering an investment underconditions of risk, investors will require ahigher rate of return to compensate themfor taking on that risk. In financialappraisal terms this is undertaken by usinga risk-adjusted rate which adds a riskpremium on the discount rate that wouldbe required to take on the investment withzero risk to take account of the riskiness ofthe investment under consideration.

Practical methods for incorporating risksin the financial investment analysis of PPPprojects include the following:

• reducing the minimum paybackperiod;

• raising the required rate of return ofthe project investment;

• adjusting cash flows for the cost ofrisk reduction; and

• adjusting cash flows to reflect thespecific impact of a particular risk.

The allocation of residual risk in PPPprojects is primarily the role of thepromoter. In choosing the appropriatepolicy for risk transfer the promoter mustconsider the basic rules for risk allocationas already presented previously. An issuecould arise that needs to be treated withcaution: if risks are likely to occur in theearly years of the project, then theremaining period is relative “risk free”.Thus, it must be appropriate to reduce therisk premium paid to the private sector(either as Government finance or throughuser charges), to avoid accumulation ofunnecessary profit by the private sector. Asolution to this could be the introductionof two types of discount rates: one for the“risk period” and the other (being lower)for the “risk-free period”.

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Care also should be exercised by thepublic sector not to undertake risks thatwill be ultimately a burden to the taxpayerin real terms. Hence, it might be moreappropriate for the public sector to foregosome revenues than make actual payments.On the other hand, the charging of the userby the private sector to cover possiblerisks, must be done in such a manner toobserve the marginal cost principle forpricing, and of course to avoid the possiblenon-accepted loss of forecasted trafficvolumes, caused by increases in usercharges above the level the user is willingto pay. There are mechanisms tosafeguard this: in most cases, in theagreements the public sector sets upperlimits for the user charges (tools), duringthe period of concession and presentsdetailed guidelines how they will beupdated in the future.

5.1.3 Socio-Economic Appraisal

It is not the purpose of this section todiscuss socio-economic analysis which iswell documented and included in the ISPAapplication process. Instead this sectionwill highlight several issues which arisethrough PPP relationships and which needto be incorporated into project designparticularly if grant financing ismaintained. These factors include:

• equity considerations relative to thechoice of PPP schemes. A project isusually considered desirable from asocietal perspective if aggregatedbenefits exceed total costs. Thisshould include an element of howbenefits and costs are distributed oversociety groups. Of particular concernis the implementation of user chargesboth in terms of their level and howthey are charged. In this respect theCommission has a particular concernthat the introduction of private sectorparticipation does not lead to undueprofit nor to unjustifiable applicationof charges

• equity consideration relative to theprovision of services. Transport and

environmental projects will ofteninclude an element of ‘social serviceprovision’ in the sense that theyprovide services to non profitableareas. PPP arrangements must ensureservice coverage is maintained andthat an equitable balance is achievedbetween profitable services and socialservice provision

Socio-economic appraisal should beundertaken from the perspective that theCommission’s main objective is to protectand enhance public benefit. Thereforesocio-economic appraisal needs to clearlydefine what impact the grant will have,how it can be measured and verified. Italso needs to identify the risks andinstitutional weaknesses which may hinderthe maximization of public benefit therebyfacilitating the development of effectivemonitoring systems and public oversight /“watchdog” institutions to work with theprivate sector.

5.2 Contract Form Design

Part 2 presents the issues surroundingcontractual arrangements and contractforms. At this stage of the PPP process itis crucial to ensure that a draft contractform is prepared and is ready to beintegrated into the following design of thetender process.

In particular attention needs to be paid tothe following issues:

• the draft contract must address andincorporate all the design featuresprepared in the preceding sections as itwill constitute a part of tender process

• the draft contract must include theconditions of grants both in terms ofconditionalities attached to the grantand the procedures under which thegrant will be allocated and disbursed

With respect to the last point it is crucialthat a draft contract is approved by theCommission before the tender process asproject approval will be dependant uponCommission approval of contracts. This is

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particularly the case with PPParrangements going beyond simple serviceand works provision. This issue is furtherelaborated on in the following section.

