Analysis & Insights
Public Private Projects - An Overview
23 Aug 2013
The purpose of this article is to give a general overview of PPPs, to look at popular forms of PPP models (namely privately financed models), as well as to discuss the various benefits and risks associated with them.
The introduction of new legislation in the Cayman Islands regarding PPPs and related projects can be viewed as a paradigm shift in the way that government views the role of the private sector in providing public infrastructure and related services. Such infrastructure may be 'economic infrastructure', where users are charged directly for use (such as power, water, transport, etc.), or 'social infrastructure', where the government essentially funds use through payments to the relevant private sector entity (such as with schools, hospitals, prisons, etc.). The Cayman Islands government has developed its own PPP policy (namely the Public Management and Finance (Amendment) Law 2012) as well as the Framework for the Financial Responsibility ("FFR") Agreement with the U.K. following recent focus on infrastructure projects within the islands and the need to fund and develop cost effective and timely solutions to proposed projects.
The goal of the PPP model is to assist the public sector in delivering infrastructure in a more cost-effective manner whilst retaining control of core services with significant input from the private sector. A central underlying component of a PPP is that it must offer value for money.
When assessing value for money, a critical issue for all parties involved in the development of a PPP is that of risk transfer. Value for money is maximised by properly allocating risk. In general terms, this means allocating each risk to the party best able to manage that risk. In theory, this reduces individual risk premiums and the overall cost of the project because the party in the best position to manage a particular risk should be able to do so at the lowest cost.
This much is agreed by all parties involved in the delivery and operation of public infrastructure. However, the achievement of the best value for money outcome requires more than just the efficient allocation of risks. Government should also consider which project delivery procurement model for engaging with the private sector is likely to deliver the best value for money. This involves consideration of both publicly and privately financed delivery models. In addition, careful consideration should be given to the development of effective market engagement and negotiation strategies in order to deliver the best value for money. Value for money is ensured when those risks that government is seeking to transfer are priced by the private sector within a competitive environment.
Popular PPP models that governments have used in the past include privately financed build, own, operate and transfer ("BOOT") transactions (with a user paying revenue stream), or design, build, finance and maintain ("DBFM") transactions (with government paying revenue stream). These are referred to in this article as privately funded projects ("PFPs"). Whilst privately financed BOOT or DBFM transactions are certainly a core member of the PPP family, they are not the only member of the family.
The most important step governments must take on a major infrastructure project in order to successfully allocate risk and achieve the best value for money outcome, is to thoroughly consider all delivery models under which it can engage with the private sector for the delivery and through-life supportive infrastructure and the provision of associated services.
By way of illustration, the PFP model offers the following value for money drivers:
(a) Risk Transfer – PFPs allow government to transfer risks to the private sector, which the private sector party is better able to manage at a lower cost than government, thereby reducing the overall cost of the project to government.
The key driver for the private sector is the profit imperative, which essentially means controlling the cost of delivery by managing the risks appropriately. On the other hand, the key driver for the public sector is risk mitigation which usually leads to more expensive cost outcomes on delivery.
(b) Whole of Life Costing – The long term nature of PFPs often requires the private sector party to assume responsibility not only for the design and construction of the facility, but also for its operation, maintenance and refurbishment. This provides a commercial incentive for the private sector to adopt design and construction methodologies which minimise the overall cost of building, operating and maintaining the facility through life. In other words, the private sector is incentivised to deliver a more efficient operational outcome by capturing operating efficiency at the development phase.
(c) Innovation – PFP projects focus on output specifications, thereby providing private sector bidders with the opportunity to develop innovative design and other solutions so as to meet government's requirement at lower cost. Further, the private sector is incentivised to create innovative solutions to unforeseen risks as they emerge.
(d) Asset Utilisation – Some PFP projects provide opportunities for third party use of the facility, thereby generating revenues, which would not be derived if the facility were built, owned and operated by government (due to the absence of commercial motivation). These third party revenues can reduce the cost government would otherwise pay as sole user of the asset or, alternatively, open up opportunities for upside revenue sharing.
The use of PFP models can enable certain projects (and their associated economic and social benefits) to be delivered to the community much earlier than would be possible if the project had to wait its turn for the allocation of government capital funds. In the case of economic infrastructure, where user charges can be imposed, PFPs can also enable government to expand its available finance, thereby allocating its limited capital expenditure budget to other projects such as schools and hospitals.
With much press regarding proposed government infrastructure projects in the Cayman Islands and the necessity to put those projects to public tender through the Public Management and Finance (Amendment) Law 2012, it will be interesting to see which PPP models will be adopted by government in the future.
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