Public Private Partnerships evolution or revolution?
GLOBAL BUSINESS CHALLENGES
PPPs - evolution or revolution?G
lobal Business Challenges 2012
Our survey results strongly confirmed what we had felt for some time from talking to clients - that for the private sector, the most important thing by a country mile is a clear pipeline of projects. If governments can deliver that, the private sector will find the money to make them happen.Geoff Wood, Partner Baker & McKenzie, Sydney
Market perspectives ii
Executive summary v
PPP landscape 1
A good model for delivering infrastructure? 8
Market challenges 14
Market opportunities 18
Current issues 29
States run their own projects and the Commonwealth separately does its own things. It would be better to have a whole of Australia approachRespondent Government sector
PPP evolution or revolution? | i
ForewordWelcome to the second report in our Global Business Challenges series.
Our first report explored bribery and corruption in the international business community, and started a conversation about whether Australian companies were taking these issues seriously. Now, in our second report, we look at a topic thats closer to home: the current state of Australia's Public Private Partnership (PPP) market.
Public Private Partnerships evolution or revolution? presents the results of our survey of a broad range of industry players with recent experience in the Australian PPP market.
Our survey respondents cover the full spectrum of market participants from government and the private sectors. Our respondents over-whelmingly endorse the PPP model as a key means of infrastructure procurement, but also identify room for improvement in the interests of more efficient and effective infrastructure delivery.
PPPs are now an entrenched feature of Australias infrastructure market but challenges and calls for the model to be changed continue.
The challenge is to move beyond broad calls for change, recognise that the PPP model is largely appropriate, and identify in greater detail the key concerns and the potential solutions. Theoverarching objective must be to ensure that the PPP model continues to meet the objectives of all participants so critical infrastructure is delivered in a manner that provides value for money for the public and private sectors, whilst allocating risk appropriately and providing incentive for the private sector to provide the efficiency and innovation it is best placed to deliver.
This report seeks to contribute to the continuing evolution of the PPP market in Australia through our survey of active market participants and our analysis of some of the key areas for improvement suggested by our survey participants.
We hope you enjoy reading our report and look forward to continuing the conversation.
Ken GrayPartner, Baker & McKenzie
Geoff WoodPartner, Baker & McKenzie
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Market perspectivesTransfield ServicesThere is no doubt concerning the significant economic impact of PPPs over the past 25 years; Infrastructure Partnerships Australia estimates it at some$60 billion. In a direct sense, this represents investment whichwouldnot have been made or which would have been delayed if paidfor from the public purse.
PPPs have also had indirect benefits, which have served Australia well in aglobalised economy. The use of PPPs has (with privatisation) helped breakthe public sector's monopoly in the provision and operation of infrastructure in Australia. Governments now have competitive benchmarks,and the standard of procurement has lifted. PPPs have demonstrated that risk can be effectively transferred to the private sector.
The question now is, is there a continuing appetite for PPPs? The evidenceprovided by this Baker & McKenzie report is positive. Although we are experiencing a period of global economic instability, fundamentally Australia is still in pretty good shape. There is money available. In my own company, I know that we have had little difficulty in finding partners interested in co-investing in the development of projects such as wind farms.
Why is this so? Getting beyond the headlines, infrastructure, whether economic or social, makes good investment sense. The services are generally "essential". The revenue streams are generally linked to inflationand are very long term. But we still need to do more to encourage PPP development, and there are still issues with our Australian model. In myview, Government could facilitate and encourage PPPs through addressing bid costs and tender period issues, and a fresh approach to risk allocation. They could also provide financial support on appropriate projects and do more to encourage true long term partnerships. They alsoneed to strongly take the lead in publicly promoting the benefits of PPPprojects, and in building a clear and reliable PPP pipeline.
We have been doing modern PPPs in this country for 25 years now, since Baker & McKenzie's Geoff Wood and I worked together on the Sydney Harbour Tunnel in the mid 1980s. They have been a great success, but there is still work to do. It is time to focus on how we can refresh the modelbased on the lessons we have learnt and in response to current market conditions.
Tony ShepherdChairman, Transfield Services Limited Patron, Infrastructure Partnerships Australia President, Business Council of Australia
It is time to focus on how we can refresh the model based on the lessons we have learnt and in response to current market conditions.Tony Shepherd Transfield Services Limited
PPP evolution or revolution? | iii
Infrastructure AustraliaPublic Private Partnerships will continue to play a key role in infrastructure provision in Australia. The evidence that they deliver superior value for money to governments and the community means that they deserve to be a preferred delivery model for many projects.
While many of the benefits of PPPs come from the private sectors discipline in managing whole-of-life costs and delivery risks, there are other areas where they can add value.
Increasingly, as Infrastructure Australia (IA) looks at major projects, it is clear that significant benefits can come from looking at the opportunities available from taking a wider perspective than just the road, rail line or port.
While governments recognise the benefits that can come from integrating infrastructure into the fabric of our cities or of designing it to promote better places, they do not usually recognise the full opportunity set. Many of these opportunities are commercial in nature and not an area where governments have strong experience or skills.
By providing the private sector with the opportunity to conceive of how infrastructure could be best designed to promote the most value to the community - as well as a financial return the opportunity inherent in infrastructure provision can often be better realised.
Especially when budgets are stretched and the demands are on governments to provide more, we cannot pass up the opportunity to capture this extra value.
Michael DeeganChief Executive Officer, Infrastructure Australia
...significant benefits can come from looking at the opportunities available from taking awider perspective than just the road, rail line or port.Michael Deegan Infrastructure Australia
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Stronger political understanding of the benefits of PPP projects will help support the processRespondent
PPP evolution or revolution? | v
Executive summaryBaker & McKenzies thought leadership report on PPPs investigates the state of the Australian PPP market, outlining issues of concern for industry and government, and ways to improve the current market.
The survey asked respondents a number of questions covering: competition in the market place; the efficiency of procurement process management; the provision of information and the quality of briefs; risk allocation and opportunities; PPP financing; and the potential for future growth in the market, looking specifically at the feasibility of widening the scope of asset classes subject to PPPs.
The survey also probed opinions around current developments, including IA's issue paper Infrastructure Finance Reform July 2011 and its impact on infrastructure growth and PPPs in Australia.
With the obvious need to replace and expand infrastructure in order to cope with capacity challenges and finite capacity of traditional procurement models, future opportunities for PPPs are set to increase.
The role of the private sector as a source of finance and expertise reinforces the case for the expansion of the PPP model. Despite this, there are concerns among the private sector that there are insufficient opportunities to get involved with PPP projects 73% of those we surveyed in the private sector thought there were not enough PPP opportunities.
However, private sector players do not feel that there is excessive capacity to deliver projects through the PPP model. When questioned on the number of private sector subcontractors in areas such as construction, design, operation and facilities management:
Only 14% thought that there was an insufficient number of subcontractors in the market
Only 11% thought that there were too many players in the market
Whilst public sector respondents were generally satisfied with the current depth of the PPP market, 35% of public sector respondents expressed a concern that there are not enough subcontractors to undertake the design, construction and operations of PPP projects
A similar percentage of public sector respondents claimed that there are insufficient sponsors in the PPP market.
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95% of private sector managers said the current bidding process is too expensive
Despite general satisfaction with the PPP market, the process through which managers bid for PPP contracts is clearly in need of renewal:
95% of private sector managers said the current bidding process is too expensive
Over half of respondents (56%) strongly agreed that this was the case, indicating that procurement costs could potentially be seen as a barrier to market entry
In addition to cost concerns, the process of bidding for PPPs is too complex according to 82% of private sector respondents
The Public Sector Comparator (PSC) is not held in high regard by the private sector, as only 20% of respondents thought it to be effective.
