Knowledge Infrastructure, S.L. © Foster Infrastructure Pty Ltd © October 2020 This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. Dissemination of this material to any third party by candidates or by the institution is not allowed without prior consent by K-Infra in writing. The APMG PPP Certification Program is a registered Trade Mark of The APM Group Limited. All rights reserved. This document is subject to intellectual property rights and it its contents cannot be copied, distributed or transferred without prior explicit consent by K-infra. CP3P – Practitioner Course Chapter 2 Establishing a PPP Framework Prepared by 1 Learning objectives • After studying this chapter, students should understand the following: ̵ The value of having a PPP framework ̵ What a PPP framework should include ̵ How to set the objectives and scope of a PPP framework ̵ Ways to establish a PPP framework in different jurisdictions, taking account of existing legal and administrative traditions ̵ The stages of a typical PPP process, and how the framework guides each stage ̵ How roles and responsibilities for PPPs can be allocated effectively between various government agencies ̵ Principles and techniques that facilitate responsible public financial management of PPPs ̵ Ways to ensure appropriate oversight and transparency of PPP programs. © K-Infra & Foster Infrastructure 2020 | Frameworks 2 Content Purpose, benefits and objectives of a PPP Framework Scope of the PPP Framework Choice of Legal and Administrative Instruments to Create PPP Framework Defining the PPP Process Institutional Responsibilities Public Financial Management of PPPs Oversight of PPP Programs and Projects © K-Infra & Foster Infrastructure 2020 | Frameworks 3 Introduction and Purpose • A PPP framework: ̵ Is the established procedures, rules and institutional responsibilities that determine how the government selects, implements and manages PPPs ̵ Establishes good PPP practice within the government ̵ Limits and manages government risk and ensures consistency ̵ Makes institutions accountable for their role in the PPP process ̵ Lets the market know how PPP projects will be developed, and how bids will be assessed ̵ Ensures that the objectives of the public and private sector are aligned ̵ Establishes rules that avoid impropriety and promote the public interest in getting quality projects done efficiently. • This chapter explains how to create a new PPP framework, or ensure an existing framework is effective. © K-Infra & Foster Infrastructure 2020 | Frameworks 4 Purpose, benefits and objectives of Frameworks Guide Sections #1, #2 & #3 5 Why have a PPP Framework? (1) 1 • A good PPP framework aims to ensure that: ̵ The right projects are selected as PPPs ̵ Projects are developed, delivered and managed in a structured, transparent and efficient way. • A good framework minimizes the risks that a PPP project will not deliver Value for Money. • PPPs involve multiple conflicting interests: ̵ If the procurement process fails to consider market conditions, the tender process may not be competitive. ̵ But if risks are not allocated If risks are not allocated appropriately, the public sector may incur costs that it cannot control and there will be. ̵ Unexpected fiscal obligations incurred by the government. © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 6 Why have a PPP Framework? (2) 1 • PPP frameworks address risks and increase the likelihood that PPPs will succeed by: • Standard practices reduce learning costs and the risk of Increasing the capability of mistakes, making it easier to transfer skills from one project government agencies to deliver PPPs to another project in another sector Providing a structured way of reconciling disparate objectives • A framework can establish a common objective between stakeholders improving the longevity of the PPP program Making sure that whole-ofgovernment risk is limited • A good framework has processes and responsibilities for identifying and mitigating government reputation risk and fiscal risks Generating market interest • A good PPP framework can communicate the quality of the PPP program and government’s commitment to potential investors, and reduce investors’ perception of risk Facilitating probity and oversight of the PPP program © K-Infra & Foster Infrastructure 2020 | Frameworks • Having clear processes, decision making criteria, and allocation of responsibilities makes such oversight more effective [traceability and accountability are higher] #1 Purpose, benefits and objectives 7 What is in a PPP Framework? (1) 2 • A PPP framework should guide governments and private partners through each step in developing a PPP, ensuring projects are well structured and delivered to meet expectations ̵ The PPP framework should contain procedures and decision rules, and ensure effective public financial management and oversight. • The framework should articulate its objectives: ̵ These make explicit what the government wants the PPP framework to achieve, and provide a basis for subsequent evaluation of the framework. • The framework should set out its scope: ̵ The types of projects to which it applies. ̵ It may be most effective for certain kinds of projects within certain sectors. • The PPP framework will often be embodied in PPP specific policy documents or legislation. © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 8 What is in a PPP Framework? (2) 2 • PPP frameworks typically define: ̵ Procedures: What things need to be done, by whom, in what order, to allow the right decision to be made and the right actions to be taken? ̵ Decision criteria: How will decisions be made at each step? ̵ Institutional responsibilities: Which entities are responsible for which tasks and objectives? • The PPP framework should set also out: ̵ How fiscal commitments are managed ̵ How proper oversight for the program is established. • Each of these elements is discussed in more detail later in this chapter. © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 9 Objectives of the PPP Framework (1) - The importance of objectives 3 • A structured and programmatic approach to PPPs can attract stronger and more consistent interest from the private sector: ̵ A PPP program may be defined as the ways in which the government plans to use PPPs to achieve improved infrastructure service provision oGoes beyond the pipeline to include additional and not yet identified projects oMay include indications of priority sectors in which PPPs are expected to be used, and the extent to which the government plans to use PPPs (rather than other service delivery mechanisms) in general or in particular sectors • The framework should promote effective, efficient and sustainable delivery of the PPP program: ̵ The framework is not an end in itself but a means to an end. • Governments should define PPP program objectives as a first step in developing the PPP framework: ̵ The objectives give direction to the designers of the framework © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 10 Objectives of the PPP Framework (2) - Common objectives 3 • The choice of objectives depends on the government’s policies and priorities. They can include: ̵ Enabling more investment in infrastructure by increasing project financing options ̵ Achieving Value for Money in the provision of infrastructure and public services ̵ Improving accountability in the provision of infrastructure and public services ̵ Harnessing private sector innovation and efficiency ̵ Ensuring that the long-term delivery and management of PPPs is sustainable, especially when stakeholders change over time (political actors, champions, representatives in ministries or PPP units) ̵ Stimulating growth and development in the country. © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 11 Objectives of the PPP Framework (3) - Don’t use PPPs for the wrong reasons 3 • The PPP framework should reduce the risk that PPPs are used for the wrong reasons: ̵ Some governments have used PPPs to reduce reported levels of government expenditure and borrowing, even when the long-term fiscal implications of the PPP projects are similar to those of a publicly financed project ̵ The framework should ensure PPPs are used to achieve substantial benefits, not to manipulate accounting results © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 12 Quiz - PPP Framework Objectives 1-Which of the following are true? 1. 2. A. B. C. D. Different PPP Programs should have different objectives Defining objectives is the final step in the development of a PPP framework Only 1 is true Only 2 is true Both 1 and 2 are true Neither 1 nor 2 is true © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 13 Quiz - PPP Framework 2-Which of the following are true? 1. 2. 3. 