Public-private partnerships

By John O’Dea*,

The PPP Knowledge Lab defines a PPP as “a long-term contract between a private party and a government entity, for providing a public asset or service, in which the private party bears significant risk and management responsibility, and remuneration is linked to performance”.

A fundamental feature in PPP is that normally the government does not own the infrastructure, but rather contracts to buy infrastructure and related ancillary services (such as an electricity generating plant) from the private sector over a pre-determined period of time.

This is a BOT (Built-Operate-Transfer) where the private entity either agrees to transfer the asset to government (with or without payment) after a period of time, or a BOO (Build-Own-Operate) project where the private sector entity effectively finances, builds, owns and operates the infrastructure facility in perpetuity.

Another model, which is a “concession” is the management of existing facilities (e.g. hospital facilities) over a pre-determined period of time against a fee.

According to Weimer and Vining, “A P3 typically involves a private entity financing, constructing, or managing a project in return for a promised stream of payments directly from the government or indirectly from users over the projected life of the project or some other specified period of time”.

“Any venture or project needs to be structured to achieve optimal risk allocation to deliver value for money.”

But PPP projects are not principally about the private sector financing public infrastructure. Financing is only one element of the computations. The very essence of a PPP is that the government does not primarily purchase an asset, but a service under specified terms and conditions, and it is this element that provides the key to the viability or non-viability of the project.

A PPP is basically a risk-sharing relationship. Any venture or project needs to be structured to achieve optimal risk allocation to deliver value for money (VFM). A PPP will not deliver value for money if sufficient risk cannot be transferred from government to the private entities participating in the project.

On the other hand, transferring or rather offloading inappropriate forms of risk only serves to add unnecessary costs to a PPP agreement. Unlike the government, the private sector always seeks to maximise its profits and consequently will only bear risks at a price.

It is therefore crucial that only efficient levels of risk be transferred. Risk management (identification, assessment, allocation and mitigation of risks) is central to determining the success of the project and achieving value for money.

In all cases, the partnerships include a transfer of significant risks to the private sector, generally in an integrated and holistic way, minimising interfaces for the government. An optimal risk allocation is the main value generator for this model of delivering public service. The notion of risk-sharing implies that both parties to the agreement have something to lose if the partnership underperforms.

A PPP is a high-trust relationship. Underpinning the partnership will be a framework contract which sets out the working conditions and guidelines, delineating among other things which risks will be allocated to which party.  This will provide the parties with some measure of certainty. For example, the government always retains the right to fine the private entity for late delivery of the project. While a standard PPP contract provides the basic architecture of the agreement, it does not and cannot possibly specify all components and allow for all outcomes. A PPP, like all successful partnerships has to be built on trust.

There are a number of advantages for the government resorting to PPPs. One involves the allegation that PPPs enable the public sector to harness the expertise and efficiencies that the private sector can bring to the delivery of certain facilities and services traditionally procured and delivered by government.

Another is that PPPs may be structured so that the public sector body seeking to make a capital investment does not incur any borrowing. Rather, the PPP borrowing is incurred by the private sector vehicle, normally a Special Purpose Vehicle (SPV), created specifically for the purpose of the project.

The upshot is that a PPP contract differs from a standard procurement contract because it is not a traditional supplier/purchaser relationship. Under a PPP agreement the parties allocate risks between them and work together in an ongoing relationship to meet project objectives.

*John O’Dea is secretary general and a member of the board of PRIMO (Public Risk Management Organisation) Europe.