One solution could see the Government reimburse some of the bid costs in projects which take an unexpected turn. Not surprisingly, this proposal was supported by an overwhelming 86% of those we surveyed in the private sector.
Other solutions to common concerns could include more standardised terms and conditions for PPP projects, a reexamination of the Governments probity processes to ensure the system is not overly complex and facilitates the sharing of information, and a willingness on the Governments part to consider adopting elements of alliancing or other relational contracting aspects of procurement in PPPs.
In addition, our survey findings indicated strong backing for central units a centralised government approvals mechanism for PPP projects. Our report identifies a procurement process which is both more centralised and standardised as two examples of where Australia can and must learn from international best practice.
We asked respondents if there are overseas PPP models which serve as best practice examples for the Australian PPP market. We found that a large proportion (45%) of respondents believed there are, and out of these 48% thought that the Canadian model is the best international example from which to learn.
We found that the Canadian model is admired by Australian industry for its efficient and streamlined approach to the bidding and procurement stages of the PPP process, among other factors.
We also found support for user charges as an alternative financing mechanism 76% claimed that user charges or other market-based mechanisms could be used in at least some projects. Despite this support there was widespread recognition that such alternative methods of financing may not be accepted by the public or communities.
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Parallel negotiations with two or more preferred bidders are a common occurrence experienced by nearly 60% of those we surveyed. It is interesting to note that opinion was divided as to whether parallel negotiations are beneficial overall. Whilst 68% of respondents believed parallel negotiation delivers benefits to the state, 51% thought that participating bidders lose out.
Our survey analysed attitudes to IA's Infrastructure Finance Reform paper and asked whether the proposed innovations in the report - availability payments, demand risk insurance, development of infrastructure funds, establishment of an infrastructure bond market, joint property development, sale of brownfield assets, tax breaks and tax increment financing - would have an impact on the PPP procurement process. We found that there was broad support for the IA innovations with tax breaks and availability payments, in particular, viewed as having the most likely positive impact.
Since our survey was conducted, there has been substantial commentary about the challenges facing two PPP projects in New South Wales - Reliance Rail and the Cross City Tunnel. It is not the intention of this report to address specific projects such as these, but obviously the lessons to be learned from them will be critical in improving the PPP model.
While high profile, troubled projects such as these will generate calls for "change", particularly regarding the allocation of risk, the important task is to identify with some precision the exact risks that need to be addressed, and the exact changes that will satisfactorily address them.
PPPs are very much here to stay. This report highlights some of the steps that can be taken to ensure the PPP model continues to evolve.
76% of respondents claimed that user charges or other market-based mechanisms could be used in at least some projects
The Australian PPP market has shown real resilience in the face of a challenging global environment. But more can be done, particularly in developing more options for funding PPPs, to facilitate transactions.Roy Weitzman, Partner Baker & McKenzie, Melbourne
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PPP landscapeThe 21st century has already given rise to a series of global trends which have increased the rate of social and economic changes. Changing demographics, principally ageing and growing populations, are placing increasing demands on existing economic and social infrastructure.
Meanwhile, we have seen how globalisation is deepening competition between nations and regions, increasing the need to develop high quality and state of the art infrastructure such as transport hubs, logistics and information technology.
Creating the necessary state-of-the-art infrastructure to meet all these demands comes at a price. Estimates of the required investment in national infrastructure range between $450 billion and $770 billion over the next decade.1 At the same time, there are other demands on government budgets intensifying the public policy imperative to deliver high quality projects at a cost-effective and sustainable price.
Although the public and private sectors have a history of working together, the current discourse surrounding the most recent form of PPPs has been building since the mid 1980s.
In the pre-PPP world, government at central or local level determined policy, decided whether or not to consult others, allocated resources and then announced the chosen procurement process.
Throughout the 1990s and early 2000s, increasingly more countries both within and outside the Organisation for Economic Cooperation and Development (OECD) area started using PPPs as a mode of delivery.
PPPs are attractive to policymakers for various reasons. PPPs can offer value for money, greater cost certainty, secure private sector expertise and innovation, more efficient allocation of risk and can potentially spread the cost of projects over a longer period of time.
Whilst PPPs remain politically controversial, our report does not seek to resolve these debates. This report takes as its starting point that 62% of our survey respondents, from government as well as the private sector, are satisfied with the most recent PPP on which they worked in Australia (Fig.1). Given this level of satisfaction, we therefore focus on current issues and room for improvement, as well as address the misunderstandings that underlie the arguments against PPPs.
Neither agree nor disagree
Fig. 1Do you agree the PPP project was well considered and developed?
PPP evolution or revolution? | 2
What is PPP?The expression PPP covers a range of different arrangements whereby the private sector delivers a public project or service. These arrangements range from relatively short-term service contracts through to long term leasehold ownership of publicly utilised assets (such as a major road).
Generally, PPPs fill a space between traditionally procured government projects and full privatisation. The feature of a PPP that distinguishes it from privatisation is the reversion (at least in theory) of ownership of the asset to the Government at the end of a stated term. Not surprisingly, the arguments against PPPs tend to be the same as the arguments against privatisation generally.
PPPs can conceptually address any infrastructure need. Two successful examples of Australian PPPs are Sydney Harbour Tunnel and Royal Children's Hospital one of the earliest and one of the most recent projects respectively.
Sydney Harbour Tunnel. This immersed tube road tunnel was developed as a partnership between the Government of New South Wales and private investors.
Transfield and Kumagai Gumi formed a joint venture company, which constructed the tunnel. Westpac provided the inflation indexed bond finance. The joint venture also had a 30-year operating contract for the management of the tunnel. The tunnel is tolled and the toll revenue repays the investors. The project was opened on time and on budget in 1992.
Royal Children's Hospital. In 2006 the Victorian Government contracted with the private sector for the replacement of the Royal Children's Hospital in Melbourne.
The hospital has been rebuilt, with the prior hospital site now reverting completely to parkland. The private sector consortium will also deliver facilities management services for the contract term. The hospital is the leading children's hospital in Melbourne, containing more single bedrooms, more neonatal cots, and more operating theatres than the prior hospital. There is also a 2,000-space underground car park, a two-storey aquarium and scienceworks display and a 90-room medi-hotel. The hospital has a leading research facility in the Murdoch Children's Research Institute, and incorporates the Department of Pediatrics of the University of Melbourne. Theproject was opened on time and on budget in December 2011.
62% of respondents were satisfied with the most recent PPP on which they worked
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Market evolutionIt is not surprising that PPPs continue to be reviewed and evolve given the breadth of critical infrastructure that is, or could be, delivered via the PPP model. Continued, and continual, discussion as to the pros and cons of PPP models is essential.
Some major changes in the Australian market are set out below.
A great expansion in the categories of assets subject to PPPs. Modern projects include convention centres, research facilities, desalination plants any project with a large capital component
The capital value has also increased enormously. While the early projects were in the $50-250 million range, most current projects are around the $1 billion mark
Risk allocation has changed in significant respects over time. Predominantly, this has been to the benefit of the private sector, although risk allocation, generally speaking, is still quite severe.
The major influences on the modern PPPs have been:
The resources boom. Prior to 2007, this boom led to significant labour cost escalation in most projects
The Global Financial Crisis. This adversely affected the cost of debt as well as the availability of finance for many projects. In some cases this led to a severe downgrading of the project debt with adverse consequences for the rating of many deals (Reliance Rail being a recent example).
Governments around the world are reviewing models for delivering infrastructure projects efficiently and cost effectively. In December 2011, the UK Treasury issued a consultation on the Private Finance Initiative (PFI), as PPPs are known in the United Kingdom, outlining the case for a "new model". Since 1992 PFI has delivered around 700 projects across a range of sectors including healthcare, education and transport. Despite this, policy makers in the United Kingdom have concerns that PFI contracts "can be too costly, inflexible and opaque".