5.3 Selection and Design ofProcurement Process

This section will describe the differentprocurement systems available to a PPPrelationship. It should be noted that at thisstage the Commission must be fullyintegrated not only because of theprocurement conditionalities attached to aCommission grant but also in an effort tocomply with EU Procurement Directives.

As set out in Part 2 it is anticipated thatthere is scope for conflict between thecurrent Commission procurementregulations and achieving the maximumbenefit from a PPP relationship. Howeverit should be noted that the Commissionregulations do not absolutely preclude theadoption of alternative procurementsystems provided that certain minimumconditions are maintained and that theCommission is involved at an early stageof the design and decision making process.This section applies to procurementrelative to an ISPA grant. In the case ofprocurement by the national / localauthority in advance of an ISPA grant (butrelated to the ISPA project) it isrecommended that the Commissionstrongly recommends the adoption ofeither EU Procurement Directives or as aminimum the conditions of theTreaty ofRome. This is to ensure that there is noscope for a conflict of interest with anISPA grant.

Part 2 identifies two types of procurementprocesses currently allowed in the pre-accession phase. suited to different typesof PPP relationships. While the Open andRestricted Procedures do not pose anyparticular difficulties for basic PPPsinvolving only private sector service,works or supply procurement, they may belimiting for more complex approaches. Asa result Part 2 proposed several methods tointroduce a greater degree of flexibility to

allow the private sector to present optionsbased essentially on reinforcing evaluationmethodology and making use of variantsolutions.

In selecting the appropriate process theNational Authority will have regard for anumber of considerations including:

• The scope and nature of the project• The degree of risk transfer proposed• The degree of precedent available to

support the choice• The role and influence of third party

funders (in particular the Commission)

In BOT type arrangements there is bothample precedent for successful restrictedprocurement and there is usually sufficientproject definition in technical scope andcosting.

In the case of more complex DBFO typeof concessions, the national authority willnormally seek maximum / optimal risktransfer. Use of the restricted proceduremay lead to the pricing of projects basedon private sector costs of equity and debtwithout sufficient scope for innovation andan efficient allocation of risk to the privatesector. The argumentation for using moresophisticated evaluation techniques and /or variant solutions includes:

• Ability to secure the best value formoney.

• Ability to optimize risk allocation• Encouragement of innovative

solutions.• Generally lower tender or bid costs.

The key to tender process selection lies inthe degree to which it is possible to definethe project. The greater the definition ofthe project, the greater the case for using arestricted process.

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6 IMPLEMENTATIONCONDITIONS

• A degree of flexibility is requiredthroughout implementationcorresponding to the differentneeds of all parties

• However project structures needto be sufficiently robust to alloweffective monitoring and toensure that the public interest isguaranteed

As discussed in Part 4 the Commissionthrough its principle of ex-ante control,has a major direct and indirect role to playin the implementation of projects bothfrom the perspective of implementationmonitoring and in creating the requiredinstitutional structures to facilitateimplementation. Indeed effectiveimplementation structures are a pre-condition to the allocation of grants.

PPP relationships will require changes tothe implementation systems associatedwith classical grant financed projects.This is primarily because the role andresponsibilities of the parties change withincreased private sector involvement. Themost important of these is thetransformation of the public sector rolefrom operator to a management andregulatory function. This requires both thedevelopment of effective regulatorysystems and monitoring practices. Thisentails a strengthening of nationallegislative, regulatory and institutionalcapacities to provide an effectiveframework for PPPs.

It is further suggested that the role of ISPAConsultant Engineer be developed toestablish an independent monitoringfunction allowing the monitoring ofprojects beyond the current constructionphase. Indeed as PPP relationshipsbecome more complex the value formoney and correct use of grants issuesextend in duration to include operationsover the period of the concession.Therefore in order to facilitate theapproval of the Commission for grantfinancing it is proposed to extend the

period of active monitoring to the life ofthe concession (if feasible) and toassociate non-compliance or nonperformance issues with a disbursement offunds (ie approval of the interim payment)or indeed repayment of the grant. In thisway the Commission maintains effectivecontrol over the use of grant funds butlinks this control to the function which thenational authorities must undertake.

