SSRN_ID1520939_code343577
-
Upload
prasenjit-sutradhar -
Category
Documents
-
view
222 -
download
0
Transcript of SSRN_ID1520939_code343577
-
8/7/2019 SSRN_ID1520939_code343577
1/15
-
8/7/2019 SSRN_ID1520939_code343577
2/15Electronic copy available at: http://ssrn.com/abstract=1520939
Financing Sustainable Infrastructure - Assessing the Risks
in Public Private Partnership Models
What is Infrastructure?
Infrastructure is easier to recognize than define.1 The term infrastructure means and include
Energy (power generation and supply), Transport (roads, rails, tunnels, bridges, ports and
airports), Water (freshwater provision, sewage disposal), Telecommunications and Social
Infrastructure (hospitals, prisons, courts, museums, schools and government accommodations).
Infrastructure is a complex technical system that provides us with a varied range of valuable and
essential services. They have great effects on economy and social relations. Their availability is
an essential tool for geographic and social integration and, consequently, they facilitate the
reduction of poverty.
The operational definition for the term sustainable infrastructure is infrastructure for sustainable
development. Further the term sustainable development cannot be divided into the two words
that form it but it should be taken as a wide, integrated and unified concept. Some of the recent
conferences held across the world clearly established that Human beings are the centre of
concern for sustainable development.2
Financing of Infrastructure:
Traditionally, governments have had the chief responsibility of managing the process of
infrastructure provision, especially funding. But of late governments across the globe are not in a
position to build the needed infrastructure, maintain existing assets and to replace worn-out
assets. Several factors are attributable for this, to name a few, rapid rise in construction cost,
changing economic conditions, tax and expenditure limitations, growth in the size of the
1
-
8/7/2019 SSRN_ID1520939_code343577
3/15
government workforce and public bureaucracy, governments' budgetary constraints, sectoral
reforms, changes in priorities, technological development, and globalization of financial markets.
So, the traditional role of public sector infrastructure development is undergoing major change as
governments in developing countries seek to bring private sector investment into infrastructure
services. A variety of means are currently used throught the world to finance infrastructure in
new areas and many countries have attempted to apply alternative and innovative methods to
address this issue.
PPP around the Globe:
The Public Private Partnership (PPP) notion is used throughout the world with a range of
meanings. In the United States, PPPs have traditionally been associated with urban renewal and
downtown economic development, while the UK Private Finance Initiative (PFI) was introduced
by the Conservative Government in 1992. Public Private Partnerships have also been viewed as a
tool for providing public services and developing a civil society in countries like Portugal, Italy,
Netherlands, Greece, Ireland, Hungary, Israel, China and India. The PPP definition in Australasia
is that government has a business relationship, long term in nature, with risks and returns being
shared, and that private business becomes involved in financing, designing, constructing, owning
or operating public facilities or services.
PPPs can be explained as agreements where government or public sector undertaking enters into
long-term contractual agreements with private sector entities for the construction or management
of public sector infrastructure facilities or provision of services to the community on behalf of a
public sector entity. PPPs can take many forms and may incorporate some or all of the following
features, although this is not a definitive or complete listing.
2
-
8/7/2019 SSRN_ID1520939_code343577
4/15
Design-Build (DB): The private sector designs and builds infrastructure to meet publicsector performance specifications, often for a fixed price.
Operation & Maintenance Contract (O & M): A private operator, under contract,operates a publicly-owned asset for a specified term. Ownership of the asset remains with
the public entity.
Design-Build-Finance-Operate (DBFO): The private sector designs, finances andconstructs a new facility under a long-term lease, and operates the facility during the term
of the lease. The private partner transfers the new facility to the public sector at the end of
the lease term.
Build-Own-Operate (BOO): The private sector finances, builds, owns and operates afacility or service in perpetuity. The public constraints are stated in the original
agreement and through on-going regulatory authority.
Build-Own-Operate-Transfer (BOOT): A private entity receives a franchise to finance,design, build and operate a facility (and to charge user fees) for a specified period, after
which ownership is transferred back to the public sector.