The overall objective of the PFI consultation is to create a new model of delivering public projects that:
Are more cost effective, with an efficient and speedier procurement process
Increase the availability of a broader range of financing sources
Are flexible enough to accommodate changing needs over time
Are financially transparent
Have in place the right incentives, risks and rewards allocation.
The current review of PPP structure and processes allows the opportunity to consider new approaches to PPP risk allocation, incorporating approaches from relationship contracting such as Alliances.Alex Hartmann, Partner Baker & McKenzie, Sydney
PPP evolution or revolution? | 4
The Government of India has also recently consulted on PPPs. A draft National PPP Policy was announced in the Governments budget for 2011/12. The draft policy is designed to encourage and create a comprehensive framework for the development of PPPs at central and state-government levels.
India has seen a huge growth in PPPs over the last fifteen years and the National PPP Policy is designed to ensure that the expansion in the use of PPPs is an effective method for meeting "the growth aspirations of the nation".2
These are just two of many examples of governments around the world looking to develop and enhance PPP regimes as they seek to overcome their own infrastructure development challenges. Australia shares this challenge and, in its report to the Council of Australian Governments in December 2008, IA highlighted the need to find ways to make better use of existing infrastructure, to remove the bottlenecks and gaps that are holding back Australia's growth, and to identify opportunities for new capital investment.
The Infrastructure Finance Reform paper of July 2011 highlighted a number of issues for discussion designed to tackle the "infrastructure deficit" a concern that demand is outstripping investment in infrastructure.3 The paper looked at obstacles to investment in infrastructure and calls for views on ways to increase the role of the private sector through enhancing the pool of finance available for infrastructure, maximising available funding and reducing the costs associated with delivery.
The debate is not just restricted to methods of financing and generating sufficient returns as our survey suggests, the processes underlying the PPP model in Australia need to be reviewed. PPP is certainly here to stay, but reform is necessary to ensure both sides of the partnership the government and private sector are rewarded.
...the processes underlying the PPP model in Australia need to be reviewed.
The overall standard is high, and at their best, PPPs are world-leading.Respondent
There is a lack of political will, and government agencies often dont trust PPPs as an option There's an attitude that getting the private sector involved in delivery is 'selling the farm'.Respondent Power, Utilities & Infrastructure
PPP evolution or revolution? | 8
Our questions on public and private sector views of the PPP market probed two key factors opportunities and management. Satisfaction was measured among a number of variables, including views of PPP opportunities and market depth, management and procurement process, most recent experiences with PPP procurement and the outcomes of PPP procurement. These angles allowed us to measure satisfaction along a number of parameters to develop a comprehensive picture, highlighting specific gaps and remedies to improve the PPP model.
Market views of current PPP opportunitiesWe asked respondents in the public sector if they agreed that there are not enough sponsors in the PPP market and whether they agreed that there are not enough subcontractors (construction, design, operations, facilities managers, etc).
One-third of public sector respondents are concerned at the lack of private sector capacity to deliver PPP projects (Fig. 2)
A similar number (35%) also thought that there are not enough subcontractors to undertake the design, construction and operation of PPP projects (Fig. 3)
50% disagree or strongly disagreed with the statements that there are not enough sponsors and not enough subcontractors in the PPP market.
Private sector respondents did not feel that there was either excessive or insufficient capacity when questioned about the number of private sector subcontractors in areas such as design, construction, operation and facilities management.
Only 14% said there are insufficient numbers of subcontractors in the market
Only 11% said there are too many players in the PPP market
Over half of respondents disagreed that there are too many players in the market
FACTS AND FIGURES
A majority of respondents (62%) said that the most recent PPP procurement project on which they worked was well considered and developed
One-third of public sector respondents were concerned at the lack of private sector capacity to deliver PPP projects.
35% of public sector respondents also thought that there are not enough subcontractors to undertake the design, construction and operations of PPP projects
83% of private sector respondents supported a proposal for the Government to consider simplifying the procurement process with the introduction of standardised terms and conditions
Only half of private sector respondents (51%) agreed that the process currently worked in a predictable manner. Asimilar number (53%) thought that the Government team functioned well
Only 23% of respondents agreed that the PSC was realistic
A majority of respondents (59%) indicated that there were parallel negotiations with two or more preferred bidders in their last experience with a PPP
A good model for delivering infrastructure?
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These responses suggest scope for growth in the market with new market entrants, particularly as opportunities for PPP projects lookset to increase in the coming years. Of more concern to the private sector is the lack of current PPP opportunities nearly three-quarters of those surveyed (73%) thought that there are not enough PPP opportunities. Almost one-third of respondents (29%) strongly agreed that this was the case, with the lack of opportunities seen to be greatest among those in financial and professional services, followed by those working in the power and utilities sector.
Market views on current PPP procurementRespondents from the private sector agreed that there are a number of opportunities for improving both PPP and procurement practices. Key amongst these is to reduce the cost of bidding for PPP projects and make the bidding process less complex.
95% of private sector respondents agreed that bidding for PPPs is currently too expensive and over half of total respondents (56%) strongly agreed that this was the case, indicating that procurement costs could potentially be seen as a barrier to entry for private sector contractors. Efforts to reduce costs and simplify the procurement process could therefore help to introduce greater competition and choice into the market place and, in turn, help to improve value for money for the public sector.
83% of private sector respondents said they supported a proposal for governments to consider simplifying the procurement process with the introduction of standardised terms and conditions. This rose to 9 out of 10 of those in the construction sector
One solution to the cost concerns could see the Government contribute to the bid costs for losing consortia in projects which take an unexpected turn. This proposal was supported by 86% of those in the private sector
In addition to cost concerns, the process of bidding for PPPs is seen to be too complex according to 82% of private sector respondents
73% would also welcome steps to reexamine the Government's probity processes, which are currently seen to be too complex and act to hinder the sharing of information. This view was particularly strong amongst private equity providers (85%) and financiers (77%).
Other reforms the Government should consider include being more open to procuring infrastructure via alliancing or other types of relational contracting. 57% of those in the private sector supported this view.
Fig. 2Do you agree there are not enoughsponsors in the PPP market?
Fig. 3Do you agree there are not enoughsubcontractors* in the PPP market?
*Subcontractor refers to construction, design, operations, facilities managers
PPP evolution or revolution? | 10
Two specific recommendations were supported by private sector respondents, suggesting that the Government should be playing a bigger role in facilitating PPP: 90% agreed that the PPP market needs an accurate and public "pipeline" of project opportunities, and 72% agreed that governments should be more actively involved in coordinating PPP projects.
Experiences of the most recent PPP procurement processTo gain a better understanding of the level of satisfaction of the PPP procurement process, we asked respondents about their experience. Significantly, there was a generally high level of satisfaction with their last PPP procurement process:
66% agreed that the delivery method proposed in the brief was the most appropriate
75% agreed that private sector teams functioned well.
Issues of privacy and confidentiality did not emerge as concerns as 83% stated that these issues were well managed. Only 15% of public sector respondents thought that the private sector needed to take confidentiality and legal privilege more seriously, while nearly two-thirds (62%) did not think this was an issue.
However, there were a number of specific areas highlighted as areas where Australia could make particular progress to improve the PPP market. Three of the parameters with the lowest ratings were:
Only 51% agreed that the process currently worked in a predictable manner
Only 53% agreed that the Government team functioned well
Only 24% agreed that the PSC was realistic. This was an area singled out for specific concern (Fig. 4).
Of note, there was a divergence of opinion on whether the Government team functioned well, depending on whether the respondent was from the public or private sector. Public sector respondents were much more likely to think that the Government team functioned well 77% as opposed to a minority of 47% in the private sector.
