Public-Private Partnerships: Basic Considerations,

Accounting and Reporting Issues

Presentation by Max Alier Resident Representative in Brazil

International Monetary Fund

Brasilia, April 26, 2005

What are PPPs? Private sector involvement in building

infrastructure assets AND providing services derived from those assets.

PPP contracts stress long-term service delivery rather than asset creation; services can be provided to the government or directly to final consumers.

Why PPPs? Right Motivation. Private sector

management and innovation should lead to better value-for-money.

Wrong Motivation. Private financing can support increased infrastructure investment without adding to government borrowing.

Characteristics of PPPs Design-build-finance-operate (DBFO)

scheme is a classic PPP. Private sector usually owns the PPP

asset for period of operation, but may transfer it to government.

Operating leases and concessions.

What is a successful PPP? Comparison is with traditional public

investment and government supply of services.

A successful PPP delivers high-quality services at lower cost than government.

What is a successful PPP?

Efficiency gains are large enough to cover higher private sector borrowing costs (or the higher financial cost charged to the government in a PPP contract).

Generating Efficiency Gains The private sector will be more efficient

than the government if it faces the right incentives.

Allocation of “economic risks”. Regulatory framework. Auctions and contract design.

Generating Efficiency Gains Economic risks are inherent to any

project: construction, financial, performance, demand, and residual value.

The key issue is allocating risks to the party that can better manage them.

The design of contracts and guarantees is essential to an adequate allocation of explicit and implicit guarantees.

Minimizing the Financing Cost Financial cost of a PPP contract is higher

than in other public liabilities because of: Higher cost of private borrowing: risk

diversification / default risk. Institutional, regulatory, and political

risks.

The government should not spare efforts to minimize these risks.

Institutional Framework

Key institutional elements for the success of PPPs:

Political commitment and good governance. Legal framework to reassure investors that

contracts will be honored. A clear, credible, and efficient dispute

resolution mechanism. Non-discriminatory regulations and taxation

regime

Institutional Framework What to do in the short-term when these

institutional elements are weak? Strengthening legal force of the contract

(e.g. Chile: Decreto-Ley) Create a trust fund to guarantee payments

(e.g. Brazil: Fundo Garantidor) Other ...

What are the concerns? PPPs are chosen over traditional public

investment and government supply of services to move public investment off budget and debt off the government balance sheet.

However, the government still bears considerable risk, and faces potentially large fiscal costs.

Proper accounting and reporting of the fiscal implications of PPPs is essential to prevent their misuse, and to make increased efficiency their main motivation.

Accounting and Reporting There is not a general accounting and

reporting standard for PPPs. Existing standards (ESA 95, GFSM 2001)

cover cash payments by and to government, the transfer of PPP assets to government, and calling of guarantees.

Private accounting standards for leases are also relevant to PPPs.

Financial Leases Distinction between operating and financial

leases. The substance of a PPP transaction may

suggest that it should be treated as a financial lease.

If risk transfer to a private partner is limited, the government can be regarded as the economic owner of a PPP asset, which it is assumed to obtain under the terms of a financial lease.

This is the basis of accounting in Australia and the United Kingdom.

Accounting for Limited Risk Transfer Under the financial lease approach, limited risk

transfer results in: PPP assets being placed on the government balance sheet; PPP investment being treated as public investment; and PPP debt being treated as a government liability.

With related transactions—lease interest and amortization, depreciation—the fiscal accounts are complicated by many imputed entries.

Net asset value builds up slowly on the balance sheet, but the basis on which private partner continues to use the asset is unclear.

Eurostat Decision PPP assets should be classified as private

sector assets if the private partner bears most construction risk, and either most availability risk or demand risk.

Since the private partner typically bears construction and availability risk, most PPP assets are likely to be classified as private assets, even though the government bears considerable demand, residual value, and other risk.

An Alternative Approach Classifying PPP assets as government or private sector

assets does not do justice to the fact that PPPs are designed to share risk according to which party can manage it best.

An alternative accounting and reporting approach would be to record PPP assets on private sector balance sheets, consistent with legal ownership.

The fiscal costs and risks associated with PPPs would then be assessed, quantified, and disclosed.

A similar approach is being considered for private sector accounting of leases, where the focus is shifting to the assets and liabilities created for each party to a lease contract.

It is unclear what approach will be taken in formulating a general accounting and reporting standard for PPPs.

Interim Approach Pending agreement on a general

accounting and reporting standard for PPPs: Government guarantees should be disclosed as

required under the IMF’s fiscal transparency code.

PPP commitments/obligations should be treated as primary spending when undertaking debt sustainability analysis, and government guarantees should also taken into account.

PPP contracts have to be disclosed. This should include future payments under signed contracts.

Disclosure For each PPP project or group of similar projects,

information should be provided on:

Future payment obligations for the following periods: 1–5 years; 5–10 years; 10–20 years; over 20 years.

Significant terms of the project(s) that may affect the amount, timing, and certainty of future cash flows, valued to the extent feasible (e.g., contingent liabilities, the period of a concession, the basis upon which renegotiation is determined).

The nature and extent of rights to use specified assets (e.g. quantity, time period, or amount as appropriate), obligations to provide or rights to expect provision of services, arrangements to receive specified assets at the end of the concession period, and renewal and termination options.

Disclosure (cont.) Whether the PPP assets (or any part thereof) are

recognized as assets on the government’s balance sheet, and how the project affects the reported fiscal balance and public debt.

Whether the PPP assets (or any part thereof) are recognized as assets either on the balance sheet of any special purpose vehicle, or in the private partner’s financial statements.

Any preferential financing for PPPs provided through government on-lending or via public financial institutions.

Future expected or contingent government revenue, such as lease receipts, revenue or profit-sharing arrangements, or concession fees.

Any project financing or off-balance sheet elements such as contingent liabilities provided by entities owned or controlled by government.

Highlights PPPs have the potential of delivering

high-quality services at a lower cost than the government. But:

Do PPPs for the right reason. Pay close attention to contract design. Strengthen the institutional framework. Proper accounting and disclosure is

essential to prevent misuse of PPPs.