Buy-Build-Operate (BBO): Transfer of a public asset to a private or quasi-public entityusually under contract that the assets are to be upgraded and operated for a specified
period of time. Public control is exercised through the contract at the time of transfer.
Operation License: A private operator receives a license or rights to operate a publicservice, usually for a specified term. This is often used in IT projects.
Finance Only: A private entity, usually a financial services company, funds a projectdirectly or uses various mechanisms such as a long-term lease or bond issue.
3
-
8/7/2019 SSRN_ID1520939_code343577
5/15
According to the World Banks (Private Participation in Infrastructure) database, among private
investment attracted for 534 projects from 2000-06 in top ten developing countries.3
About 100
billion has been committed by the Tony Blair government for 400 Private Finance Initiative
(PFI) contracts in the UK and little over AUD$20 billion of private finance may be channeled
into the public assets over the coming five years.4 In some countries around the world, specific
statutes have been enacted to regulate PPP transactions, the largest of which is China, which
embraced this model to prepare infrastructure for the recently concluded 2008 Olympic Games.
One of the most significant developments in India in the last few years has been the putting in
place of laws to allow private money to be invested in infrastructure through Public Private
Partnership (PPP) franchises. The government set up the India Infrastructure Finance Company
Limited (IIFCL), a Special Purpose Vehicle (SPV) to help facilitate PPP deals and also to
conduct feasibility study. To attract larger investments in infrastructure development, the
government has also set up an Infrastructure panel to look into long term funding for
infrastructure projects. Till 29th October 2008, US$ 13,284 million on 65 different proposals
largely on roads, rails and ports were approved by the Indian government across the different
states of the country and another proposals worth US$2,211 is awaiting for the approval. 5
4
-
8/7/2019 SSRN_ID1520939_code343577
6/15
Exhibit No.1
Different PPP Models and Degree of Risk Transfer and
Private Sector Involvement
Models of Public-Private Partnerships:
As stated earlier one can conceive of many models for the PPPs, but the following are some of
the common models. Various other models can also be envisaged.
DegreeofPrivateSectorInvolvement
P
P
P
M
o
d
e
l
DesignBuild
Operation&Maintenance
Build Finance
BuildFinanceMaintain
BuyBuildOperate
DesignBuildOperate
DesignBuildFinanceMaintain
DesignBuildFinanceOperate
DesignBuildFinanceOperateMaintain
BuildOwnOperateTransfer
5
D
e
g
r
e
e
O
f
P
ri
v
a
t
e
S
e
c
t
o
r
R
is
k
-
8/7/2019 SSRN_ID1520939_code343577
7/15
FIGURE NO. 1 FIGURE NO. 2
The above models (figure nos.1 and 2) are basically relies on the vendors ability to fund the
project and run it independently of the public sector partners intervention. The public enterprise
authority is vested with the private partner for a limited period of time. An effective monitoring
and evaluation framework is needed for implementing such a model. Invariably the business is
run under strong business related Service Level Agreements (SLA). While the vendor shares the
entire financial risk of the venture, the government shares the risk of loss of administrative
control leading to citizen dissatisfaction. However, given the current low satisfaction levels with
government services amongst the citizens, it is expected that this model will lead to improvement
in these levels rather than deterioration of service levels. Accordingly it is considered appropriate
for the private vendor to have a larger share of the revenue in this model of PPP. This model is
particularly suitable where the capital investment is low and many private vendors can be
attracted to invest in to the venture. Where the revenues can be predicted with certainty, the fixed
pay off variant will be useful. However when revenue figures are completely unpredictable
variable pay off will be more useful and appropriate.
6
Fixed Pa Off Model
Fixed Pa Off
Govt. Vendor (SPV) Business
Run Business
Revenue
Administrative Control Ca ital Investments
Variable Pay OffModel
Govt. Vendor (SPV) Business
Part of
Variable Payoff
Revenue
Administrative Control Ca ital Investment
Run Business
-
8/7/2019 SSRN_ID1520939_code343577
8/15
FIGURE No. 3. FIGURE No. 4
Fixed Pay Off with Capital investment Variable Pay Off Capital investment
by Government by Government
In these models (figure nos.3 and 4) the capital investment is done by the government and the
business is run by the private partner. This model is especially useful where the government
wishes to utilize the efficiency of the private sector in running important citizen services.