In contrast, there is a general view in the marketplace among both public and private sectors that the private sector is competent in understanding PPP briefs. Surprisingly, the public sector had more confidence in the private sector understanding PPP briefs than the private sector had in itself. 73% of those in the public sector believed the private sector understood the briefs, compared to only 62% of those in the private sector.
DisagreeNeitheragree nor disagree
Fig. 4Do you agree that the PSC was realistic?
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The effectiveness of the Public Sector Comparator The PSC is a tool used by governments in many jurisdictions to compare the value for money projections resulting from the delivery of a project using the PPP model with the delivery of the same project by traditional procurement methods. When asked whether the disclosure of the PSC assisted bidders in the PPP process, three-quarters of respondents (76%) stated that it did. (Fig.5). All of our public sector respondents (100%) agreed and 69% of private sector respondents thought the PSC was of assistance, demonstrating some unease amongst the private sector.
However, both public and private sector respondents expressed concerns, with the majority of the private sector respondents believing that the PSC offers an ineffective comparative tool. Overall, only 20% thought it to be effective, compared to 46% who did not think it was effective.
This study probed views around the benefits of disclosing the PSC, with many respondents arguing that full disclosure and further details are necessary for it to be truly beneficial. Calls were made for PSC disclosure to include details on the assumptions underlying the PSC, details of the transferred risk adjustment, and greater transparency about the methodology and underlying calculations.
Parallel biddingA majority (59%) of our respondents indicated that there were parallel negotiations with two or more preferred bidders in their last PPP. 68% thought that parallel negotiations added value to the state. There was, however, a significant divergence depending on whether the respondent was from the public or private sector. 100% of public sector respondents agreed that the parallel negotiations delivered added value to the state. This figure fell to 62% of private sector respondents.
When asked whether parallel negotiations delivered benefits to the participating bidders (ignoring any offset advantages incurred), 64% of public sector respondents agreed, compared to only 21% of private sector respondents (Fig. 6).
Fig. 5Did the disclosure of the PSC assist biddersin the PPP process?
Disagreeor no opinion
Fig. 6Do you agree that parallel negotiationsdeliver benefits to the participatingbidders?
PPP evolution or revolution? | 12
it would be beneficial if the government/procuring body effectively gave some level of compensation to a losing bidder.
Respondent Business Unit Head, Government sector
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There's clearly room to engage the private sector in a wider range of asset classes, if government is willing to be creative.Ken Gray, Partner Baker & McKenzie, Melbourne
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Satisfaction with PPP outcomesIn total, 71% of our private sector respondents had been involved in a winning PPP bid during the previous three years. Whilst on the surface this is a high percentage, the fact that nearly one-third of the market had not won a deal in three years raises significant questions for the viability of continued participation in PPP bidding for those companies.
Our survey identified that private sector respondents thought there was room for more parties in the market. When a third of the existing market has not won a deal in three years, this desire for greater competition seems hard to reconcile.
A measure of whether the market is working well is the extent to which these private sector respondents were satisfied with outcomes negotiated in PPP projects.
Where risk allocation in relation to industrial action had been an issue, the outcomes had been largely satisfactory - 48% either satisfied or extremely satisfied. Only 20% were either dissatisfied or extremely dissatisfied. Equally positive outcomes were noted in dealing with allocation of risk from vandalism (where 57% were satisfied or extremely satisfied) and market disruption (where 50% were satisfied or extremely satisfied).
There were, however, a number of market challenges where a significant minority of respondents were less happy with negotiated outcomes. In the following cases we found:
36% were dissatisfied or extremely dissatisfied with the design approval process negotiated in their contract
25% were left dissatisfied or extremely dissatisfied when negotiating inclusion of entitlements to extensions of time
24% were dissatisfied or extremely dissatisfied when negotiating risk allocation regarding contamination
22% were dissatisfied or extremely dissatisfied when negotiating on refinancing
FACTS AND FIGURES
The most highly rated policy intervention came in the form of tax breaks, with 86% of respondents stating that this would have a positive impact on the procurement process
62% of respondents believed that demand risk insurance would positively impact on the PPP procurement process
56% of respondents felt that the risk allocation in PPP projects was both overly onerous for private sector participants, while at the same time not representing value for money for government. This concern was greatest among those working in property and construction (65%) and in primary industries (88%)
Nearly three-quarters of respondents believed user charging could be more widely applied in the market, though concerns over public hostility could be a barrier to wider adaption
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20% were unhappy regarding allocation of risk in relation to industrial action
19% were unhappy with negotiated outcomes on planning approvals.
Given the potential for issues to arise during the course of a project, the need for flexibility in dealing with unforeseen changes is clearly crucial. On this point, there were sharply divergent views over the extent to which both the public and private sector teams were able toadapt:
73% rated the private sector team as either flexible or extremely flexible
Only 26% gave the same rating to the public sector team.
Financing and funding PPP projectsIn 2011, the Australian Government announced the formation of the Infrastructure Finance Working Group (IFWG) under the auspices of IA. The IFWG made a number of recommendations to improve financing and funding of infrastructure projects which are listed below.
MAXIMISING FINANCE MECHANISMS AND REPAYING INVESTORS SUGGESTIONS IN THE INFRASTRUCTURE FINANCE REFORM PROPOSALS
Enhancing the pool of available finance Maximising available funding
Superannuation funds Availability payments
Infrastructure bonds User chargers and network pricing
Infrastructure funds Tax Increment financing
Government equity and debt assistance Joint property development
Demand risk insurance
Sale of brownfield assets
Taxation treatment of infrastructure investments
Source: Infrastructure Australia, Infrastructure Finance Reform Issues Paper, July2011
Project financing: enhancing the pool of finance availableThe global financial crisis is having a prolonged effect on the availability and cost of private project finance. The diminishing appetite for risk has seen the growth of larger consortia of multiple funders and of the trend towards tougher loan covenants.
Fig. 7Which of the innovations have had a positive impact on the PPP process?
Fig. 8Which of the innovations have had apositive impact on the PPP process?
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The majority of respondents thought that each of the innovations proposed by IA in its 2011 report would have a positive impact on the PPP market by enhancing the pool of finance available (Fig.7 and Fig8). Oursurvey asked respondents what overall impact they thought eachof the potential measures would have on the procurement process. The findings revealed widespread support for measures that will enhance the pool of available finance.
Tax treatments of infrastructure projectsThe most highly rated policy intervention came in the form of tax breaks. Not a single respondent disagreed that tax breaks would have a positive impact, while as many as 87% thought that they would play a positive role (Fig. 9).
The impact of tax breaks clearly has a positive role to play in promoting further PPP activity, yet the wider tax system should also be considered when attempting to create attractive conditions for long-term investment, as taxes will have a major impact on the cost ofcapital and investment decisions made by the private sector.
Demand risk insuranceAlthough support for demand risk insurance was relatively lower, it is asubject worthy of further review in light of the role demand forecasting has played in PPP projects.
The results show that IA's discussion around the role of demand risk insurance is seen in a largely positive light among PPP market participants, with 62% of respondents believing that this innovation would positively impact the PPP procurement process. This compared to only one in ten who disagreed (Fig. 10).
If demand risk insurance helps to bridge the gap between public and private sector appetites for patronage risk for the delivery of future toll roads then it is a worthwhile innovation to the market.
Project funding: The need to maximise available fundingGoing forward, the Government could consider a range of new funding options which could fundamentally alter the way in which risk is shared between the public and private sectors. The IA Issues Paper 2011 sets out options for reform ranging from the Government taking an equity stake in projects (as in the case of the National Broadband Network) through to the co-funding of projects.
Fig. 10Do you agree that demand risk insurancehas had a strong impact on thePPP process?
Fig. 9Do you agree that tax breaks have had astrong impact on the PPP process?