The remainder of this section is dedicatedto practical contract and performancemanagement issues.

6.1 Contract Management

The implementation of any public sectorinfrastructure project requires a significantlevel of proactive management of theinterface between the National Authorityand the Contractor in order to ensure thatthe service is provided in accordance withthe precise requirements set out in theProject Agreement and OutputSpecification. In a conventional project,project management covers the proceduresand organization needed to take a projectthrough the planning, design, procurementand construction stages before handing itover to operational staff to deliver theservice. In the context of a PPP project,two separate management processes mustbe considered:

• Project management - dealing with thedevelopment of a project up to andincluding award of contract, generallyalong the lines of conventional projectmanagement, but with additionalexpertise reflecting the changed natureof the process; and

• Contract management - describing theprocedures and organisation requiredto ensure that the appropriate serviceis provided from the date of contractaward to the end of the operatingperiod.

In a PPP project that involves a transfer ofoperating activity to the private sector,contract management extends throughout

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the term of the contract. The overallobjective of contract management is toensure the actual delivery of a service thatrepresents value for money and typicalcontract management responsibilitiesinclude the ongoing monitoring ofperformance, the management of change,the authorisation of payments and themaintenance of records and reporting.Contract management responsibilities mayalso include the discharge of statutoryduties in relation to reporting to NationalAuthorities.

6.1.1 Performance Management

Performance management forms part ofthe contract management function andrelates to the monitoring of servicedelivery and the assessment ofperformance relative to the standardsdefined in the Output Specification. Sincepayment for services will be based uponthe achievement of specific objectives, thisis a critical matter that will determinewhether or not the Contractor is incompliance with the contract terms andtherefore the amount of payment due.

The transfer of risk in the ProjectAgreement must be confirmed on anongoing basis by the performancemonitoring carried out. This will ensurethat the level of service required by theOutput Specification is delivered and if acompliance failure is identified, this willbe reflected both in payment penalties andin an obligation on the Contractor toremedy the default. It follows that anyfailure to implement effective performancemonitoring arrangements may result inperformance risk reverting to theContracting Authority with a consequent

loss of value for money. Effectiveperformance monitoring and managementof the risk transfer element of the contractis critical from the point of view of servicedelivery and value for money. Wheremonitoring shows under-performance bythe Contractor, the contract manager mustensure that the obligations of theContractor under the terms of the ProjectAgreement are properly enforced. Theonus on Contracting Authorities in relationto the effective management of PPPcontracts will be critical to ensuringsatisfactory long-term service delivery andrisk transfer. Performance monitoring willinvolve a variety of significant tasks.These tasks are usually set out in theProject Agreement and are likely toinclude:

• the review and analysis ofmeasurements of specified parameterscarried out by the Contractor relatingto load conditions and the performanceof a facility;

• the review of quality control andquality assurance procedures to ensurethat quality systems are in place andeffective;

• the independent monitoring by theContracting Authority to verify thatthe monitoring undertaken by theContractor is accurate and valid; and

• the independent calibration ofmeasurement equipment used in thedelivery of the service to verify itsaccuracy.

Key issues arising in relation to thecontract and performance management ofPPP projects will include:

• the identification of the skills and expertise required to effectively manage the implementation of a PPPproject and to ensure that these resources are put in place early in the process;

• the ability to ensure effective and non-reversible transfer of risk;• the impact on Contracting Authorities of PPP projects in terms of the availability and long-term retention of

the expertise and resources needed for contract management;• the procedures for reviewing PPP projects, especially in the pilot phase, with a view to learning lessons as

experience is gained; and• the nature of the ongoing relationship between the Contracting Authority and the project funders including the

Commission. In a project involving private finance the funders will also have a long term role in ensuringthat the service is delivered satisfactorily and that the payment stream is secure.

