Updated: 20th March 2007
FINA 522:
Project Finance and Risk Management
Lecture Four
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PUBLIC PRIVATE
PARTNERSHIPS
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Private Public Partnerships in
Infrastructure
• A major new user of project financing techniques
• Infrastructure traditionally financed and managed by
governments
• Demand for infrastructure has been growing faster than
government funding available, particularly in emerging
economies.
• Recent trend has been to involve the private sector in
the supply and provision of these services
• For example: Roads, Bridges and Tunnels, Light Rail
Networks, Airports and Airport control Systems, Water
and Sanitation, Electricity Generation, Hospitals,
Schools, Prisons
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Private Public Partnerships in Infrastructure
• For a PPP to be successful, there has to be
a clear benefit for both the public and the
private partners
• In the spectrum of public sector verses
private sector service delivery, PPPs lie
somewhere between simply the government
contracting –out of a set of service delivery
to the private sector and a complete private
market to plan, design, build and operate a
facility that provides the service
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Private Participation in Infrastructure
(PPIs)
• Private sector involvement requires
commercial rates of return
• Projects have to lend themselves to
generating these returns.
• The public partner typically gains in the
sense that a desired project is
implemented without any financial strain
on the budget
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Private Participation in Infrastructure
(PPIs)
• In many instances, the governments
receive tax payments from the project, and
in certain cases, a share of the profits.
• The structure of the partnership can vary
along a spectrum from a leading private
sector role to a marginal one.
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Different PPP Models
Degree of Private Sector Risk
Privatisation
Buy-Build-Operate
Build-Own-Operate
Build-Own-Operate-Transfer
Build-Lease-Operate-Transfer
Lease-Develop-Operate
Design-Build-Operate
Operation / Maintenance
Service /License
Design-Build
Government
Degree of Private Sector Involvement
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Public-Private Partnership Models
• Design-Build (DB): Under this model, the government
contracts with a private partner to design and build a
facility in accordance with the requirements set by the
government. After completing the facility, the government
assumes responsibility for operating and maintaining the
facility. This method of procurement is also referred to as
Build-Transfer (BT).
• Design-Build-Maintain (DBM): This model is similar to
Design-Build except that the private sector also
maintains the facility. The public sector retains
responsibility for operations.
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Public-Private Partnership Models (Cont.)
• Design-Build-Operate (DBO): Under this model, the
private sector designs and builds a facility. Once the
facility is completed, the title for the new facility is
transferred to the public sector, while the private sector
operates the facility for a specified period. This
procurement model is also referred to as Build-TransferOperate (BTO).
• Design-Build-Operate-Maintain (DBOM): This model
combines the responsibilities of design-build
procurements with the operations and maintenance of a
facility for a specified period by a private sector partner.
At the end of that period, the operation of the facility is
transferred back to the public sector. This method of
procurement is also referred to as Build- OperateTransfer (BOT).
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Public-Private Partnership Models (Cont.)
• Build-Own-Operate-Transfer (BOOT): The government
grants a franchise to a private partner to finance, design,
build and operate a facility for a specific period of time.
Ownership of the facility is transferred back to the public
sector at the end of that period.
• Build-Own-Operate (BOO): The government grants the
right to finance, design, build, operate and maintain a
project to a private entity, which retains ownership of the
project. The private entity is not required to transfer the
facility back to the government.
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Public-Private Partnership Models (Cont.)
• Design-Build-Finance-Operate/Maintain (DBFO, DBFM or
DBFO/M): Under this model, the private sector designs,
builds, finances, operates and/or maintains a new facility
under a long-term lease. At the end of the lease term, the
facility is transferred to the public sector. In some countries,
DBFO/M covers both BOO and BOOT. PPPs can also be
used for existing services and facilities in addition to new
ones. Some of these models are described below.
• Concession: The government grants a private entity
exclusive right to provide operate and maintain an asset over
a long period of time in accordance with performance
requirements set forth by the government. The public sector
retains ownership of the original asset, while the private
operator retains ownership over any improvements made
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during the concession period.
Public-Private Partnership Models (Cont.)
• Service Contract: The government contracts
with a private entity to provide services the
government previously performed.
• Management Contract: A management
contract differs from a service contract in that the
private entity is responsible for all aspects of
operations and maintenance of the facility under
contract.
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Public-Private Partnership Models (Cont.)
• Lease: The government grants a private entity a
leasehold interest in an asset. The private
partner operates and maintains the asset in
accordance with the terms of the lease.
• Divestiture: The government transfers an asset,
either in part or in full, to the private sector.
Generally the government will include certain
conditions with the sale of the asset to ensure
that improvements are made and citizens
continue to be served.
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Public Private Partnerships (PPPs)
 Main characteristics of PPPs are:
1. Private sector is given responsibilities for one or
more of the following tasks:
i.
ii.
iii.
iv.
v.
Defining and designing the project
Financing the capital costs of the project
Building the capital physical assets (road, bridge)
Operating and maintaining the assets in order to deliver the
product/service
Significant risks is transferred from the government to private
sector
2. Bundling of responsibilities or the
allocation of two or more tasks to a
unique partner(s)
3. Allocation of the financing task, private
financing.