States run their own projects and the Commonwealth separately does its own things. It would be better to have a whole of Australia approach...Respondent Business Unit Head, Government sector
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Does Australia need a more centralised approach?While 53% of survey respondents believed that the Government team functioned well in their most recent procurement process, our survey found that across both the public and private sectors it was clear that there is support for a more centralised procurement approach.
Two-thirds of those in the public sector said they support a centralised approval mechanism for PPP projects
65% of public sector respondents would welcome a centralised state government mechanism for approving PPP projects. Nearly one quarter (23%) strongly support this.
Mirroring the views of those in the public sector, there is a general sense that the market could benefit by having greater centralisation via a "pipeline" of PPP opportunities:
Private sector respondents felt that the Australian Government should be more active in coordinating projects (72%)
70% agreed that this should be done through a centrally managed process through which PPP projects are approved
67%agreed that in order for PPPs to be efficiently procured, a centralised state government approvals mechanism is needed
Financiers are most likely to believe (82%) that a centralised state government approvals mechanism is needed.
IA has already identified that the need to deliver better governance represents a major challenge in overcoming some of the inefficiencies and inconsistencies which might otherwise impact adversely on infrastructure operations and investment. This view was shared by our respondents, the majority of whom called for the introduction of a more centralised system of procurement. A number of respondents also called for a more streamlined decision making process by government.
FACTS AND FIGURES
Canada was cited as the most obvious place to look for best practice (48%)
65% of public sector respondents would welcome a centralised state government mechanism for approving PPP projects.
72% of private sector respondents felt that the Government should be more active in coordinating projects and 70% thought that this should be done through a centrally managed process through which PPP projects are approved
95% of private sector respondents believed that bidding for PPPs is too expensive
90% of private sector respondents believed that the market needs an accurate and public "pipeline" of project opportunities
83% of private sector respondents believed governments should consider a stripped down procurement process, with model terms and conditions, and limited returnable schedules
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Overseas models that work45% of respondents thought that Australia could learn from PPP models used in other countries (Fig. 11). This rose to 65% of those who work in the public sector.
Only 12% thought it was not possible to learn from overseas markets. In contrast, many respondents were able to cite specific areas where Australian PPP projects could benefit from expertise built up elsewhere - in particular Canada and the United Kingdom.
World leaders in PPP development - CanadaWith Canada cited as the most obvious place to look for best practice (according to 48% of respondents) our survey returned large amounts of positive feedback on the Canadian PPP model (Fig. 12).
One respondent claimed that Canada has a greater commitment to PPPs, and generally manages to avoid the frequent use of multiple bid stages. Overall, the bid process is simpler, with less required of bidders".
Another respondent claimed that Canada had a "systematic approach to using PPPs for delivery".
The Canadian PPP system can be said to have gone through three waves of development. The first wave, in the 1980s and 1990s, was largely characterised by individual projects (i.e. a non co-ordinated program). Significant projects included:
The Confederation Bridge between the eastern provinces (thelongest bridge in the world, crossing ice-covered water)
Nova Scotia schools (Canada's first venture into P3 schools)
The 407 ETR toll highway (the world's first all-electronic, barrier free toll highway).
In the second wave, from 2000 to 2005, activity started to ramp up and provincial programs and specialist agencies emerged. Thesecond wave also saw dominant models (build/finance and design/build/finance/operate) and dominant sectors (hospitals and roads) emerge.
There were a number of key success factors which characterised the second wave. These included developing pilot projects, developing a financing model, identifying champions, building expertise, providing value for money, risk identification and allocation, engaging the market and legislative reform.
65% of public sector respondents said they would welcome a centralised state government mechanism for approving PPP projects
Fig. 11Does another market provide a goodexample for the Australian PPP market?
PPP evolution or revolution? | 20
The third wave from 2006 to 2010 resulted in a series of highway, hospital and municipal services projects across Canada, with some jurisdictions more involved than others.
In Canada the responsibility for infrastructure investment is quite diverse. The Federal Government maintains a strong interest in projects of national significance, such as major ports and borders, and provides financial support to provinces and territories. In general, provinces have responsibility for hospitals, large intercity highways and schools, while municipalities have responsibility for local infrastructure such as roads, water and sewerage services.
One of the key benefits to the Canadian PPP system is that it has the public's strong backing. Generally, Canadians see the need for private sector involvement in infrastructure renewal.
PUBLIC-PRIVATE PARTNERSHIPS IN DIFFERENT SECTORS (SUPPORT/SOMEWHAT SUPPORT %)
Hospitals Roads Water Sewage Recreation Transit Schools
2011 66 71 67 67 75 73 66
2010 62 72 53 58 74 67 62
2008 63 71 55 58 72 67 60
2007 63 73 55 60 71 66 63
2006 63 72 55 60 72 67
2005 63 71 53 58 73 67
2004 62 72 54 60 73 65
Source: The Canadian Council for Public-Private Partnerships, From the Ground Up: Canadian Opinion on Public Private Partnerships 2004-2011
Canadian pension funds are among the most active investors in infrastructure, with some funds having a portfolio allocation towards equity infrastructure of 10% or more.
After testing the waters through third party managed funds, Canadian pension funds over the years have been able to acquire the knowledge, expertise and resources to invest directly in infrastructure. Not only are they able to co-invest, but also to take leading roles in consortia, competing with other funds and financial sponsors when bidding for projects. This means that the funds investors have in-house resources to produce their own research and risk assessment for infrastructure projects without being dependent on external consultants.
Pension fund investment in PPPs is encouraged indirectly by way of offering such funds a predictable, relatively safe investment for funds with Canadian Government co-investment, rather than by way
Fig. 12Which jurisdiction provides a goodexample for the Australia PPP market?
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of specific incentives to pension funds to invest in PPPs. For example, the Government of Canada took a leadership role in developing PPP opportunities within Canada through two initiatives, both part of the Building Canada plan approved in 2006. The first was the C$1.25billion Public Private Partnerships Fund. This program supports innovative projects that provide an alternative to traditional government infrastructure procurement. The PPP Fund has helped expand infrastructure financing alternatives in Canada, provided incentives to attract investments from the private sector, and increased knowledge and expertise in alternative financing. The PPP fund provides up to 25%of the value of a projects direct capital costs, leveraging municipal and provincial commitments which will cover for the rest of the costs. The C$1.25 billion directly leverages C$5billion in PPP infrastructure investments in Canada.
In addition, the PPP Office, funded by the Government of Canada, facilitates a broader use of PPPs in Canadian infrastructure projects, including through the identification of PPP opportunities at the federal level.
The Building Canada plan also encourages the development and use of PPP best practice by requiring that PPPs be given consideration in larger infrastructure projects funded through the Gateways and Border Crossings Fund and by the Building Canada Fund. Specifically, all projects seeking C$50 million or more in federal contributions mustassess and consider the viability of a PPP option.
While the Canadian PPP market grows as a whole, provincial differenceswill continue to dissolve as a result of market forces. Asjurisdictions compete for infrastructure investments, they will have to become competitive within the Canadian landscape.
Significant industry organisations, such as the Canadian Council for Public-Private Partnerships, play a role in making information about projects available to a variety of bidders, thereby increasing competition. However, there remain differences (particularly in the types of investments and legal documentation) between provinces which must bemanaged when working across multiple Canadian jurisdictions.
World leaders in PPP development United Kingdom It is not surprising that the United Kingdom has been identified as a leader, as it is undoubtedly a reference jurisdiction for PPP projects. The United Kingdom is one of the countries that has implemented the largest number of PPP projects in the widest variety of sectors in recentyears. However, PPPs have always been politically controversial and particularly since the change of government in 2010 and the ongoingeconomic crisis in Europe, there has been increasing scrutiny ofthe efficacy of the model.