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6.1.2 Principles of Contract andPerformance Management

The implementation of public sectorinfrastructure projects using the PPPapproach is intended to deliver costeffective, reliable and timely services atagreed prices and to agreed qualitystandards, consistent with legal standards,financial probity and managementaccountability. The success of this processwill be significantly aided by themaintenance of a good relationshipbetween the Contracting Authority and theContractor. The expertise developed bythe Contractor during the procurementstage should be maintained throughimplementation and operation in order toensure consistency of approach and adetailed understanding of the process. Indoing so, care must be taken with regard tothe items set out below:

• contract management structures shouldbe established during the procurementstage in parallel with the projectmanagement function in order toensure a full understanding of how thespecifics of the service and themonitoring systems are reflected in thecontract documentation.

• personnel will require a detailedknowledge of contract documentationin order to provide for continuity inachieving effective service delivery.

At the outset, it will be necessary for theContracting Authority to establish realisticfinancial and resource budgets to cover thecosts relating to contract management andperformance monitoring. Whilearrangements can be made to have thesecosts covered by the Contractor, it isusually considered more satisfactory thateach party bear its own costs in order toavoid any possible conflict of interest. Inaddition, while the PPP approach isdesigned to allocate risk to the Contractor,competent contract management isnecessary to ensure that this risk transfer iseffective.

6.1.3 Project Agreement

The contract management andperformance monitoring duties associatedwith a PPP project will be derivedsubstantially from the terms of the ProjectAgreement. The Project Agreement willinclude specific provisions in relation to:

• Monitoring - provisions on contractmanagement covering the monitoringto be undertaken by the ContractingAuthority and the financialconsequences of under-performance.

• Risk management - management ofthe risks to be retained by theContracting Authority or which fall tothe Contracting Authority formanagement due to substandardservice delivery by the Contractor.

• Change management - provisions inrelation to change management,covering items such as technicaldevelopments, changes in law,changes in volumes and changes inContracting Authority requirements.

• Under-performance - a ContractingAuthority may have to enhance thescale, nature and frequency of itsmanagement and monitoringcapability where there is continuedunder-performance by a Contractor.

• Interdependence - some projects maybe dependent on delivery of certainenabling services by the ContractingAuthority, for example, the operationof water or drainage networks, thedelivery of waste, or trafficmanagement in a roads network. Thismay require organisational interfaces,information flows and the meeting ofkey milestone dates or objectives, tobe included in the Project Agreement.

Over time, the under resourcing of thecontract management function can lead tothe inadvertent re-acceptance of risks thathave been allocated to a Contractorthrough the earlier procurement process.In this way, the Contracting Authority mayend up with liabilities in respect of assetcondition or service performance notpreviously expected or envisaged. Majordifficulties can arise in relation to the

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satisfactory performance of a Contractorunder a PPP project where the obligationsof the Contractor are not rigorouslypoliced and insisted upon by theContracting Authority from the outset.Typical problems that can arise include:

• a failure to ensure quality control ofconstruction may lead to asset defectsin the long term;

• a failure to maintain plant andequipment may similarly result inincreased liabilities for the ContractingAuthority at the end of the contract;

• a failure to manage the interfacebetween the Contracting Authority andthe Contractor may lead to the blurringof responsibilities or even the transferof performance liability. This mightoccur, for example, if poormanagement of the network causedunacceptable load conditions at asewage treatment works;

• a failure to implement independentmonitoring or equipment calibrationmay result in a failure to detectunsatisfactory performance or anoverpayment for service delivery; and

• a failure to resolve issues or disputespromptly may lead to more seriousconflict and a loss of control of thecontract.

6.1.4 Relationship Management

In practice a flexible but controlled rangeof contacts may be required to manageeffectively the day to day delivery of therequired services. It will be important toensure that such arrangements are properlymanaged so as not to confuse therespective contractual responsibilities ofeach party. Underlying thesearrangements will be specific provisions inthe Project Agreement to be administeredby the contract management team,covering all aspects of service delivery andpayment. These will include:

• Output Specifications - establishingthe required levels of performance andthe associated informationrequirements for judging service

performance, all of which must becapable of objective measurement;

• Payment arrangements - enforcingand monitoring the paymentmechanism, including the conditionsrequired for the commencement ofpayment and the basis for ongoingcertification (frequency, measurementbasis, variations, and specificconditions);