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Public Private Partnerships (PPPs)
Why PPPs have become an alternative to traditional methods for the provision
of public services?
1. Ex ante Competition (Private sector firms compete to do project)
 Marshaling the pro-efficiency forces of competition lowers
costs.
 Competition at the bidding stage, ex ante.
 Less likely that tax payers will get value for money their if
such ex-ante competition does not exist
2. Scarce Skills
 Private sector has skills not available in the public sector
 Allocate certain tasks to a private partner who has the skills
and also the incentive to reform at a high level
3. Poor Labor Relations
 Private sector through the forces of competition may offer
a skilled, efficient and flexible labor force. The public sector
labor management may be inflexible due to tradition, civil service
laws, and political protection of certain groups of workers
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Public Private Partnerships (PPPs)
4. Innovation
 Some parts of the project may need new approaches and
innovative thinking
 The extend of PPPs will depend on the complementarities
between the tasks
5. Risk
 Major risk can be managed better by private sector (ex.
construction-delay risk, being contractor and operator give
incentive to minimize such risk)
 Political risk is better managed by public sector
6. Economies of scale
 Private sector is taking advantage of economies of scale from
the operation of similar project in other jurisdictions, the PPP
option becomes more attractive
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Public Private Partnerships (PPPs)
7. Observability and measurability of quality
 Concerns about the quality of services
 The partnership agreement should specify the required
quality, provide the measurement of verification of quality and
provide for enforcement of the contracts’ requirement.
8. Constrains on public sector borrowing
 Being in depth and further borrowing risk on deteriorating of
government, credit rating cost of borrowing increases
 Allocating the financial tasks to the private sector
PPPs should be embraced only when they allow government to provide
services of an acceptable quality at lower cost to taxpayers
(consumers)
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Risk Analysis
• PPPs involve a range of risks:
– Construction risks: relate to deign problems, building
cost overrun and project delays
– Financial risks: variability in interest rates, exchange
rate and other factors affecting financing costs
– Availability risks: relate to continuity and quality of
service provided and in turn depend on “availability”
of an asset
– Demand risks: relate to ongoing need for the service
– Residual value risk: relate to future market price of
assets
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Risk Analysis
• It is necessary to achieve significant risk transfer in order
to derive the full benefits from the capital inflows from the
private sector and the management change
• Financing costs of risk transfer and pricing of risk are
important in efficient allocation of risks
• Risk Transfer and Financing Costs
– With complete market in risk bearing, project risk is not affected
by the particular source of financing (finance theory)
– Incomplete markets in risk bearing affect project risk as sources
of financing defines the risk of project
– Various sources of financing will determine how this risk will be
allocated
– Private sector transfers risk to financial markets
– Governments transfer it to taxpayers in general
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Risk Analysis
• Pricing of Risk
– To use PPPs, government must compare cost of
public investment and provision of service with
using PPPs to provide the service
– PPPs sometimes are an efficient way for
government to relieve its risks
– Government has to pay for the risks that it
transfers to the private sector
– Project-specific risk (e.g. interruption of supply
of building materials, labor problems, unfavorable
weather, etc) can be diversified across a number
of government or private sector projects and need
not be priced by the government
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Risk Analysis
– Market risk reflects the economic
developments that affect all projects and
cannot be diversified and should be priced
properly
– private sector demands a discount rate
that includes a risk premium on the risk
free discount rate that typically
government uses
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Competition and Regulation in PPPs
• Private sector efficiency is main reason for PPPs
• Competition is the important source of efficiency
in both the private and public sector
• Competition in award of construction and service
contracts necessary to foster competition,
managerial improvement and spur innovation
• In the case where private sector sells to public
sector, there is little scope for competition after
the contract is awarded and government usually
regulate prices
• Price regulation and incentive based regulations
are used to increase output, hold down prices,
limit monopoly profits
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Prerequisites for PPPs Success
•
•
•
•
Political commitment
Good governance
Government expertise
Effective Project Appraisal and Selection
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Risk Transfer
• Need for Risk Transfer to the Private Sector
– Determines whether PPPs is a better option than to have
public investment and government provision of service
– Influences the appropriateness of accounting and
reporting treatment of PPPs
• Risk Transfer and Ownership
– PPPs are legally owned by private and are legally
mandated to bear the risks of the project
– If government bears ownership related risks, it is in effect
the owner of the asset, and in that case the PPPs will be
indistinguishable from traditional methods of financing
– Different risks are associated with owning and operating
an asset and risk transfer can be assessed by reference
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to these rights and obligations
Risk Transfer
• In the case where ownership related risks are not specified
by PPP contracts, risk transfer can be assessed by
reference to the overall risk characteristics of the PPPs
• In the Non-separable contracts (ownership and service
elements cannot be distinguished) the balance between
demand risks and residual value risk borne by government
is used in the UK
• Demand risk is borne by government if service payments to
a private operator are independent of future need for the
service
• Residual value risk is borne by the government if the asset
is transferred to the government at more or less than its
residual value
• Other factors such as government guarantees, extent of
government influence over asset design and operation can
be used to assess the degree of risk that has been
transferred away from the government
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