Canada has been quite innovative, particularly after the GFC. Theyve got centralised approvals, but theyve also got a stronger political commitment to them.Respondent Government sector
PPP evolution or revolution? | 22
A central, government-led review of PPPs is currently underway, which will lead to changes in the nature of PPPs in England and possibly through the rest of the United Kingdom.
Growth of PPPs in the United Kingdom
In much of the post-Second World War period, private investment in public infrastructure was limited to a few examples. However, in the late 1980s a number of legal restrictions were removed and a framework for actively encouraging PPPs was introduced by the Conservative Government in 1992 under the name of the Private Finance Initiative.
The PFI was strongly supported by the successor Labour Government from 1997 to 2010. As of 2010, over 920 projects across all sectors had been recorded, including health, education, defence, road and rail transport, street lighting, waste, accommodation (prisons, courts, etc.), social housing and IT. It is estimated that PPP projects accounted for 60% of schools projects and 70% of hospital projects in those years.4
Different regional models
Though the United Kingdom is not formally a federal state, under the 1997-2010 Labour Government, significant powers were devolved from the central UK Government to regional governments in Scotland, Wales and Northern Ireland, with central government departments retaining responsibility for England.
The decision whether to implement PPP projects now rests with the regional governments and so in practice, a federal-type arrangement exists under which each of England, Scotland, Wales and Northern Ireland are able to develop different models for the implementation of PPP projects. The nature of the devolution arrangements has meant that there is the greatest scope for divergence in models between England and Scotland.
All four regions have implemented projects under the PFI, but Scotland has now developed the "non-profit distributing" or NPD model.5
Implementation of PPP projects in the United Kingdom
Prior to developing any infrastructure project, public authorities in England are required by guidance from the Treasury (the UK's finance ministry) to compare the estimated cost of procurement through the PFI and on a conventional basis and carry out an assessment as to which procurement option represents the best value for money.6
There has been some form of central PPP unit in place for a number of years to advise public authorities on the implementation of PPPs.
The UK experience is valuable because they...have more appropriate performance measures for PPP in social infrastructure.Respondent Power, Utilities & Infrastructure
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Responsibility for PPP policy has long been under the direct or indirect responsibility of the Treasury, though for much of the 2000s, a body called Partnerships UK (which was itself a PPP) performed many of the roles of a central PPP unit. It was replaced in 2010 by a Treasury unit called Infrastructure UK, which includes representatives from the private sector.
A number of individual ministries (e.g. Ministry of Defence) and local authorities have also established their own PPP units. Accordingly, there is a high degree of awareness of PPPs at all levels of government in the United Kingdom.
Respondents to our survey made a number of references to the use of standardised documentation in the UK. The PPP Policy Team within the Treasury has developed a detailed set of guidance for the implementation of PFI projects, including mandatory wording for contract documentation. This has evolved over time to reflect changing market conditions and is now in its fourth version (known as SoPC4).7
Use of SoPC4 is mandatory for PFI projects in England except in sectors where separate standard forms have been developed, such as health, education, housing and defence.
The bid process and approach to risk allocation is clearly understood and has generally been accepted by the sector stakeholders involved. Use of SoPC4 has undoubtedly had a positive impact on the efficiency of the bidding and negotiation process for PPPs in England by eliminating the need to "reinvent the wheel" for each project and the renegotiation of minor issues. However, SoPC4 is by no means perfect and the following (non-exclusive) high-level criticisms may be noted:
The UK model could benefit from shorter procurement periods. The Canadian model is useful here, including lock down of documentation post-selection of preferred bidder and penalties for delay beyond a prescribed date (post preferred bidder) to reach financial close
Standardisation has not eliminated the complexities caused by project-specific factors, planning regulations and commercial issues
The use of standardised documentation itself can give rise to inefficiencies in the process as where changes to SoPC4 are required, the public authority must apply to the Treasury for specific derogation from SoPC4
From a practitioner's perspective, the SoPC4 documentation itself can be unnecessarily long and complex.
Summary of respondents' views on varying international approaches to PPP
It was felt that Canada has a greater commitment to PPPs, managing to avoid the frequent use of multiple bid stages: "Overall, the bid process is simpler, with less required of bidders". Approach to risk allocation and documentation makes for a more cost-effective bidprocess.
It was cited how the use of standardised contracts by HM Treasury and the Project Review Group concept in the UK was beneficial to the overall management of PPP schemes. TheUnited Kingdom was also praised for sensible risk allocation between the public and private sectors and its track record in delivering more projects over time.
PPP evolution or revolution? | 24
Recent criticisms of PPPs in the United Kingdom and review of the PFI
As with the use of PPPs in most jurisdictions, PFI in the United Kingdom has been controversial since its inception. It is not possible to address all the issues here, but criticism has primarily been based on perceptions that PFI enabled the private sector to make an excessive profit from the provision of public services, that the cost of developing a PFI project is greater than the cost of conventional procurement, and that PFI projects are overly complicated. For example, until 2002, the private sector was frequently able to keep the entire benefit of refinancing gains.
The UK's Conservative-Liberal Democrat coalition government came to power in May 2010 and approved a number of PFI projects in its first year in office, but in October 2010 reduced the incentives that authorities in England had to implement PFI projects and in November 2011 announced that it intended to carry out a fundamental reform of the PFI in England.
In essence, the objective is to retain public private partnerships in a broad sense for the delivery of public infrastructure, but at a reduced cost and in a way that maximises the potential benefits for the public sector more effectively than has hitherto been the case.
Whilst not all of the goals may be achievable (particularly given the current state of financial markets and institutions in Europe), the process of debate and eventual evolution of the model mean that the United Kingdom will remain an interesting jurisdiction for international comparisons.
PPP across Asia PacificOur survey respondents also noted Hong Kong and Singapore as jurisdictions from which Australia might learn, but to a much lesser extent than Canada or the United Kingdom.
Across the Asia Pacific there have been trends towards public private partnerships.
In Asias more developed economies, PPP (also referred to as PFI in Asia) has already become an established tool of public policy, with Japan a leader in the field.
Since enactment of Japan's PFI law in September 1999, 375 PFI projects (asat 31 December 2010) have been carried out, and the PPP model hassteadily become established as a method through which public facilities can be provided.
Amendments to the PFI Law were introduced in June 2010 as part of the Japanese Government's "new growth strategy" aiming to expand the contribution of the PPP model to growth of the wider economy. Changes include encouraging private operation of state owned facilities
...the UK has a more streamlined process, and standardised documents that make the bid costs lower.Respondent Finance and Insurance
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pursuant to a concession, expanding the class of eligible assets, encouraging the private sector to propose opportunities for PPP projects, obliging government to publish plans for PPPs, greater transparency as to PPP terms and encouraging the secondment of government officials to the private sector to improve knowledge sharing.
Interestingly, in light of our survey results, the changes to the law establish the "PFI Promotion Department", as a special department in the Cabinet, with the prime minister as chairman. The PFI Promotion Department is to liaise with and coordinate the actions of other relevant administrative bodies in relation to PFI matters and to ensure that such processes take place smoothly.
In the fast emerging economies of Asia, the continued high economic growth necessitates the development of infrastructure across all sectors of the economy power, water, roads, ports, airports, urban bus and metro lines, health and education facilities.
In Vietnam, a PPP law has been enacted and 28 projects (as at December 2011) have been proposed for consideration by the private sector, with the eight priority projects involving highways, an airport, water treatment plants and hospitals.
In India, it has been estimated that to bridge the infrastructure gap, over Rs 24 trillion (US$500 billion) in investments was required with at least US$150 billion needed from the private sector, over a five year period (2007-2012).
A National PPP Policy has been announced and consultation is underway on the Public Private Partnership (Preparation, Procurement and Management) Rules 2011, Usefully, the Ministry of Finance has established a website - www.pppinindia.com - as a central source of information on PPPs.