However the capital costs are high enough for private enterprises to be in a position to invest in
to the project. The governments ability to invest high capital and the private vendors ability to
run the business efficiently is combined to provide a best of breed solution. The entire financial
risk in this model is taken by the government. The government also incurs the administrative risk
of project failure and subsequent loss of credibility amongst the citizens. Thus these models need
to be run under strong Service Level Agreement. Government needs to exercise close control
over the vendor in this model. Government also becomes the major beneficiary of the revenue
generated through this model. Large facilities like Hotels and hospitals may be run using this
model. These models can be used for running of large airports, rail stations and ports. When
revenue generation is not linked to the services provided by the private vendor, the fixed pay off
model will be used. However when the services provided by the private vendor directly impact
the revenue generation process, the variable pay off model should be used.
Govt. Vendor (SPV) Busines
Fixed Pay Off Run Business
Revenue
Capital Investments
Govt. Vendor (SPV) Busines
Variable Pay Off Run Business
Revenue
Capital Investments
-
8/7/2019 SSRN_ID1520939_code343577
9/15
FIGURE NO. 5
Variable Pay off Run Business
The above two models (figure nos.5 and 6) tries to divide the risk and return between the PPP
partners equally or in an agreed ratio. Both partners invest capital in to the project. Returns are
shared as per the original capital investment ratio or may be on the risk perception of the
partners. Projects requiring large capital like oil refining etc may fall under above category. This
model tries to distribute the risk and return between the PPP partners. Invariably the vendor will
also have a large stake in the success of the project. Thus these models are likely to work with
fair degree of autonomy to the vendor. Government may make initial investments and then
accrue annual revenue for their investments. Where the revenues can be predicted with certainty,
the fixed pay off variant will be useful. However when revenue figures are completely
unpredictable variable pay off will be more useful and appropriate.
Assessment of Risks:
The nature of the risks changes over a period of time of the project. Most of the risk of a PPPs
comes from the mere complexity of the arrangement itself in terms of documentation, financing,
taxation, design, process, sub-agreements and the like. At least ten risks face by PPPs involving
infrastructure project:
8
8
Capital Investment by both and
Fixed Pay Off Model
Fixed Pay Off
Govt. Vendor (SPV) Business
Run Business
Revenue
Administrative Control Ca ital Investments
Govt. Vendor (SPV) Business
Revenue
Administrative Control Ca ital Investments
Capital Investment by both and
Variable Pay Off Model
FIGURE NO. 6
-
8/7/2019 SSRN_ID1520939_code343577
10/15
(i) Technical risk, owing to engineering and design failures;(ii) Construction risk, may occur because of faulty construction techniques, cost
escalation and delays in construction;
(iii) Operating risk, because of higher operating and maintenance costs;
(iv) Revenue risk, due to volatility of prices and demand for products and services whichleads to revenue deficiency;
(v) Financial risk, owing to variability of interest, exchange rates, inadequate hedgingfor the same and all factors that can influence the cost of financing the project;
(vi) Fore majure risk, involving war and other natural calamities and disasters;(vii) Political risk, because of change changes in law, unstable government and policies;(viii) Environmental risk, owing to adverse impact on environment and hazards;(ix) Residual value risk is related to the future market price of the asset. This is important
if property of the assets needs to be transferred back the government at the end of a
certain period of time.
(x) Project default risk, because of failure of the project from the combination of any ofthe above.
Most of the above cited risks are common to any PPP, in some PPPs agreements, revenue risk
might be very low and indeed insignificant. For instance, the projected revenue from a toll bridge
might be more assured than that of an oilfield. In principle, the risks of PPPs can be evaluated by
9
-
8/7/2019 SSRN_ID1520939_code343577
11/15
-
8/7/2019 SSRN_ID1520939_code343577
12/15
various future outcomes are merely wild guesses. Risks can be insured, diversified, computed
with different probabilities whereas true uncertainty or disaster scenarios are different.
