Public-private partnerships: another view

Wednesday 22 September 2004

An article in The Independent on 8 September suggested that using public private partnerships (PPPs) to build the infrastructure so badly needed in New Zealand would lead to the taxpayer underwriting the deal, that PPPs were not financially transparent and that overseas experience showed PPPs posed an unacceptable risk to public services.

While there are clear lessons to be learned from the UK experience with PPP, I would suggest that many of the concerns outlined in the commentary are not among them.

In terms of financial transparency, the authors implied that all private sector debt created by PPP projects is not reported in government accounts. The balance sheet treatment of PPPs in the UK is determined by the allocation of a particular set of risks, rather than simply asking whether it is the public sector or the private sector that provides the project funding. As at June 2003, 57% of UK PPP projects by capital value were actually reported on the public sector balance sheet.

In addition, the UK government regularly reports the level of ongoing costs and future payments under PPP contracts, costs that would not automatically be monitored or disclosed for a conventionally procured project.

With conventional procurement these future costs - such as a building’s long-term maintenance costs - are not priced and do not appear in the government accounts, but are still picked up by the taxpayer (however large they may be) when those future costs are incurred.

“Commercial sensitivity” has not hindered financial transparency and cannot prevent public sector due diligence or prevent the UK’s National Audit Office from publishing comprehensive reports into the value for money implications of a wide range of PPP contracts.

The financial models that record the private sector’s expected costs and rate of return are comprehensively audited by the public sector. The private sector’s funding arrangements are also reviewed, and there is the potential for in-depth scrutiny by other government entities such as Parliamentary committees and the National Audit Office. In reality, there is a very robust review process for PPP.

Contrary to the Commentary article, there is no government “guarantee” of lender or shareholder repayment on a termination in the UK. This is entirely appropriate as it is fundamental to PPP that the private sector’s capital, and not just its profit, should be at risk.

In the UK, the only circumstances in which shareholders and lenders will be paid out in full is if there is a public sector default (such as a failure to make a required payment) or for a limited range of other events which the private sector cannot be expected to manage or price (such as war or terrorism).

It is difficult to see why this is unreasonable, or why it would be value for money for the private sector to price and assume these risks.

If the private sector were to default, the contract can be retendered and the private sector will get as compensation whatever someone else is prepared to bid to take over the contract.

It is fair that a payment is made on a default termination, otherwise the public sector will get for free assets built with private sector money, but such a payment may be substantially less than the sum that the lenders and shareholders have invested in the project.

So there is no guaranteed level of government payment and, in any event, the public sector may not even have to put its hand into its pocket to make the payment.

The implication from the references to “failed deals” is that such deals may adversely affect public services or may require government “bailouts”.

It is true that there have been PPP deals that have not been a financial success for the private sector, or which have been subject to unexpected financial shocks which have required temporary government support.

Examples of the former are projects in which private sector revenues are based on the level of patronage of the asset in question, such as the Royal Armouries and Croydon Tramlink PPPs. In both these PPPs, “patronage” risk was passed to the private sector, and a lower than expected level of patronage caused the private sector contractor substantial losses.

An example of temporary government support being required is the UK’s National Air Traffic Services (NATS) PPP which represented the sale of a 46% stake in the company that managed the UK’s airspace. The steep drop in air traffic after September 11 led to a correspondingly steep drop in fees for this entity, and it came under financial stress.

All of these projects are examples of the limits to the types of risks that the private sector can be expected to price and manage: there has been a substantial move in the UK away from patronage-based projects and the private sector could hardly be blamed for not predicting and pricing events of the magnitude of September 11.

More importantly, however, at no time was there any disruption to public services or a threat to public safety, a finding reinforced by separate reports into these projects. In reality, the fact the projects were privately financed by bank debt made it more, rather than less, likely that there would be continuing provision of important public services.

In a conventionally procured project, a private sector contractor may be tempted to walk away from an unprofitable contract, but lenders will not walk away from a PPP because it is in their interests to ensure continuity of service and thus achieve a higher level of compensation payment on any subsequent retendering.

In fact, I am not aware of a single termination of a UK PPP contract for private sector default or of repayment of the private sector’s investment in the project.

The recent Commentary quite properly refers to issues of how the costs of a PPP procurement are compared to those of convocational procurement by a public sector comparator.

However, the criticism of PPP is not that it inflates the public sector’s costs - these are determined by reference to historic public sector procurement data - but that it overvalues the risks that are transferred to the private sector, thus allowing the private sector to appear better value.

The robustness of the public sector comparator analysis is often cited as a weakness by critics of PPP, and it is a key political and policy challenge to government to ensure this comparison is robust and is seen to be robust.

The Commentary does not refer to other practical difficulties with PPP. The level of due diligence required by lenders and shareholders means that bid costs are higher than under conventional procurement. Therefore PPP may not provide value for money in smaller transactions.

Also PPP is best adapted to areas where long term public service requirements can be stated with confidence: information technology is one area where this may not be the case.

Of course, New Zealand should pay attention to the practical lessons to be learned from overseas experience, particularly those from the UK. But if PPP can generate even a part of the savings that have been suggested by overseas experience then its use will be well justified.