...Hong Kong and Singapore [are] jurisdictions from which Australia might learn.
There are a couple of PPPs out there that have gone badly the good ones don't get press.
Respondent - Manufacturing, Wholesaling & Retailing
Im unconvinced about the financial structures of PPPs they are high risk...have been pushed to a point where banks get uncomfortable...Respondent Finance and Insurance
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Current issuesThe responses to our survey raised some thought-provoking issues as to the opportunities for further improvement and advancement ofthe PPP model in Australia. This section of the report contains ourobservations on some of those issues based on the following overall concerns:
How can we make the PPP transaction more efficient?
What is the best way to finance PPPs?
How can we expand the PPP market?
How can we best leverage the tax system?
How can we make the PPP transaction more efficient?Process the fourth "P" of PPPsMany of our survey respondents commented on the PPP procurement process including on matters ranging from the standardisation of documents to probity, and also more substantive matters such as the reimbursement of bid costs and the bidding process. All of these relate to the "process" by which PPPs are developed and awarded and, as our survey reveals, all have the potential to impact upon the market for, and popularity of, delivery of infrastructure by means of aPPP.
Unfortunately, and inevitably, issues of process are usually interconnected, and sometimes work in opposite directions. They cannot be viewed in isolation, and the private sector, as well as government, needs to appreciate where trade offs arise in the pursuit of objectives.
Standardisation of documents, for example, simplifies bidding for a PPP but at risk of compromising flexibility, and it is important that users of standard documents (government and the private sector) understand the documents and particularly what can be departed from, when and why.
A response that a requirement is "standard" or "market practice" is never as effective as a reasoned justification for a requirement. As noted earlier, 83% of respondents favoured a stripped down procurement process, including standard terms and conditions, rising to 91% in the construction industry (Fig. 13) (perhaps understandable given the experience in that sector with well developed Australian standard documents).
Fig. 13Which sectors support a stripped downprocurement process?
PPP evolution or revolution? | 30
PPPs, particularly as they extend to new asset classes, will be highly complex, high value transactions, with much at stake in terms of not only financial issues but also the delivery of public services. Only with a reasonably high volume of transactions in a particular assets class will it be possible to achieve the "commoditisation" of the process that has been seen in so many other forms of financial transactions and in UK PPPs. This is yet another reason for encouraging a strong pipeline of projects which our survey respondents are looking for.
Other process issues deserving of comment are:
Not surprisingly, 86% of our private sector survey respondents supported the suggestion that government guarantees the bidding costs of the losing consortia. Our survey reveals an overall picture of a market looking for opportunities, as the more opportunities the more chances of success and the greater ability to spread costs.
There is presently enormous pressure on private sector proponents to win each transaction due to the heavy investment in bidding costs and because the next transaction may not come for some time.
As welcome as it would be for the Government to bear some of the bid costs, greater efficiency would be derived from improvements to other aspects of the bidding process, as this suggestion merely transfers risks and cost from the private sector to the Government (which is less able to manage this risk).
Absent some fault in the management by the Government of the procurement process or unforeseen abandonment of the project, there seems little to be gained overall by simply passing responsibility for bidding costs from one party to another. Themost effective way of mitigating the adverse impact of bid costs would be to have a larger and more certain pipeline of projects, offering more chances of success and the ability to spread costs further.
73% of our private sector respondents would welcome steps to re-examine government probity processes. There is a significant risk that probity might interfere with the ability to achieve innovation in PPPs. Particularly when new asset classes are under discussion for PPP procurement, there is nothing to be gained by hindering discussion of options outside of the specific brief (and in some projects an interactive, workshopped process to develop the brief is effective). Bidders should be able to explore options with the Government, and obtain feedback, without the Government feeling obliged to create a "level playing field" for all bidders, or as obliged to treat a tender as non-conforming. As noted above, if the outcomes conform, the methods of achieving those outcomes should not be viewed as non-conforming.
30% of private sector respondents supported the suggestion that government guarantees the bidding costs of losing consortia
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Parallel bidding and a BAFO requirement obviously create cost for the private sector (and the Government) but it is hard to see an alternative in complex, high value transactions. Only in high volume, largely commoditised transactions might it be reasonable to expect that the "binding" bids are as well developed as they can be, and that nothing material is to be gained by taking forward two or three of the field of bidders, or requiring them to put forward a "best and final offer".
In more complex, high value transactions, it is to be expected that there may be more value to be extracted by the Government by a period of negotiations with a very small group of bidders. It is, however, reasonable to ask why this should be more than one party. For the private sector, a period of exclusivity is the price they require in order to truly develop the most finely priced and attractive offer (as only exclusivity offers the justification for the investment of the final level of money and other resources to get to a bid as attractive to the Government as possible).
Design reviewA significant proportion of respondents (36%) were dissatisfied or extremely dissatisfied with negotiated outcomes as to design, making it the issue in relation to which the highest level of complaints were made (while noting that a healthy majority of respondents were therefore basically happy at least with how the issue was being handled) (Fig. 14).
There has been much press coverage in early 2012 of the NSW Government's decision to "bail out" the Reliance Rail consortium to keep the troubled rolling stock project on track. This is one of only very few instances of such action by an Australian Government on a PPP contract (Spencer Street Station and the Sydney Airport Rail Link projects being the others).
Press coverage of that project has for some time indicated that a major alleged cause of the delays that have plagued the project has been the very slow and complicated design approval process stipulated by the State Rail Authority.
From our experience, this is only the latest of a number of projects where design approval has been a source of great friction in public/private sector interaction.
The subject is a complex one. Private sector players argue that if government is engaging them for their demonstrated expertise, and placing full design and construction responsibility on them (which carries with it the legal commitment to ensure the end product is fit for purpose, an absolute commitment enforceable regardless
Neither satisfied nor dissatisfied
Fig. 14How satisfied were you with the designapproval process?
PPP evolution or revolution? | 32
of whether the private sector has been negligent or not, backed up by extensive guarantees and bonds which the private sector must provide), then the Government entity involved should concentrate on carefully articulating its end user requirements in the contract specification.
Private sector players argue they should be allowed to get on with the job, free to innovate and determine the best way to ensure they meet their fitness for purpose warranty obligations. If they fail to do so, they argue, the Government can sue for any losses suffered.
On the other hand, government organisations pride themselves on their role as the guardian of the public interest (especially where, as intransport and health sector projects, there are serious safety issues to address). Government is at pains to ensure that it does not, by failing to rigorously review every minute detail of the private sector's design inrecent years, increasingly not only by using their own staff, but also by engaging costly independent consultants leave any risk of a system orequipment failure that might compromise the service to, or safety of, the public.
There is merit in both sides of the debate the problem, however, is thatthe private sector is usually encouraged to commit to very ambitious timelines for project completion.
The major area for concern is that these timelines become greatly threatened (exposing the private sector to delayed cash flow, liquidateddamages liabilities to the Government and to default under their financing documents) if the design review process takes materiallylonger than anticipated. This is especially the case if the review processproduces requests by the Government entity for a myriad of minor detail changes of questionable importance, as it sometimes seems to do.
Of course, the root cause of delay in the process can sometimes be incompletely or unprofessionally prepared design on the private sector's part (or the design not really embodying what was promised in the tender), in which case the private sector cannot complain if its errors are identified. Greater care (or candour) on the private sector'spart on these issues would discourage governments from stipulating excessive bid requirements (like mandating a mark up of thedesign brief).
One way of trying to address these tensions contractually is to provide for deemed approval of designs if the Government fails to indicate its view within a specific negotiated time frame for its review after designsare submitted. Governments, however, often resist being made subject to such strictures, or pragmatically avoid the issue by continuingto issue queries or requests for further information to buy themselves more time.