• Financial performance - reviewingthe ongoing financial performance andposition of the Contractor against theforecasts set out in the financial modeland enforcing and monitoring anyarrangements for revenue sharing orprofit capping;

• Monitoring arrangements - involvingthe defined monitoring obligations ofthe Contracting Authority and theContractor, the provision of facilitiesfor monitoring by the ContractingAuthority, and the procedures fordetermining compliance;

• Security and insurance - monitoringcompliance with specific conditions inrelation to insurance policies,indemnities, tax clearancecertification, safety procedures andsystems;

• Management of interactions -managing all of the interfaces betweenthe operations of the Contractor andthose of the Contracting Authority.These interfaces may cover networkmanagement issues, the effects of newplanning and development and theregulation of existing development(for example, waste collection anddischarge licenses);

• Dispute resolution - providingmechanisms for problem solving anddispute resolution where and whenappropriate;

• Compliance - setting out thearrangements for dealing with noncompliance by the Contractor

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including enhanced monitoring,proposals for rectification andpayment deductions;

• Contingency for default -arrangements to cover default on thepart of the Contractor or itssubcontractors where the continueddelivery of the service is at risk,including step-in rights;

• Change management - implementingand managing the procedures andprotocols for dealing with changingrequirements over the life of theproject; and

• End of contract conditions - dealingwith maintenance, the condition of theassets at the expiry of the contractperiod and the ability of theContracting Authority to re-tender forthe provision of the service.

6.1.5 Quality Monitoring

In a conventional infrastructure project,monitoring involves direct sampling,analysis and compliance determination bythe Contracting Authority. In a PPPproject, these quality managementprocesses will be performed differently inthat the Contractor will be expected toprovide for performance monitoring andquality management as part of its role.The Contracting Authority will then beentitled to independently verify theinformation produced by these systems asconsidered necessary.

The role of the Contracting Authority willtherefore be to audit these systems, withplanned and random spot checks, to ensurethat performance is being measured andreported reliably, accurately andcomprehensively. Similarly, detailedapproval of drawings or other designarrangements may not always be regardedas essential provided the quality assurancesystem established by the Contractor isdemonstrated to be effective.Nevertheless, it is in the interest of theContracting Authority to ensure a robust

and high quality facility to minimise therisk of operational problems later.

Equally, the Contracting Authority will notnormally interfere in relations between theContractor and its subcontractors.However, the Contracting Authority willalso wish to be satisfied that theContractor retains proper control of theproject and that its contract managementarrangements are generally robust. Forthese reasons, it is usual to retain atechnical adviser during the constructionstage to monitor and confirm that theContractor is complying with the OutputSpecification and to review the testing andcommissioning process. The level ofresources applied to this task will dependupon the complexity of each individualproject but will always be less than in aconventional project. Where private sectorfinance is involved, the contract managerwill also need to liaise closely with therepresentatives of the funders, includingsharing of information and joint presenceat meetings with the Contractor. It isimportant to note that both the ContractingAuthority and the funders have a commoninterest in the quality of the asset and therequired standard of service commencingon time.

6.1.6 Dispute Resolution Procedures

Formal dispute resolution procedures forthe efficient and cost effectivedetermination of issues arising during thecontract should be put in place as analternative to legal procedures. Thecontract manager must endeavour toresolve matters in dialogue and discussionwherever possible. Where this fails andmore formal dispute resolution proceduresare invoked (such as conciliation,arbitration and litigation), the contractmanager should have comprehensiverecords of all relevant issues and becapable of giving evidence and generallysupporting the Contracting Authoritythroughout the process.

