Around the world there is a growing use of public-private partnerships ("PPPs" or "P3s") by all levels of government to meet the need for a wide range of public infrastructures such as roads, bridges, hospitals and schools. Once found in only a few countries and sectors, PPPs are emerging as an important model for infrastructure projects.
The United Kingdom was one of the first to pioneer this trend, beginning with its Private Finance Initiative ("PFI") in the 1980's. Since then, countries as varied as Australia, France, Netherlands, Japan, Brazil and India – as well as Canada – are increasingly relying on PPPs as the model of choice to deliver public infrastructure.
What is different about a public-private partnership?
A PPP has been defined as "a partnership agreement in the form of a long-term performance-based contract between the public sector (any level of government) and the private sector (usually a team of private sector companies working together) to deliver public infrastructure for citizens."1 It is interesting that a separate revenue stream like a toll road is not essential – the partnership can involve any type of infrastructure, ranging from highways and bridges to hospitals, schools and more.
In traditional government procurement, the government essentially borrows directly the necessary capital for the project in the form of a government bond, pays a contractor to build the facility, and repays the debt and interest over the life of the bond. The bond is secured by the general credit of the government, and so the government carries all the financial risk of the project. In a PPP project, the government has private sector partners with their own equity at risk in the project.
The debt financing relies on the contracted payments from the project itself – analogous to mortgage payments – not the "full force and credit" of the government. As a result, the equity and debt partners in a PPP project are highly motivated to conduct thorough due diligence on the project risks, and they work directly with the design, build and maintenance companies in the team.
One of the characteristics of a PPP project is the resulting highly sophisticated parsing of risks in the contractual arrangements between the design, construction, financing, operations and maintenance members of the bid team. In effect, the government participant obtains highly motivated assistance in the due diligence for the project, and can therefore place its focus on specification of the outcome.
What are the benefits of PPPs?
Although not advocated for any and all infrastructure projects, proponents of PPPs maintain that, where they are suitable, they offer several benefits as compared to the traditional methods of public procurement.
- PPPs allow the costs of the investment to be viewed over the lifetime of the asset. Since the project evaluation is based on the net present value of all the costs that will be incurred over a period of, say, thirty-five years, the designers can take a long-term view – considering, for example, whether a better-quality road surface today will save maintenance costs in 20 years time. This is not always practicable in traditional procurement, where up-front capital costs can be the primary focus and constraint.
- PPPs are intended to measure risk and place it with the party best able to manage it. When an equity partner has its entire investment at risk, or when a bank can look only to the particular project itself for repayment of their loan, both are highly motivated to control the project costs.
- The private sector typically assumes the risk associated with the design, build, financing and maintenance of the project. The whole lifecycle approach and the use of performance-based incentives give the competing teams of bidders the flexibility and encouragement to adopt innovative approaches that yield cost savings.
- Finally, PPPs generally have an enviable track record for on-time, on-budget delivery. The private sector has a strong incentive to complete the project as quickly as possible in order to start the stream of "mortgage payments" that will be paid by the government over the life of the asset.
Critics of the PPP concept argue that PPPs must be more expensive than direct procurement, because bank financing will always cost more than the rate on government bonds. PPP proponents respond that the interest rate "spread" between government bonds and commercial financing is a measure of risk, and the absence of a measurement of risk in traditional procurement is not the same as the absence of risk. In a PPP project, not only has the project risk been measured and subjected to extensive due diligence, the government also has partners with their own funds participating in that risk.
In a PPP project, the government's role shifts from directing and managing the project to specifying and overseeing the service levels required of the project. PPPs allow governments to focus on the outcome of the project and thereby ensure that public interests are served.
1 Partnerships British Columbia, Understanding Public Private Partnerships, (www.partnershipsbc.ca ).
Copyright 2010, Wolrige Mahon LLP
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