Private sector players argue they should be allowed to get on with the job.
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On balance, there seems to be a genuine need for governments to look seriously at this practical "log jam" area, and propose pragmatic ways in which their reviewers, both in house and consultants, can minimise the delays to the review processes being experienced currently.
The "knock on" effects of delays to the review process in the context of project finance arrangements and extremely tight PPP timetables are potentially too dire for governments to ignore, and simply do things at the slower pace common on traditionally procured projects, especially given that winning PPP consortia will invariably include carefully selected, technically expert and financially deep pocketed contractors able to stand behind their commitments and fix problems if they emerge.
Governments must try harder to resist the urge to "second guess" the private sector's design approach along the way.
PPPs and other forms of contractingOur survey respondents recognised that PPPs are just one form of project delivery, and some suggested further consideration ofalternatives such as alliance contracting (Fig. 15). It is interesting to consider whether and how alliance contracting principles can be builtinto PPPs.
"Pure" alliance contracts adopt a fundamentally different approach to contract administration and risk allocation between the alliance participants from that adopted in PPP structures by:
Incorporation of a "no blame" clause, under which the parties agree to release each other from legal claims, except in limited andextreme circumstances of "wilful default"
Payment of the non owner participants for their actual costs of performing work (as opposed to margin and profit) in nearly all circumstances (even in instances of delay, negligence, cost overruns and rectification of negligent work) to ensure that a contractor does not incur a loss on the project
Incentivisation of alliance participants by the opportunity for increased profitability by payment of gainshare for "game breakingperformance"
Conversely, margin and profit placed at risk by the painshare regime if the private sector participants fall below pre-agreed benchmarks (including where project costs exceed the target costestimate)
PPP evolution or revolution? | 34
All decisions regarding the management of the project require unanimous agreement between all alliance participants on a "best for project" basis (other than a small number of owner-reserved powers)
Management of the project by a team drawn from all alliance participants, appointed on a "one team" and "best for project" basis.
Whilst the objective of these features of alliance contracts is to incentivise behaviours which deliver better project outcomes (including on both budget and program), they do not provide the apparent certainty of a traditional fixed price/ fixed completion date construction contract and clear legal rights of recourse invariably required by financiers of PPP projects to date.
For this reason, alliance contracting has so far been rejected as insufficiently "bankable" for use in PPP projects. Proponents of alliancing argue that the supposed certainty of traditional construction contracting is greatly overstated and a true comparison of the risks of both procurement methods demonstrates that alliance contracts are in reality significantly less risky, and more reliable on time and cost outcomes, than traditional procurement.
Alliance contracting also offers a greater degree of flexibility than traditional PPP structures to respond to scope change arising during the lifespan of a project (e.g. due to demographic, technological or government policy changes).
Notwithstanding these features of "pure" alliance agreements, the apparent gap between alliance contracts and PPP structures may be able to be bridged in the following ways to make alliances bankable:
Careful structuring and due diligence regarding operation of the gainshare/painshare mechanism to ensure that it creates a comprehensive and consistent commercial incentive to successful delivery of the project
Provision of completion guarantees by non-owner alliance participants and key suppliers and subcontractors
Deadlock breaking mechanisms to avoid the "nuclear" option of dissolution of the entire alliance structure
Specialised insurance regimes which respond in the absence of legal liability between the alliance participants
Requirements for greater initial subscription of equity or standby contingent equity or financing for use in the event that costs overrun the target outturn costs, recognising that this will add to the costs of the project
Neither agree nor disagree
Fig. 15Do you agree that governments should bemore open to procuring infrastructure via alliancing or relationship contracting?
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Potential for competition between PPP consortia only in respect of suitability to perform the owner/operator role, leaving the successful proponent to tender the construction and financing of the project as "Reimbursable Costs", with the tendered costs of finance and construction subsequently paid by government on an open book basis
Engagement of third party subcontractors and suppliers to performpackages of works on traditional legal fixed cost/fixed time/legal recourse contracts (including collateral warranties to financiers)
Use of "hybrid" alliance contracts under which specific liabilities are retained by and enforceable against the non - Owner participants (although this risks undermining the benefits of "pure"alliances).
Adoption of the above suggestions, coupled with increasing academic studies showing favourable comparative outcomes of alliances following rigorous investigation of projects procured on an alliance basis, could see a greater willingness by both government and the private sector to incorporate alliance principles in PPP projects.
What is the best way to finance PPPs?Bond markets One of the key recommendations in the IA issues paper is that action be taken to revitalise the project bond market.
The bond market has historically provided a useful tool for project financing as bonds typically have long tenors and sharper pricing. The disappearance of the bond market after the global financial crisis has had a significant and adverse effect on PPPs.
Unsurprisingly, 78% of respondents found the establishment of an infrastructure bond market to have a positive impact on the PPP procurement process (Fig. 16). On the other hand, little concrete detail exists as to how they might reinvigorate the market.
In their issues paper, IA discussed tax concessions or direct grants attached to bonds to make them more attractive. Their commentary reflects an underlying suspicion of this proposal. For example, they suggest that much of the benefit might be captured by financiers, and note that experience showed indifferent results in leveraging tax advantages in this way.
In our view, it is likely that the advantage to be derived from attaching tax concessions to bonds would be marginal (although much would depend on how generous the tax concession was). Rather than
Fig. 16Which innovations have had a positiveimpact on the PPP process?
PPP evolution or revolution? | 36
a stream of new projects, such a concession might contribute to perhaps just one or two. The cost of the administrative burden might outweigh the advantage.
One item not addressed in the IA report is to examine the ratings system for project bonds. Traditionally, unwrapped project bonds have had a shadow rating of investment grade (BBB+). This is out of the range of some investment funds. There is, however, a good argument that based on their track record project bonds, at least for availability payment based projects, should enjoy a much higher rating. This could have a significant effect on the market.
In the medium term, another option may be to revive the monoline insurer model, particularly by a clear focus by one of the remaining AAA rated monoline insurers on the project bond market. It is noted that it was not project bonds that caused the ratings of most of these insurers to be reviewed, but rather their participation in the subprime mortgage area.
The most substantial factor which, in our view, would contribute to the revival of the PPP bond market is to facilitate the participation in the market by superannuation funds.
Superannuation fundsIA devotes part two of its issues paper to superannuation. It examines a number of particular areas in which superannuation funds could be encouraged to invest in the bond market. It discusses a number of issues, including:
A mandate for Australian superannuation fund trustees to participate in infrastructure as an investment class
Focus on a long term pipeline to give certainty to funds
Making available infrastructure expertise.
The suggestion that superannuation funds be mandated by law to invest in Australian infrastructure should, in our view, be dismissed.
Superannuation funds themselves indicated that despite the stringent asset class risk limits, the main constraints are not a lack of desire to invest in the industry but rather impediments that make it less attractive than other assets. The principal concerns were in regards to competing bid costs. A mandate would not repair these issues. Similarly, the repair of these issues would make a mandate irrelevant. Overall, it would, in our view, cause more harm than good to mandate as it might have the effect of making some funds involuntarily overexposed to this sector.
Theres a need to spend some political capital to convince the public that some of these public assets even social infrastructure like schools and hospitals could be privately owned.Respondent Power, Utilities & Infrastructure
37 | Baker & McKenzie
The concern in relation to deal flow expressed by superannuation funds is the same concern held by the market as a whole. Private sector survey respondents almost uniformly agreed (90%) that the publication of a project pipeline would be welcomed, and that there are not enough current PPP opportunities (73%).
Expertise may be of concern, with many funds lacking the capacity for project evaluation. Some had previously relied on the monoline insurers to fulfil that role. Although this concern is true in general terms, it is caveated in the context of individual funds. For example, funds manager