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ANNEX 1. BIBLIOGRAPHY

1. “Public Private Partnership – A Local Government Guide”: Ministry of MunicipalAffairs, British Columbia, Canada, 1999

2. “Public Private Partnerships; Introduction, Handbook, Recommendations andConclusions. Private Operations and Financing of TEN’s”: NEI Transport, 2001

3. “Achieving Public Private Partnerships in the Transport Sector”: Diebold Institutefor Public Policy Studies, New York, 2002

4. “Road Projects in Transition Europe”: Transportation Equipment and InfrastructureReview, Euromoney Publications, 1998

5. “Public Private Partnerships Guidance Note”: Department of the Environment andLocal Government, Ireland, 2000

6. “Law in Transition”: EBRD, Spring 20017. “Lending in Central European Countries”: European Investment Bank, 20028. “Joint Venture PPP for Urban Environmental Services Project”: UNDP9. “Project Financing of Toll Motorways in Central and Eastern Europe a Signpost for

Transition?”: John Crothers, Law in Transition, Spring 199710. “8th ISPA Management Committee, Working Document 01/ISPA/MC/010’: European

Commission Feb 9 200011. “Practical Guide to Phare, ISPA, Sapard Contract Procedures”: European

Commission, 200012. “ISPA Manual”: European Commission, DG Regio, July 200113. The Financing of Trans-European Transport Networks”: European Commission, DG

Transport, 199714. “Fair Payment for Infrastructure Use, A Phased Approach to a Common Transport

Infrastructure Charging Framework in the EU.”: European Commission, WhitePaper, COM(1998) 466 Final

15. “Interpretative Communication on Concessions”: European Commission, JOCEC/121, 29 April 2000

16. Council Directives, 93/37/EEC - Works, 93/36/EEC, - Supplies 92/50/EEC -Services, 93/38/EEC – Utilities

17. ‘Report to the Seville European Council on the Status of Work on the Guidelines forState Aid and Services of General Economic Interest”: CMP.A3/AA/D(2002) 293

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ANNEX 2. NOTES FROM THE WORKSHOP

Working session on the draft guidelines: Building a Valuable Approach for PPP-ISPAprojects,

Brussels, 4th July 2002.

The final agenda of the day is annexed with the actual speakers

The high quality presentations were thorough and informative whereby a range of ideas,incentives, examples and experiences in connection with PPP were shared. A number ofpoints were raised that reveal a degree of consensus on what exactly preparations for PPPshould involve. The debate and workshop not only contribute to the preparation of theguidelines, but also the wider debate on the Cohesion Fund and Structural Funds, as well as atCommission level – enhancing the discussions relating to aspects of PPP and PublicProcurement, Competition and State Aid.

1. Common themes emerging in the presentations:

There is a body of experience that has developed in a number of countries to dateproviding a strong basis for the elaboration of suitable PPPs. There emerged a convergentunderstanding that good PPPs due to their complexity, need to be well prepared, andrequire political backing at a high level. The public authority remains accountable butthrough early and well apportioned risk sharing the full range of benefits of PPPs can beharvested.Most of the presentations cited not only the positive financial aspect, but also the benefitsthe private sector can bring in terms of innovation, greater efficiency, and value formoney. Task forces, new legislation and political commitment are driving forces for theprocess, however, caution should remain in that PPPs cannot be seen as a quick fixsolution and should be developed only for appropriate projects.A major emphasis also centred on the need for success stories in Candidate Countries aswell as early evidence of success in the development of PPP projects (although the needfor good preparation and the application of rules on the duration of projects underCommunity funding was a concern).At the European level, there is a role for support, simplification of legal issues andsharing of know-how. Furthermore, PPPs must fit well in the domestic sphere, beingtailored to the institutional arrangements present in a specific country. The legal aspectsof PPP frameworks were discussed at length. The treaty provisions, principles andlegislative frameworks provide for sufficient flexibility of interpretation which canfacilitate the designing of PPP guidelines in order to achieve compatibility withCommunity rules and yet being conducive for effective Private interventions. In this wayit is possible to envisage for ISPA a role of innovator in providing a structural architecturefor PPP in the practice of Community funding feeding into Cohesion and Structural Fundsbut also into Pan and Trans European projects in Transport Energy Environment.

2. The working session on the guidelines:

The discussions issues are outlined below. The main points moved between analysis andmore policy-oriented statements and questions. The range of themes included eligibilityin relation to the legislative basis, the need for a regulatory framework, the peculiar ofmarginally viable communities in the CEEC and the viability of PPP, as well as thepolitical and pragmatic sides of PPP.