Exhibit No. 2
Analytical Approach Towards Risk Assessment
Entity Risk Perspectives Key Variables Major Risks Risk Analysis
Note: Basic Framework is adopted from Grimsey and Lewis 2002
Can a Public Infrastructure need best be met through a partnership with a Private Sector?
The answer to the above question yes because PPPs are a win-win-win partnership. From the
governments point of view, it takes care of the infrastructure backlog, stimulate economic
Govern-
ment
Value-for-
Money
Contingent
risk
NPV of
Project
Capability of
SPV and
Interest
rates
Expected
Cost
Sensitivity
of risks
Special
Purpose
Vehicle
Impact on
return
IRR on
Equity
Demand
Factors,
Price
sensitivity,
Life of the
Project,
Performance
Monte
Carlo
simulation
Lender /
Banker/Bond
holders
Default/
Delays oninterest
and
principal
Interest
coverage
ratios,Debt
Equity
ratios
Downside
Sensitivity
analysis
Demand
FactorsPrice
sensitivity
Life of the
project,
Performance
11
-
8/7/2019 SSRN_ID1520939_code343577
13/15
growth, create jobs, transfers costs and risks from public sector. Basically, government seeks to
utilise private sector finance in the provision of public sector infrastructure and services and
thereby achieve value for money. Value for money is defined as the effective use of public funds
on a capital project, can come from private sector innovation and skills in asset design,
construction techniques and operational practices and also from transferring key risks in design,
construction delays, costs overruns to private entities for them to manage.
From the project sponsor point of view PPPs or PFI is essentially a variation in project financing
characterised by the creation of a SPV for the project with the objective of making direct
revenues to pay for operating costs, interests costs on debt and providing the desired return on
the risky capital. From the users perspective they are getting the infrastructure / services
delivered on time and budget and better value for money.
Conclusion:
Though PPPs have evolved from the project finance space, they are quite different in terms of
complex contractual agreements, governance and accountability measures. The empirical
evidences across the globe indicate that PPPs have the potential to provide infrastructure at more
reasonable prices than comparative delivery through the public sector.4 In PPPs governments
shifts the risk to the private sector that is best known to manage risk. Moreover, the basic
objective for the governments is to achieve value for money in the services provided at the same
time makes sure that the private sector entities meet their contractual obligations properly and
efficiently. Value for money and risk sharing are the two building blocks on which the PPPs are
built with the support of robust, long term revenue stream and over the period of time. In order to
guarantee value for money, the relative strengths and weaknesses of each PPP scheme should be
12
-
8/7/2019 SSRN_ID1520939_code343577
14/15
considered. Depending on the sector of application, some models are better suited than others in
delivering targeted outputs and in ensuring accurate risk management. Choosing the wrong
model or inaccurately evaluating the risk management capacities of each party may have
extremely costly consequences and a negative impact on public accounts. This paper only
touches the surface of different financial models perceived in structuring a PPP deal as well
assessing the risks associated with them in an infrastructure framework. Each of these models
can be investigated further for risk return patterns and advantages gained to government and the
private enterprise to arrive at well structured PPP contracts.
13
-
8/7/2019 SSRN_ID1520939_code343577
15/15
References:
1. Canadian Council for Public Private Partnerships, Position Paper, Retrieved on 21 stAugust 2008 from www.pppcouncil.ca
2. Conrado Bauer, Investing in sustainable Infrastructure Worldwide Role of theEngineering Community retrieved on 20th August 2008 from www.worldbank.org
3. Devapriya and F. Pretorius (2002). The Economic Implication of Project FinanceArrangements for BOO / BOT Power Projects in Asia, Journal of Construction Research,
Vol 3. No.2, 285-309
4.
Grimsey, Darrin and Lewis K. Merwyn (2002), Evaluating the risks of public private
partnerships for infrastructure projects, International Journal of Project Management,
107-188
5. Hodge A Greame (2004), The Risky Business of Public Private Partnerships, AustralianJournal of Public Administration, 63 (4):37-49, December
6. Knight Frank. Risk, uncertainty and profit. Boston: Houghton Mifflin, 19217. Private Participation in Infrastructure Database retrieved on 21st August 2008 from
http:\\ppp.worldbank.org
14