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Discussion on Key PPP Issues:

• First of all it was expressed that the guidelines have no legal value nor can they be takenas a blueprint approach to specific. In relation to this a point was raised urging for aconcrete understanding of what form of PPP would be eligible for ISPA finance.However, it was recognised that there are no detailed rules at present – only generalprinciples and treaty provisions, which are fundamentally flexible. As stated in art 6 ofthe EC Regulation 1267/99 the definition is on “…public equivalent expenditures bybodies whose activities are undertaken within an administrative or legal framework byvirtue of which they are regarded as equivalent to public bodies”

• The Spanish experience of PPP, which began in 1995 was outlined where PPP accountsfor 25% of total operations in the transport sector. This has led to the building up of a‘Concessionary Culture’ in Spain - the first country to have PPP in Cohesion Fundprojects. Various speakers agreed on the need for a European regulatory framework as away to promote additional investments and to oversee the whole concession business: thisis not a tool, rather a requirement.

• The question of whether PPP is financially suitable for two thirds of the CEEC populationwho live in small towns was raised. More specifically, what can be done to aid sewagetreatment in these areas and how is it going to be possible to subsidise this?

• Similarly, in relation to smaller communities – aggregating the population is not alwayspossible for many reasons. Economies of scale at plant level are not available. ThroughISPA however, the Water Framework Directive provides for ‘groups of projects’ - arelatively new dimension, to increase the economic viability of projects which helpmaintain the population patterns of these areas.

• A more pragmatic attitude to PPP is emerging . Returns are reasonable for the privatesector, yet certain areas go less comfortably with PPP – such as services that directlytouch the public on a daily basis. Regulation provides the basis for an ongoing balancebetween quality and cost. Accountability and the right of appeal of the regulator istherefore a useful tool for PPP in terms of range and diversity.

• There is a need to develop momentum and a need to develop early successes. Basicproblems must be resolved at the beginning, otherwise programmes will be overwhelmed:good selection is essential as to demonstrate achievements on expectations. In thetransport sector, many priority projects have not progressed because they have not beenconvinced of their basic viability and there are fundamental doubts – therefore, the issueto address is what can be done to improve project viability and ensure a sound basis forPPP?

• Concerning the TENs cross-border projects are an area of legal complexity and maydeter private investors.

• On the issue of the renegotiation of contracts: a World Bank study on concessions incontracts in Latin America was highlighted whereby 50% were renegotiated. Problemscan arise here if a bilateral monopoly is created where the outcome is based on bargainingstrength – this may not be in the public sector favour. Robust National Regulations,internal negotiating capacity to achieve fair re-negotiation is necessary. The private sectorcan gain from re-negotiation but also the public sector can ensure good deals forconsumers.

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• One speaker underlined the usefulness of PPP for gaps in finance especially in CCs.There are limits with rules, however, the guidelines are exhaustive. It was pointed out thatstate procurement and competition rules should not be understood in terms of ‘eligibility’,rather compliance with the EU rules as they are laid out. There is a need for seeking theright balance – changing the situation and ensuring legal stability with an obligation toensure the public interest.

• Concerning ‘windfall profits’ - ISPA should ideally increase social benefit – seek a wayto renegotiate down the windfall profit if any. Complex and broad is the role of a publicbody that retains responsibility and necessitates control efficiency to monitor to ensurebusiness in the public interest. Consumers can act as a counterweight and controllingmechanism within civil society to ensure sustainable delivery of service.

• In the case of the UK: re-financing of a concession already in place to share benefitsdisproportional in favour of Government (due to the regulatory framework) but also forthe Private Partner (so to retain its interest).

• The benefits going to the private sector from the UK experience must be built into thedesign of the contracts. The nature of discussion should focus on – how to design goodPPP (independent of ISPA) and how to combine PPP and grants? Good projects are theissue and then PPP is the option. It was again advocated the need for simple guidelinesthat should give clarity on the eligibility of projects for the grant and how much would begiven. On the issue of small towns: Phare and EBRD are looking at this issue – thestrategic and structural concerns for delivery that are involved which do not necessarilyinvolve PPP, since the difficulties involved with a PPP as a regional service provider maybe too great to organise on that level.

• There is an emerging consensus and Member State experience is being built upon wherethe ideological debate seems to have now settled. Questions relate to this for the EC andISPA; One commentator has emphasized that private sector interest had to be decidedearly – and that ISPA has already begun. What practical conclusions from the guidelinesvis à vis projects for the ISPA Committee and the political awareness of this can bemade? With consensus: will ISPA and furthermore Cohesion and Structural fundsprojects systematically go hand in hand with PPP?

• The rate of assistance and how this is handled in the bidding process could give rise to thecreation of perverse incentives i.e. with an efficient bidder not as much ISPA grant isneeded so that the city has no incentive. There is a need for concrete guidelines on thisaspect to avoid paradox situations.

• In Candidate Countries and from the business community in Member States – there is ashared interest to upgrade major infrastructure through these projects. The opportunity toparticipate in this is the reason for PPP and for the guidelines which become the basis forfacilitation.

• One concern relates to the upper limit of CCs in absorbing projects. A number of factorscome into play here such as project management in a given sector, period, country andindeed the macro economic conditions which are all involved.

• The guidelines like a ‘map’ are not to be seen as the solution nor as definite or staticposition of the European Commission and they represent a decision to ensure the focusremains on the public interest.

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3. What next

• The final version of the guidelines after careful incorporation of all comments consistencychecks and final editing will be distributed to selected audiences and available on theISPA website at the INFOREGIO.

• Dissemination seminars will be organised in Candidate Countries to enhance the practicalnature of the Guidelines without pre-empting specific decisions on individual projects.Contribution from the member states would be useful i.e. Designing laws for theconcession or assistance (if required) for the establishment of the task force for PPP.

• Specific task assignments through experts will continue organised by the ISPADirectorate to analyse specific cases and propose appropriate solutions in line with theprinciples enshrined in the guidelines which were re-stated in the closing remarks of theDirector General of DG REGIONAL POLICY Mr Guy Crauser:

• ensuring open market access and equal fair and transparent competition under the publicprocurement directive;

• protecting and safeguarding the public interest;• ensuring compatibility between PPP and State Aid rules;• defining the right level of grant contribution and the right PPP formula tailored to the

specific circumstances.

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Working Session on theDraft Commission PPP Guidelines for ISPA

Building a Valuable Approach to PPPBrussels, Thursday 4 July, 2002

Centre BorschetteRue Froissart 361040 Bruxelles

Agenda

Time Topic Speaker

9:30 Registration

10:00 Welcome, Introduction and objectives of theWorkshop

Mr L. Riera, Director ISPADG Regional Policy

10:20 Opening remarks:Incentives for PPP in Poland

Ministry of Transport – PolandMr P. Vonau

10:40 PPP Experience of the EBRD in ISPAcountries: the role of the international loanproviders

EBRDMr Robin Earle, Senior BankerMr Chris Shugart, Senior Banker

11:00 PPP Experience of the EIB in ISPAcountries: success story

EIBMr T. Barrett, Director

11:20 PPP Experiences and Lessons form MemberStates – the value of PPP from theperspective of the Grant Provider andbudgetary authorities

Italy, Mrs V. Leone, Legal expert PPP,Ministry of EconomyFrance, Mr J-M Etienne, FrenchGovernmentUK, Mr M. Gerrard, Partnerships UKIreland, Mr E. Kearns, PPP Taskforce

12:30 Presentation of Draft Guidelines PB Consortium – Mr S. Murray,Consultant

13:00 Lunch

14:30 Summary and issues for working session.The Role of Grant Providers in PPPs: thekey issues

Mr U. Bassi, DG Internal MarketMr A. Baron, DG Energy and TransportMr O. Slocock, DG CompetitionMr R. Ridolfi, Coordination DGRegional Policy/ISPA

15:15 Working Session on Key PPP Issues fromthe draft guidelines

Facilitated by PB Consortium, MrRiera, Mr Ridolfi

16:30 Summary of Workshop Results Mr L. Riera

17:00 Closing Remarks Mr G. Crauser, General Director DGRegional Policy

17:15 End of workshop

guidelines for successful public

Documents