4. A. B. C. D. PPP frameworks typically define Procedures, Decision Criteria and Institutional Responsibilities The PPP framework should aim to reduce the risk that PPPs are used for the wrong reasons A PPP program is basically the same as a pipeline with concrete dates and a commitment to tender a number of projects A structured and programmatic approach to PPPs can attract stronger and more consistent interest from the private sector 1, 2, 3 and 4 are true Only 1, 2, 3 are true Only 2, 3 and 4 are true Only 1, 2 and 4 are true © K-Infra & Foster Infrastructure 2020 | Frameworks #1 Purpose, benefits and objectives 14 2 Scope of the PPP Framework Guide Sections #4 15 Scope of the PPP Framework – Introduction 4 • The scope of the PPP framework indicates the types of projects the framework will apply to. • The scope is generally defined by four dimensions: ̵ Jurisdiction ̵ Sector ̵ Size ̵ Contract type © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 16 Scope of the PPP Framework: Dimensions Jurisdiction 4 Federal Systems • A Federal government framework can only extend to PPPs that fall within the federal government’s competence . • Frameworks in Federal systems are often developed at the sub-national level. • Federal funding mechanisms can assist PPPs at lower levels of government. Non-Federal Systems • The national government may promulgate a framework. • Sub-national governments may also develop frameworks for sectors within their competence. Local Government PPPs • Extent of national control varies from country to country. • In federal systems, there may be state to state variations in how the framework applies to local government. © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 17 Scope of the PPP Framework: Dimensions Sector 4 • If the government intends to focus on PPPs in just a few sectors, the framework may be designed with these sectors in mind: ̵ The application of the framework may even be explicitly limited to those sectors. oExamples: –South Africa: PPP framework created explicitly for highways (as well as a separate, more tailored framework for other PPPs) –Philippines: special regime for privately-financed power plants. • Other frameworks may cover multiple sectors, but still set limits. oExample: –Singapore’s PPP policy (2004) limited its scope to those sectors “in which other similar countries have had proven success with PPP” –Countries that explicitly exclude certain sectors (like health) • Some frameworks have no limits on the sectors to which they can apply. © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 18 Scope of the PPP Framework: Dimensions – Size 4 • The relatively high transaction costs of implementing a PPP can make PPPs below a certain size unviable: ̵ Many governments therefore define a minimum size (or value) for PPP projects ̵ Examples: –Singapore’s PPP policy (2004): PPPs will be pursued only if they have an estimated capital value of over US$50 million –Brazil’s PPP law: Minimum size of 20 million reals (USD 11.7 million) for individual projects. • Some jurisdictions bundle small projects to economize on transaction costs: ̵ Example: –Pennsylvania Bridges Project: Rehabilitation of 558 bridges bundled into one large project • PPP size limits may change over time as the government improves its understanding of the size of suitable projects. © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 19 Scope of the PPP Framework: Dimensions Contract Type 4 • Many frameworks are explicitly limited to a particular subset of the range of possible PPP contracts ̵ Some limit the types of contracts permitted or in scope of the framework –For example, PPP framework may only contemplate government pays or the opposite. –Certain obligations / scope of contract may be excluded (e.g. in Ecuador private sector may not be in charge of water supply service) ̵ Some limit the duration of contracts –Example: European (EU) general legislation limiting PPP / concession contracts up to 40 years • Others allow PPPs of any type within a single framework • Typically, the legal traditions of the country influence the type of contracts the PPP framework applies to (for example, government-pays, user-pays, or both) ̵ Examples: –The scope of the UK's Private Finance Initiative (PFI) program has been predominantly government-pays contracts, with minimal user-pays elements –The French PPP framework was originally framed around user-pays concession contracts. © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 20 Scope of the PPP Framework – advantages and disadvantages of Unified Frameworks 4 • Countries with established PPP programs, often apply PPP frameworks across all sectors and even across multiple jurisdictions within a country (federal, state and local) Advantages Disadvantages • Simplicity for government agencies and investors • Efficiency • Consistency: Many PPP issues are the same regardless of the sector or jurisdiction • Difficult to develop and inflexible to change • Unable to address unique infrastructure challenges • ‘Parallel’ PPP frameworks within a single jurisdiction can deliver PPP programs that target specific objectives –Example: Spain has a specific sectoral law for water which incorporates specific regulations for water PPPs including a longer permitted duration of contracts • Alternatively, an ‘umbrella’ policy can be developed, which then has sector specific versions or detail © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 21 Quiz - PPP Framework Scope 3-Which of the following is correct? A. If a PPP Framework prescribes a minimum value of $20 million for PPPs, school buildings costing $2 million each cannot be delivered as PPPs B. A PPP Framework can apply to a single sector, or to multiple sectors C. A PPP Framework should be developed first by the National government, and then applied to lower levels of government D. The PPP Framework must state only a specific type of PPP contract that may be used © K-Infra & Foster Infrastructure 2020 | Frameworks #2 Scope of Frameworks 22 3 Legal and Administrative Approaches to create a PPP Framework Guide Sections #5 23 Legal and Administrative Approaches Introduction 5 • PPP frameworks need to be: ̵ Documented; and ̵ Enforced • In developing enforcement mechanisms, governments need to consider: ̵ How will the PPP framework be made binding on government officials? ̵ How will the PPP framework be communicated to all stakeholders? ̵ What will give legal force to PPP agreements? • How frameworks are documented and given force varies widely between jurisdictions: ̵ Some are enacted as laws, others are policy documents and manuals. • PPP frameworks also build on, and incorporate, many preexisting public sector management frameworks. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 24 Legal and Administrative Approaches - Impact of Legal Traditions Common Law countries Civil Law countries Tend to rely on policy documents and administrative guidance materials More likely to enact the framework in statute law and use detailed rules and regulations with legal force Longer history of government-pays PPPs than civil law countries Long history of user-pays PPPs (often termed “Concessions”) User-pays PPPs are a more recent development Government-pays PPPs are a more recent adaption from common law countries © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 5 25 Legal and Administrative Approaches – Common Law Countries 5 • Governments in these countries generally don’t need laws to establish PPP frameworks or enter into PPP contracts: ̵ In these countries, policy statements and administrative documents are often the best approach. oExamples: –Britain: HM Treasury sets PPP policy (just for England) – Australia: National PPP Policy has been agreed to by the Federal government and each state and territory government; departures from the policy and guidelines are possible, but must be approved by the relevant PPP authority (usually treasury or finance) –Jamaica: PPP policy was adopted by the cabinet, and then published; The Development Bank of Jamaica was mandated with managing the implementation of the policy. ̵ Many common law countries have Westminster system governments, with the executive accountable for policies in parliament and through elections. ̵ In these countries, PPPs are usually private law contracts, adjudicated and enforced through the courts or contractual arbitration. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 26 Legal and Administrative Approaches - Common Law Countries (continued) 5 • Some common law jurisdictions do create PPP laws ̵ Why?: oTo override existing laws that would otherwise restrict or delay PPP projects; or oTo provide greater force, stability, transparency, and accountability ̵ Examples: –US States: PPP laws create exceptions to other state laws already on the books that prevent PPP contracts; and provide stability and legislative control in systems of government where there is a strict separation of legislative and executive power, unlike the Westminster system. –Kenya; States in India: PPP laws increase accountability and transparency of the program, provide greater policy stability, and signal stronger commitment to investors and funding agencies. ̵ Disadvantages: Longer time to pass a law; loss of flexibility; difficulty of coordination between the legislature and the executive. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 27 Legal and Administrative Approaches - Civil Law Countries 5 • Civil law countries tend to embody PPP frameworks in laws ̵ In civil law tradition, government agencies may only do what they are explicitly authorized to do. ̵ Civil law limits government discretion with defined rules. ̵ The types of law used differ from jurisdiction to jurisdiction. oExamples: –Spain: PPPs are empowered and controlled through the public procurement law . –Chile: Controls all PPPs through its concession law. –The Philippines: Special BOT Law evolved into a PPP law. –France: “Government-pays” PPP contracts were authorized and controlled by a specific statute. • Some civil law countries subject PPP contracts to special administrative law provisions, others treated them as private law contracts –Turkey: certain contracts are established as private law contracts. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 28 Legal and Administrative Approaches - Dispute resolution 5 • The PPP framework should be explicit about mechanisms that are used to reduce the need for court action ̵ Why? oCourt processes can be slow and expensive oJudges are not familiar with the complex and technical matters involved in PPP contracts ̵ It is often a good idea to include alternative dispute resolution mechanisms in contracts, such as mediation, [dispute resolution boards DRB] and arbitration provisions ̵ Enforcement mechanisms that reduce the need for court action, such as escrow accounts and performance bonds, can also be useful tools. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 29 Building on and Incorporating Pre-Existing Government Frameworks (1) 5 • A PPP framework is not constructed in isolation ̵ It builds on, incorporates, and modifies pre-existing frameworks • It makes sense to use existing frameworks as far as possible and to ensure that PPP-specific elements dovetail with existing systems • It is good practice to review the legislative and administrative context to ensure that it is not incompatible with key elements of the objectives of the PPP framework ̵ Examples: –In Brazil and India there are taxation rules which discriminate against private sector subcontracting of operations and maintenance in PPPs –Discrimination against foreign investors (for example, convertibility, confiscatory taxes on repatriation of equity) should be reviewed in order to attract the participation of international/global investors and developers. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 30 Building on and Incorporating Pre-Existing Government Frameworks (2) 5 • Pre-existing frameworks that may be relevant include: ̵ Administrative law: In many civil law countries, government agencies are governed by administrative laws. ̵ Procurement law: PPP transaction processes must typically comply with public procurement law and regulations, unless PPPs are exempt. –Example: In Ecuador PPPs are exempted of application of procurement/tender regulations for public works and services. ̵ Public financial management law: May regulate matters such as project approval requirements, fiscal limits, budgeting and reporting requirements. ̵ Sector laws and regulatory frameworks: These frameworks may: oConstrain the government’s ability to contract with the private sector, or provide rules for doing so – for example: –Concessions for utility services may be governed by public utility regulation: typically the case with energy or water. –Essential infrastructure may be subject to open access rules under competition law. oAffect tariffs and service regulation, and set out the role of regulatory agencies, and how these interact with the terms of the PPP contract. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 31 Building on and Incorporating Pre-Existing Government Frameworks (3) 5 • Other rules affecting private firms will apply to companies involved in PPP projects, and should therefore be considered ̵ Examples: –Environmental law and regulations –Laws and regulations governing land acquisition and ownership –Licensing requirements, particularly for international firms –Tax rules –Employment law –Accounting standards. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 32 Quiz - Legal and Administrative Approaches 4-Which of the following is correct? A. In civil law countries, a specific PPP Law is required to enable government to undertake PPPs B. In common law countries, government-pays PPPs are usually a more recent development than user-pays PPPs C. A PPP Framework doesn’t need to take into account conflicting laws or policies D. The PPP Framework should include mechanisms to prevent disputes going to court © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 33 Framework for Sub-National PPPs - Introduction 5 • Where there are multiple levels of government, one level may wish to empower, influence, or control a lower level of government ̵ In federal systems, national governments may wish to affect the legal framework for states ̵ National and state governments may also wish to enable, control or influence local government entering into PPPs. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 34 Framework for Sub-National PPPs - Federal Systems 5 • In federal systems, constitutions normally specify which matters are the preserves of states, and which of the federal government. ̵ PPP frameworks at the state level therefore apply to PPPs that are within state competencies. ̵ Federal rules apply to PPP projects that are within federal competencies and executed by the federal government. • Federal government constitutions generally restrict them from intruding on how state governments discharge matters within the state’s competence. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 35 Framework for Sub-National PPPs - Local Government 5 • State or national governments can usually legislate with respect to the behaviour of local governments within their jurisdictions ̵ There are a variety of approaches to applying state or national PPP frameworks at the local level, for example: –In Spain, PPPs done by local authorities have to respect the national general procurement legislation, as well as a specific law regulating municipal service procurement. –In Australia and Canada, the national PPP policy does not apply to local government: PPPs are rare at the local level due to the small size of projects developed at this level © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 36 Framework for Sub-National PPPs - Incentivizing Sub-National PPPs 5 • Governments can also incentivize lower level PPPs through intergovernmental fiscal transfers rather than laws. Examples: –United States: the Transportation Infrastructure Finance and Innovation Act (TIFIA) incentivizes state governments transport PPPs by offering concessional finance in the form of direct loans, loan guarantees, and standby lines of credit –Canada: Federal funding of provincial and municipal PPPs comes with requirements as to how projects are structured and managed. –Ecuador: central government provides “fiscal incentives” to PPPs promoted by sub-national governments by exempting the SPV to pay corporate taxes and enjoying other incentives (import duties, VAT etc). • Such incentives are not always efficient –In Britain, “PFI credits” paid by the National government to local authorities as grants to support local PPP projects were criticized and abolished (in 2010) as they discriminate procurement in favour of PPPs by giving additional spending power local authorities just for PPPs. • Investors often consider local governments to be less reliable counterparts due to lower credit ratings or limited resources. ̵ This can create a role for national governments to provide financial or technical support to local governments (possibly accompanied by a desire to control such PPPs). © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 37 The role of Sub-national PPPs - Examples (1) • Australia: ̵ Most large-scale infrastructure development is a state responsibility ̵ State governments were instrumental in the development of a national PPP policy framework, which has been endorsed by all states and territory, as well as the federal government • Canada: ̵ Most infrastructure development is a provincial government responsibility ̵ PPP frameworks are developed at the provincial level, without federal oversight ̵ The federal government can however influence the delivery of provincial PPP programs by financing local and municipal PPP projects through the P3 Canada Fund © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 38 The role of Sub-national PPPs - Examples (2) • India: ̵ India’s Union Government, through the PPP cell in the Department of Economic Affairs, leads the development of the PPP framework. oThe PPP cell is responsible for all PPP matters, including policy, schemes, programs, and capacity building ̵ State governments also have the right to enact their own PPP legislation oSeveral states including Andhra Pradesh , Gujarat, and Karnataka have created their own PPP frameworks and have successfully developed their PPP projects. • US: ̵ The national government is responsible for very little infrastructure ̵ PPP frameworks are created by state governments ̵ There is no federal level PPP framework. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 39 Quiz - Sub-national and local PPPs 5-Which of the following are correct? 1. 2. A. B. C. D. A PPP Framework should be created at the national level and also applied to any projects undertaken at a Sub-national or local level. National governments can provide financial or technical support to PPPs undertaken at a Sub-national or local level. Only 1 is correct. Only 2 is correct. Both 1 and 2 are correct. Neither 1 nor 2 is correct. © K-Infra & Foster Infrastructure 2020 | Frameworks #3 Legal & administrative 40 4 Defining the PPP Process: decision criteria, procedures and institutional responsabilities Guide Sections #6 41 Defining the PPP Process - Introduction 6 • The framework should provide guidance on each stage of developing and implementing a PPP project: ̵ From initially identifying candidate projects. ̵ To managing PPP contracts throughout the project lifecycle. • The Framework should ensure that only ‘good’ PPP projects are developed: ̵ PPPs should be cost-benefit justified, provide better Value for Money than traditional public procurement, financially viable and fiscally responsible, and attractive to the market. ̵ These criteria cannot be fully assessed until the PPP is fully designed and structured, but this is costly. ̵ Successful PPP programs tackle this problem through progressively more rigorous screening at successive stages of project development. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 42 Defining the PPP Process - Overview 6 • This section introduces the key decision criteria, procedures, and institutional responsibilities that should be considered across the PPP process: ̵ Details on the specific tasks at each step are provided in the chapters 3 to 8 of the PPP Guide and an overview of the process is provided in chapter 1. • These are simply basic guidelines, noting that: ̵ There are many subtleties in the PPP process. ̵ What works well in one culture or public administrative system may not work as well in others. ̵ Local circumstances and how the public sector works should be understood before adopting practices from elsewhere. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 43 Identification of Projects and Screening (1) 6 • The process starts with project origination ̵ It follows the same or uses a similar process as for originating public sector investment projects [they are in fact public investments!] ̵ Projects are screened for their potential suitability as PPPs. ̵ Screening at this stage is usually indicative, limited to the information available at relatively low cost. • Decision criteria ̵ The project should fit in with a broader plan for the sector. ̵ The project should meet PPP program objectives. ̵ The project should be economically viable and fiscally responsible: oProjects should not proceed unless they are economically sound. oProjects that may impose costs or incur liabilities that are beyond the financial capability of the government should be avoided. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 44 Identification of Projects and Screening (2) 6 • Procedures and institutional responsibility ̵ The PPP framework should identify the following: oWho proposes PPP projects? oCan only government entities with investment programs submit a proposal? oCan private proponents also put forward proposals for PPP projects? ̵ The framework should identify who approves further development of PPP projects. oSuccessful PPP projects typically require the support of: 1. the line agency, that is, the department initiating the project. 2. the finance ministry. 3. other central authorities. ̵ The framework should identify the level of documentation required to be submitted to the stakeholders involved in approving the project proceeding, so that an informed decision is made. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 45 Appraise the Project (1) - Introduction to Appraisal 6 • Candidate projects that survive the “screening” are then developed and appraised ̵ This is an iterative, or multi-stage, process ̵ The appraisal report, often called a “Business Case” or “Full Feasibility Study”, is typically the basis for approval to proceed with the PPP transaction • The PPP Guide assumes that the investment decision and the procurement decision are considered as part of the same process ̵ This requires that the government either: oEstablish requirements for the systematic appraisal of all projects –This requires wide-scale government support and may be impractical oEstablish a requirement for the appraisal of PPP projects –Makes PPPs subject to greater scrutiny than non-PPP projects –Ensures only worthwhile projects are implemented as PPPs © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 46 Appraise the Project (2) - Decision Criteria 6 • The Investment Decision: A project is a “good project” if it is: ̵ Economically, technically, environmentally and legally feasible: oAll projects, PPP or not, should demonstrate that they are ‘good’ projects oSpecialist skills are required to undertake such an appraisal ̵ Affordable: oShould be assessed from both the government and user perspectives –Government liabilities, direct and contingent, must be within budget constraints –Services provided by the PPP need to be affordable to the users • The Procurement Decision: The project is suitable to be a PPP if: ̵ It is commercial viable (and bankable): oThe project must be able to generate returns to the investor and enable investors to raise debt from lenders ̵ The project is expected to deliver Value for Money as a PPP: oA PPP is considered Value for Money if the project is expected to deliver higher net economic benefits if done as a PPP. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 47 Appraise the Project (3) - Assessing Value for Money 6 • There are many ways of assessing Value for Money: ̵ Traditional approach (developed in the UK): oDetermine whether a PPP will have a lower (risk-adjusted) cost to the government than a conventional procurement ̵ Alternative approach: oDetermine which delivery option will maximize benefits for a given budget –E.g. in New Zealand, the test is which approach is likely to deliver greater net economic benefits • Value for Money assessment is usually qualitative during initial screening and then quantified during full appraisal ̵ Quantitative Value for Money analyses are necessarily based on assumptions and forecasts, hence their accuracy is limited ̵ Some jurisdictions (e.g. Canada) also use qualitative indicators to select a procurement option © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 48 Appraise the Project (4) - Procedures & institutional responsibility 6 • The PPP framework should specify: ̵ The required content of the PPP appraisal or of the “feasibility study”– this includes: oThe studies that need to be done (for example, demand forecasts). oThe questions that need to be answered to determine if a project is economically, financially, technically, environmentally, and legally feasible [i.e. the feasibility criteria]. ̵ Who approves the PPP appraisal: oAny PPP project will require the support of numerous stakeholders to be successful. oThe PPP framework should identify the approval process needed for proceeding to the next phase. –Many jurisdictions require a decision by the cabinet in favour of proceeding. –Others delegate the decision to a government agency [or a committee/commission], perhaps with the assent of one or more central agencies or a PPP unit. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 49 Structure the Procurement Process and Project Contract (1) - Introduction 6 • Before the PPP transaction can be implemented, the tender documents and the draft PPP contract need to be prepared. • The tender documents should include the evaluation criteria and proposal requirements. • The contract should fully define the outputs, responsibilities, and risk allocation. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 50 Structure the Procurement Process and Project Contract (1) - Introduction 6 • Before the PPP transaction can be implemented, the tender documents and the draft PPP contract need to be prepared. Tender Documents • Should include the evaluation criteria and proposal requirements (as well as information on the project) © K-Infra & Foster Infrastructure 2020 | Frameworks Contract • Should fully define the outputs, responsibilities, and risk allocation #4 Defining PPP Process 51 Structure the Procurement Process and Project Contract (2) – “Decision Criteria” 6 • All significant risks should be identified and allocated to the most appropriate party ̵ The success of a PPP lies in how well risks have been allocated. ̵ If risks are not allocated appropriately, the project will cost more than necessary • The framework should ensure that appropriate risk management plans can be developed. ̵ For those risks allocated to the public sector (example: RoW!), appropriate plans need to be in place that both minimize the likelihood of the risk occurring and the impact in case the risk does occur. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 52 Structure the Procurement & Contract (3) – Procedures & institutional responsibility 6 • The Framework should specify: ̵ Approaches to risk allocation, risk management plans and draft contracts. oSome governments have standardized rules about risk allocation, others look at each project on a case-by-case basis. oDrafting contracts requires the expertise of experienced PPP lawyers. Agencies without this experience in-house will need to secure it by using outside counsel. –For example, British Columbia brought in lawyers and technical advisors from Australia and the UK, jurisdictions with established PPP frameworks. ̵ Guidelines for procurement oDocument the standard PPP procurement process. oThis will signal to prospective partners how they can be involved and reduce the likelihood of disputes. o“Model” and “Standard” contracts can ensure consistency in the design of PPP contracts, while sending clear messages to the market. ̵ How to gain approval for proceeding to the next phase (the tender process) © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 53 Structuring (4) – Standard and Model Contracts 6 Standard Contract • A contract that public agencies are required to use (or at least required to document and justify any deviations from it) • May not be a full set of all provisions in the contract, but rather a set of recommendations (including alternative approaches for some issues) in the form of guidelines © K-Infra & Foster Infrastructure 2020 | Frameworks Model contract • An example contract that embodies good practice and is available for agencies to use #4 Defining PPP Process 54 Structuring (5) – Advantages/Disadvantages of Standard and Model Contracts Advantages • If done well, model or standard contracts: • Reduce the risk of the contract being wrong (for example, poorly drafted or with an inappropriate risk allocation) • Save time and money for the bidders by reducing the time required to understand each contract • Enable the project team to focus their work on developing and tailoring existing processes and legal documentation, rather than drafting contracts from scratch • Reducing the time required for caseby-case negotiations as both parties have an expectation of what is acceptable. © K-Infra & Foster Infrastructure 2020 | Frameworks 6 Disadvantages • It is hard to write one contract that will apply to a wide range of different deals. • Therefore, using standard contracts may reduce the quality of contracts compared to having experienced advisors develop a specific contract for each project. #4 Defining PPP Process 55 Structuring (6) – Should a Standard or Model Contract be developed? 6 • Jurisdictions should strike the right balance between standardization and customization. ̵ If most of the projects will be fairly similar (for example, all governmentpays contracts for social infrastructure) then a single standard contract may make sense. ̵ If there are various categories of projects envisaged, standard contracts for each category may be warranted. ̵ If a wide range of different deals are expected, one or two model contracts, coupled with some standard for contract drafting, may be best. oStandards for contract drafting could include preferred risks allocations, a list of topics that should be addressed in all contracts, and sample provisions for some topics that are likely to be similar across multiple contract types (such as extraordinary adjustments, force majeure, dispute resolution, and termination provisions). © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 56 Tender and Award (1) – Introduction 6 • A well designed and implemented procurement is central to achieving Value for Money from the PPP. • The process will include [and the guidelines to be developed in a proper framework may cover these aspects]: ̵ marketing the PPP. ̵ checking the qualifications of bidders. ̵ inviting and evaluating proposals. ̵ interacting with bidders during the process. ̵ selecting the preferred bidder. ̵ concluding the contract. • Stakeholder engagement is essential to this and all other stages, but the Guide develops here some key aspects. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 57 Tender and Award (2) – Stakeholder engagement 6 • Risks of inadequate stakeholder consultation: ̵ The contract may not be acceptable to the private sector and its lenders, resulting in no bids. ̵ Lack of public support for the project may result in it being cancelled by the next elected government. ̵ Public demonstrations, labour union action, or public boycotts may result in delayed implementation or reduced profitability. • The PPP Framework can include a policy on stakeholder engagement, addressing concepts like: • Stakeholder identification and analysis. • Information disclosure. • Stakeholder consultation. • Negotiation and partnerships. © K-Infra & Foster Infrastructure 2020 | Frameworks • Grievance management. • Stakeholder involvement in project monitoring. • Reporting to stakeholders. • Management functions. #4 Defining PPP Process 58 Tender and Award (3) – The tender decision 6 • Only at the end of the tender process will the government know the final cost of the PPP project and other terms. ̵ At this point there may be a final check to ensure the project still meets the PPP criteria. ̵ However cancelling a project (e.g. because it is not expected to offer VFM, or is not affordable) at this point is undesirable and can damage the market reputation of the jurisdiction. oUnless the market has confidence that the project will proceed, the private sector will be unlikely to spend money preparing a bid. ̵ So the PPP framework should set out in advance the circumstances under which a project will not proceed. –Example, in some jurisdictions (such as British Columbia, Canada, or commonly in EU), “affordability ceilings” are revealed to ensure the market knows the maximum that the public sector is willing to pay. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 59 Tender and Award (4) – “Decision Criteria” 6 • To test if the procurement was appropriate, the following criteria are helpful: ̵ Was the procurement competitive? oFor example, have most qualified private partners heard about the opportunity? The competition will only be as good as those competing. oHave qualified private partners been given ample opportunity to express their interest and develop proposals? If timelines are too short, or processes too onerous, private partners will avoid becoming involved ̵ Has the process been transparent and conducted with integrity and fairness? oThe way that the award process is administered should be clearly communicated and responsibilities clearly allocated. oThe criteria for award should be transparent, with well-defined and objective, qualification criteria, technical specifications, and bidding requirements. oThe tender process should ensure that all bidders are treated fairly. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 60 Tender and Award (5) – Procedures and Institutional Responsibility Process Procedures Institutional responsibilities • PPP marketing • Evaluation of qualifications (and short-listing if that occurs) • Evaluation of proposals The framework should provide guidance on how to ensure the process is smoothly delivered and that common pitfalls are avoided, without being prescriptive. The framework should state who evaluates, who makes the selection decision, and who approves the contract. • Reaching commercial close The framework should give guidance on the extent of negotiations permitted to reach commercial close. As above, the framework should state who approves the contract. • Reaching financial close The framework should address the risk of delays and contractual changes in getting to financial close. The framework should state: • who manages this process for government • who approves any changes to the contract necessary to reach financial close. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 6 61 Manage the Contract (1) – Introduction 6 • This is the longest phase of the project • The challenge is to ensure the PPP provides Value for Money throughout the contract, both construction and operations © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 62 Manage the Contract (2) – “Decision Criteria” 6 • The PPP framework should: ̵ Ensure that issues during construction and service delivery are communicated by the concessionaire to the implementing agency, and, if required, to relevant central government agencies. ̵ Include a strong operations team and governance mechanisms for reviewing performance and escalating issues to better equip the government to manage the PPP and make hard decisions ̵ Include governance mechanisms to help the government agency to be a good working partner which private parties can have confidence. • The Framework should help to deal with unexpected events after contract execution, without a need for contract renegotiation. • Sometimes renegotiation may be required. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 63 Manage the Contract (3) – Renegotiation 6 • In circumstances where renegotiation may be required, the PPP framework should: ̵ Ensure the renegotiation process is carefully managed by the government, with proper resources and a proper governance structure. The objective of renegotiation should be to secure an outcome that meets the objectives of the public sector better than would adherence to the original contract terms. ̵ Allow for changes in the risk allocation if this is necessary and offers a net benefit when compared to alternatives such as cancellation of the contract. ̵ Recognise that advisors may need to be re-engaged at this stage. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 64 Manage the Contract (4) – Procedures and Institutional Responsibility 6 • PPP contracts are typically managed by the relevant line agency. • Central agencies will also need to be informed of emerging issues and risks. • The PPP framework should set out how the line agency and relevant central agencies should communicate. • The framework should also specify how contracts should be completed or terminated. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 65 Quiz - Defining the PPP Process 6-Which of the following is correct? A. The government should investigate a project in as much detail as possible before selecting it as a potential PPP for appraisal. B. The PPP Framework should prohibit renegotiation of contracts, as renegotiation is not in the public interest. C. The PPP Framework should define in very precise terms how the tender process is to be conducted and how bids are to be evaluated. D. Using standard contracts may reduce the quality of contracts compared to having experienced advisors develop a specific contract for each project. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 66 Privately Initiated Projects (1) – Introduction 6 • Some governments accept unsolicited or privately-initiated PPP projects: ̵ Governments can harness information and ideas that private firms have about how to provide services, but allowing firms to promote their own project ideas is tricky. oIf the idea is then put out to competitive tender, firms may not volunteer good ideas since they cannot benefit from doing so. oNot putting the idea out to competitive tender could allow a firm to charge more than the cost for a service, leading to allegations of favouritism. • The PPP framework needs to strike the right balance between: ̵ providing incentives to private proponents to submit high-quality project ideas ̵ deterring poor quality proposals ̵ ensuring competitive tension, and ̵ demonstrating transparency. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 67 Privately Initiated Projects (2) – Benefits and Pitfalls Benefits Pitfalls • Allow governments to benefit from the knowledge and ideas of the private sector. • A significant advantage where limited government capacity means the private sector is better able to identify infrastructure bottlenecks and innovative solutions. • Provides government with information about where commercial opportunities and market interest lie. • Government must devote resources to assessing and procuring unsolicited proposals. • Resources might be better allocated to projects known to be in line with government plans and priorities. • Negotiating on an unsolicited proposal – with no transparent or competitive procurement process – can create problems. • May result in poor Value for Money, due to lack of competitive tension. • May provide opportunities for corruption and give rise to complaints about the fairness of the process, especially if there is no competitive process. • For these reasons, some countries prohibit the use of unsolicited proposals for PPPs. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 6 68 Privately Initiated Projects (3) – Creating Competitive Tension 6 • Some jurisdictions have developed mechanisms to take advantage of unsolicited proposals, while also introducing competitive tension. • Approaches include: ̵ Swiss challenge – an open bidding process is conducted. If the proponent does not win, it is invited to match the winning bid and win the contract. ̵ Bid bonus – the proponent receives a scoring advantage typically defined as an additional percentage added to its evaluation score in an open bidding process. ̵ Inclusion in best and final offer round – a two-stage bid process, with short-listing, is used. The proponent of the unsolicited proposal is automatically included in the second stage. ̵ Developer’s fee – the proponent is paid a fee by the government or the winning bidder. The fee may reimburse some project development costs, or provide a return on developing the project concept. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 69 Privately Initiated Projects (4) – Dealing with Intellectual Property 6 • To encourage unsolicited proposals, the government needs to commit to protecting intellectual property: ̵ Otherwise, there is little incentive for the private party to invest in any new or innovative ideas. ̵ Possible approaches: oCompetitively tender the project by specifying required outputs, and not the required technology to deliver those outputs. This approach is consistent with good practice in defining output-based performance requirements for PPPs. oIf the intellectual property is crucial to the project, such that it could not be implemented otherwise, direct negotiation may be warranted, along with procedures to benchmark project costs. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 70 Privately Initiated Projects (5) – Clear processes 6 • Clear processes for handling unsolicited proposals (USP) are important for transparency and achieving Value for Money. • Clear processes: ̵ assist the government in managing such a proposal ̵ incentivize private developers to invest resources in developing good quality project proposals ̵ encourage competitors to engage in the bidding process. • See figure 2.1 in the Guide for an example of an USP process. • It is worth considering specifying time periods within which each step in the process will be taken: ̵ Specific deadlines for government actions can provide assurance to the private sector that their proposal will not languish in the process ̵ However tight limits on the time allowed for competing proposals can deter competition. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 71 Quiz - Privately Initiated Projects 7-A PPP Framework states that the government can enter (directly) into a contract with a party that proposes a privately initiated project in any of the following circumstances: 1. 2. If the project provides benefits to the community; or If the private proponent owns intellectual property that is crucial to the project, such that it could not be implemented otherwise. How could this Framework be improved? A. Delete or amend paragraph 1, as the fact the project will provide benefits to the community is an insufficient reason, by itself, to accept such a proposal. B. Delete or amend paragraph 2, because the government should buy the intellectual property and then put the project out to tender. © K-Infra & Foster Infrastructure 2020 | Frameworks #4 Defining PPP Process 72 5 Institutional Responsibilities Guide Sections #7 73 Institutional Responsibilities - Introduction 7 • Institutional responsibilities define which entity will play what role at each step of the process. • Institutional arrangements differ widely from place to place. ̵ This depends on the particular needs of the PPP program and the preexisting institutional roles and capacities. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 74 Institutional Responsibilities – General Principles 7 • General principles for effective PPP institutional arrangements: ̵ Build on existing institutional responsibilities and processes; oThere will already be sector agencies with responsibility for planning and developing projects, which should generally continue in their existing role. oExisting public sector procurement rules and public financial management rules will provide the background framework which can be tailored to allow and support the development of PPPs. ̵ Design the institutional architecture appropriately for the likely scale of the task; ̵ Develop policies and architectures in parallel with the first projects; ̵ Assign responsibilities to agencies that have the incentives, information, and competence to discharge the responsibilities and clearly define any institutional relationships; and ̵ Avoid creating overlaps and additional coordination needs. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 75 Institutional Responsibilities – Typical Responsibilities (1) 7 Identifying and procuring projects • Driving projects forward: • Identifying potential projects, appraising, structuring, drafting the contract, tendering the project, managing the contract Ensuring coordination and best practice approaches • Ensuring that: • correct processes are followed • analysis of a proposed PPP is complete • all the agencies that need to comment or give their go ahead do so • the body with approval authority receives all the information it needs to make a sound decision Public financial management • Ensuring that there is sufficient fiscal space to fund direct liabilities • Dealing with situations where risks allocated to the public sector crystallize into fiscal expenditures Approving projects • Giving the go ahead for the project to proceed. Approvals may be needed at several stages of project development © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 76 Institutional Responsibilities – Typical Responsibilities (2) 7 • It is useful to identify an existing institution, if available, that is suitable for each of the main responsibilities. • Where existing institutional infrastructure and skills are insufficient, the establishment of a PPP unit may be helpful. • External advisors may be needed to support the skills available in-house. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 77 Institutional Responsibilities – Identifying and Championing Projects 7 • Projects can be identified and championed by the procuring authority or central authorities. • The PPP law or policy may specify: ̵ which government entity is allowed to enter into PPP contracts ̵ which authorities are responsible for PPP implementation. oIt is common for agencies with existing responsibilities for infrastructure, such as a department of transportation or local authority, to be the procuring authority and to champion the project. • In some jurisdictions, a central authority leads the identification and championing of projects that are suitable to be PPPs. ̵ Such agencies may also run the procurement on behalf of the sector or local authority. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 78 Institutional Responsibilities – Ensuring Coordination and Best Practice (1) Why? • Sector agencies may lack PPP skills: • Little experience in engaging with the private sector on privately financed projects. • Lack expertise in rigorous project analysis. • Inadequate focus on achieving Value for Money for the government as a whole. • Coordination across the government is needed, but sector agencies cannot provide this. © K-Infra & Foster Infrastructure 2020 | Frameworks 7 How? • Specialized PPP units. • External PPP transaction advisors. • Inter-departmental committees to oversee each PPP transaction • Specialist entities in different implementing roles (e.g. regulatory agencies dealing with contract oversight). • Central Agencies. #5 Institutional Responsibilities 79 Institutional Responsibilities – Ensuring Coordination and Best Practice (2) Specialized PPP units • A repository of skill and experience in developing PPPs. • Support contracting authorities in implementing PPP projects. • Often an extension of a central agency such as the ministry of finance. External PPP transaction advisors • Governments do not have all of the in-house expertise and skills needed to develop PPPs. • All engage external specialist advisors for detailed, technical tasks, such as conducting feasibility studies and drafting PPP contracts. • The extent and nature of external advisory support needed will change as the program evolves. © K-Infra & Foster Infrastructure 2020 | Frameworks 7 Inter-departmental committees • Can oversee each PPP transaction. • Often include representatives from the sector ministry as well as ministries of finance and planning, and legal representatives. • Processes should be streamlined and efficient to avoid committees becoming bureaucratic bottlenecks. #5 Institutional Responsibilities 80 Institutional Responsibilities – Ensuring Coordination and Best Practice (3) Specialist entities in different implementing roles • Implementation responsibilities can be divided between entities. • Example: Peru, where the procurement agency is responsible for implementing the PPP transaction, and sector regulatory agencies are responsible for monitoring the private parties’ compliance with the PPP contract © K-Infra & Foster Infrastructure 2020 | Frameworks 7 Central Agencies • Agencies with “whole of government” (rather than purely sectoral) functions. • Usually involved in commenting on major policies initiatives and projects. • Involved in the creation of the PPP framework. • The framework then generally requires that advice from the central agencies be sought at particular points in the PPP process. #5 Institutional Responsibilities 81 Institutional Responsibilities – Ensuring Coordination and Best Practice (4) 7 • Common central agency roles: ̵ Ministry of finance roles: oOften central to the controlling function for PPPs. oHelps ensure that the PPP program is focused on achieving Value for Money and that fiscal risks are managed. ̵ Planning agency roles: oWhere national planning agencies perform a strong coordination function in infrastructure or economic policy generally, they may also regulate the PPP process. oThe program generally works best when there is also a mechanism for effective coordination with the finance ministry. ̵ Attorney general’s role: oSignoff may be required for major contracts, including PPPs. oThis is not a universal requirement – some governments recognize that private law firms in their countries have greater expertise in fields relevant to PPPs such as construction and project finance. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 82 Institutional Responsibilities – Approvals (1) – Approval requirements 7 • Most governments define who can give approval for capital investment projects at various points in the project lifecycle: ̵ PPPs often do not require government capital investment, hence they may not automatically be subject to these rules. ̵ Many governments therefore define similar requirements for PPPs. • Creating several decision points allows weak projects to be stopped before they consume too many resources or develop a momentum of their own: ̵ Approval is typically needed to enter into a PPP transaction. ̵ Final approval may be needed before the contract is signed. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 83 Institutional Responsibilities – Approvals (2) – Who gives the approvals? 7 • Jurisdictions vary as to which entity can approve a PPP: ̵ Some require legislative approval of projects. ̵ More often, approval may come from the cabinet or a cabinet level committee, the finance ministry, or a combination of agencies and authorities. ̵ Approval responsibilities may depend on the size of the project, as is typically the case for other capital investments. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 84 Institutional Responsibilities – Approvals – Example 7 • An example will be discussed in class if time permits or the class will discuss how are handled approvals in their country. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 85 Institutional Responsibilities – Role and Benefits of PPP Units (1) 7 • Many governments create a dedicated unit tasked with implementing, facilitating, or advising on PPPs. ̵ May be a separate entity, or within an existing department. • PPP Units can have a range of roles – see next slide. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 86 Institutional Responsibilities – Role and Benefits of PPP Units (2) Control and oversight of the PPP process • Ensuring that the right steps are taken in developing a PPP, so the project meets the appraisal criteria, and that all required approvals are obtained. • The PPP unit may also act as an approving body Development of the PPP framework • Management of evolution (but not creation) of the PPP framework, including developing the process guidelines and keeping them updated Promoting PPPs within the government • For example, reminding implementing agencies that it may be desirable to do large new projects as PPPs Advising and supporting agencies to implement PPPs Acting as a knowledge centre Providing communication channels to investors Monitoring and support after financial close 7 • Offering experience and specialist skills acquired because of their focus on PPPs and involvement in numerous projects • Collating and disseminating knowledge and information about PPPs • Ensuring that knowledge is shared across procuring authorities and made available to the public • Helping bidders and financiers with information about the program and upcoming opportunities • Assisting the procuring authority with contract management • Ensuring critical information on changes in the PPP’s risk status is communicated to relevant central agencies to enable them to monitor the project’s contingent liabilities © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 87 Institutional Responsibilities – Designing PPP Units (1) 7 • A PPP unit’s design should reflect its functions ̵ Units that focus on regulating and controlling the PPP process should generally be located in finance ministries or planning agencies. ̵ If a PPP unit is undertaking multiple functions, it needs to be designed to avoid potential conflicts of interest. ̵ If a unit is guiding, advising, and approving PPPs, then it needs to ensure: othere are internal firewalls; and othat it involves other entities involved in approvals, or that it brings in additional scrutiny by audit or other oversight agencies. • The role of the PPP unit will need to change as the PPP program matures and government agencies build up expertise and start developing their own PPP units. ̵ At the outset of a program the PPP unit will likely carry out multiple roles, but over time it may move towards the regulatory and supervision role. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 88 Institutional Responsibilities – Designing PPP Units (2) – Key choices to be made Unit location • Within an existing department or independent? • May be allocated in a line ministry or department, a central agency such as the ministry of finance (or within a national financial agency or national development bank), the ministry of planning, or the prime minister’s office. • More than one PPP unit may coexist, each with different roles and scope of responsibilities Functions to be undertaken • Regulation, control and oversight? • Promotion? • Advice? • Communications? • Monitoring and support? © K-Infra & Foster Infrastructure 2020 | Frameworks 7 Resourcing Funding mechanism • How will it attract and retain the right talent to a public sector organization? • Specifically, legal and financial skills, where equivalent positions in the private sector can be better paid? • Staffing PPP units may in turn have an impact on how they are structured and governed. • How are operating costs funded? • A budget allocation? • A charge to procuring authorities for its services? • Consider the incentives: • If procuring authorities have to pay, they might be less willing to involve the PPP unit • If the PPP unit relies on procuring authorities for its revenue, it may be more proactive, but may have a conflict of interest in exercising control and oversight functions. #5 Institutional Responsibilities 89 Institutional Responsibilities – Designing PPP Units (3) – Risks and Pitfalls 7 • A lack of clarity in the PPP unit’s role may worsen, not improve, coordination. • If it has insufficient resources (for example, to undertake appraisals), the unit may become a bottleneck. • Tension between entities wanting to control the unit may lead to conflict in its design, and in turn to delays in the creation of the PPP framework and delivery of the PPP program. • Also, PPP units cannot perform miracles. ̵ They are unlikely to help much if high-level political commitment to a quality PPP program is lacking. ̵ They must be integrated into the mainstream project approval and budgeting process in the government if they are to be successful. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 90 Quiz - Institutional Responsibilities 8-Which of the following is correct? A. The relevant sector agency should not be responsible for PPP procurement, as it will have a conflict of interest. B. A PPP Unit that advises and supports agencies implementing PPPs should not also have a role in control and oversight of the PPP process. C. The relevant sector agency should champion PPP projects, as it will inevitably have the greatest capability to conduct the rigorous project analysis required. D. Inter-departmental committees can be effective in overseeing PPP transactions. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 91 Quiz - PPP Units: roles and benefits 9-Which is incorrect with respect to potential roles and benefits of a PPP Unit? A. The role “control and oversight of the PPP process” ensures that the right steps are taken in developing a PPP, so the project meets the appraisal criteria, and that all required approvals are obtained. B. Promoting PPPs within the government implies that a PPP Unit will push procuring agencies to use PPPs as a preferred route so more PPPs are developed as soon as possible and this helps market appetite for the country’s program. C. The role of “advising and supporting agencies to implement PPPs” is sensible and beneficial as a PPP Unit will be able to offer a great deal of experience and specialist skills acquired because of their focus on PPPs and involvement in numerous projects. D. The role of “Providing communication channels to investors” is intended to help bidders and financiers with information about the program and upcoming opportunities so as to protect or boost the market interest in the PPP program. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 92 Quiz - Typical Responsibilities 10-Which one is correct: A. The typical responsibilities include identifying and procuring projects, ensuring coordination and best practice approaches, managing public financing and oversighting the contract. B. The typical responsibilities include identifying and procuring projects, ensuring coordination and best practice approaches, managing public financing and approving projects. C. The typical responsibilities include identifying projects, ensuring coordination and best practice approaches, managing public financing and approving projects. D. The typical responsibilities include identifying projects, financing projects, ensuring coordination and best practice approaches, managing public financing and approving projects. © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Institutional Responsibilities 93 6 Public Financial Management of PPPs Guide Sections #8 94 Public Financial Management of PPPs Introduction 8 • Public financial management of PPPs: ̵ Concerns controlling reporting and budgeting for fiscal obligations. ̵ Aims to reduce the risk of PPPs costing the government more than expected or placing undue burden on future generations. • PPPs commit governments to substantial future obligations ̵ But public financial management is generally geared to annual appropriations for expenditure. oTo resolve this situation, PPP-specific public financial management is required • Poor financial management of PPPs can have wide reaching economic impacts. ̵ Rating agencies examine the implications of PPP fiscal commitments when rating government debt. ̵ If PPP commitments are not well managed, the government’s bonds may be seen as a risky investment, increasing government’s cost of debt. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 95 Public Financial Management of PPPs – Types of Fiscal Commitments in PPPs (1) Direct Liabilities Payments that must be made if the PPP proceeds (although there may be some uncertainty regarding the value) Contingent Liabilities Payments where the occurrence, timing and magnitude depend on some uncertain future event, outside the control of government Examples: Examples: •Upfront "viability gap” payments •Availability payments •Shadow tolls or output-based payments •Guarantees on particular risk variables •Compensation clauses •Termination payment commitments •Debt guarantees or other credit enhancements © K-Infra & Foster Infrastructure 2020 | Frameworks 8 #6 Public Financial Management 96 Quiz- Public Financial Management 11-Which of the following is true A. It is not possible to estimate contingent liabilities in advance, therefore a contingency fund is required. B. The amount of PPP direct liabilities represents government’s fiscal exposure to a PPP (or a portfolio of PPPs). Contingent liabilities do not represent a real fiscal exposure or commitment as the related payments are uncertain. C. Risks assumed or retained by the government represent a contingent liability (for example in the form of compensation clauses in the contract or specific guarantees such as those related to minimum traffic), and these should be estimated and considered when assessing affordability. D. Termination payments specified in the contract for early termination scenarios represent a direct liability. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 97 Public Financial Management– Types of Fiscal Commitments in PPPs (2): the case of government off –taker 8 • If a government owned entity enters into a PPP, there are two levels of liability: The liability of the governmentowned entity • Recorded by the entity in question • May be consolidated into whole-ofgovernment financial reporting Central government liabilities • Liability to make good if the government-owned entity defaults • May be explicit or Implicit © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 98 Public Financial Management of PPPs – Identifying/Quantifying Direct Liabilities 8 • During appraisal, direct fiscal commitments can be estimated from the financial model. ̵ The direct fiscal contribution required is usually the difference between the cost of the project (including a commercial return on capital invested) and the revenue expected from non-government sources such as user fees. • The fiscal cost can be measured in different ways. ̵ Estimated payments in each year: Most useful measure when considering the budget impact of the project; and ̵ Net present value of payments: Captures the government’s total financial commitment to the project, and it is often used if incorporating the PPP in financial reporting and analysis (such as debt sustainability analysis). • How the payments might vary due to changes in key variables (such as demand, inflation and currency exchange rates) should be assessed. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 99 Identifying / Quantifying Contingent Liabilities • More difficult than for direct liabilities, since the need for such payments, and their timing and value, are uncertain. • Two possible approaches: Scenario analysis Making assumptions about the outcome of any events or variables that affect the value of the contingent liability, and calculating the cost given those assumptions 8 Probabilistic analysis Define how the variables that affect the value of the contingent liability will behave, then use mathematics and computer modelling to calculate the resultant costs Produces an estimate of the distribution of possible costs Requires reliable data from which to estimate the probability distributions of the underlying risk variables © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 100 Quiz - Types of Fiscal Liability 12-A national government is considering the following two options for supporting a PPP project being developed by a sub-national government. The project will be a government pays project, with the sub-national government making availability payments to the private partner. That national government is willing to meet these payments, if necessary, during the first 5 years of availability payments. 1. 2. Option 1 is for the national government to agree to make payments to the sub-national government during the 5 year period, with the payments by the national government to the sub-national government matching the amount and timing of the availability payments by the sub-national government to the private partner. Option 2 is for the national government to give a guarantee to the private partner, guaranteeing payment of the availability payments during the first 5 years. • What fiscal liabilities would these options create for the national government? A. B. C. D. Options 1 and 2 both create direct liabilities for the national government. Options 1 and 2 both create contingent liabilities for the national government. Option 1 creates a direct liability and option 2 creates a contingent liability. Option 1 creates a contingent liability and option 2 creates a direct liability. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 101 Affordability, Budgeting and Accounting/Reporting 8 Affordability •Identifying whether fiscal commitments can be accommodated within budget constraints. Budgeting •Ensuring money is appropriated and available to pay for costs. Accounting/ Reporting © K-Infra & Foster Infrastructure 2020 | Frameworks •Transparency and disclosure of commitments and payments that have been made. #6 Public Financial Management 102 Ensuring Fiscal Commitments are Affordable 8 • Affordability is the “ability to be accommodated within the inter-temporal budget constraint of the government” (OECD) • PPP costs are long-term and include contingent liabilities: ̵ not easy to decide whether they are affordable. • Affordability can assessed by considering: ̵ The medium-term expenditure framework (3 years or longer). oMake conservative assumptions as to how overall budget limits will evolve oConsider whether PPP payments can be accommodated within those limits ̵ The annual budget constraint. oIntroduce budget rules to ensure that PPP commitments are considered in the annual budget process. –Example: Colombia: When a PPP project is signed, a cash transfer is made to a contingency fund. The transfer equals the expected value of payments under any revenue. This means the decision to accept a contingent liability has an immediate budget impact that must be considered. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 103 Budgeting for Fiscal Commitments - Introduction 8 • Budgeting ensures money is appropriated and available to pay for costs the government has agreed to bear. ̵ It is difficult to budget for PPPs in traditional annual budget cycles because PPP costs may be contingent or occur in the future. oHowever credible and practical budgeting approaches are needed for good public financial management, and to assure private partners that they will be paid. • Budgeting for direct commitments to PPPs. ̵ Upfront or grant payments to PPPs, typically made within the first few years of a project, can be relatively easily built into annual budgets and medium-term expenditure frameworks. oSome governments (for example, India) have introduced funds (known as Viability Gap Funds) from which such payments will be made. ̵ Longer-term direct commitments, such as availability payments, are more challenging. oThe private party faces a risk that payments may not be appropriated when due. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 104 Budgeting for Fiscal Commitments – Long-term Direct Commitments Where risk of government not appropriating is low Where risk of government not appropriating is high • No special budgeting approach for direct, longterm PPP commitments. • It is assumed that a responsible legislature will always approve appropriations to meet the government’s legally binding payment commitments. • Mechanisms may be introduced to reduce the risk. • Example (Brazil): • Legislate to treat PPP subsidy payments in the same way as government debt service payments – once subsidy is approved, annual appropriation requires no further legislative approval. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 8 105 Budgeting for Fiscal Commitments – Contingent Liabilities 8 • Challenging because payments may become due unexpectedly ̵ The government may need to request a supplementary appropriation • Two ways to avoid this: Create additional budget flexibility •For example: •Include a contingency line in the budget from which unexpected payments can be made; or •Allow spending in excess of the budget without need for additional approval in certain defined circumstances. © K-Infra & Foster Infrastructure 2020 | Frameworks Create a contingent liability fund •An account to which transfers are made in advance, and from which payments for realized contingent liabilities will be made when due. •Can help control the government’s fiscal commitments to PPPs as well as provide a clear budgeting mechanism. •Can avoid the timing issues that arise if funds must be appropriated through the budget process in order to meet a contingent liability. #6 Public Financial Management 106 Quiz - Budgeting for Fiscal Commitments 13-It is difficult to budget for contingent liabilities, as payments may become due unexpectedly. Which of the following is true when responding to this challenge? 1. 2. A. B. C. D. This may be dealt with by creating budget flexibility, for example by including a contingency line in the budget from which unexpected payments can be made, or allowing spending in excess of the budget in certain defined circumstances. This may be dealt with by creating a contingency fund, i.e. an account to which transfers are made in advance, and from which payments for realized contingent liabilities will be made when due. Only #1 is true Only #2 is true Neither is true Both are true © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 107 Budgeting for Fiscal Commitments – Contingent Liability Funds - Example 8 • Indonesia Infrastructure Guarantee Fund ̵ Mandated to provide guarantees for government contracting agencies’ financial obligations under PPP agreements ̵ Paid up capital of $500m ̵ Has a stringent selection process for determining which projects to guarantee © K-Infra & Foster Infrastructure 2020 | Frameworks #5 Public Financial Management 108 Accounting for, and Reporting on, Fiscal Commitments (1) – Types of reporting 8 Government finance statistics Government financial statements Budget documentation and reporting • Summary statistics on the state of a government’s finances. • Intended to be internationally comparable. • May follow regional or international standards, such as those set by Eurostat or the IMF • Most governments publish audited financial statements • Some governments follow internationally recognized standards on what should be in financial statements, such as the International Public Sector Accounting Standards (IPSAS) • Most governments prepare reports on financial performance as part of budget preparation and reporting. • Not subject to international standards • There are international guidance materials (for example, by the IMF and OECD) that promote transparency. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 109 Recognizing PPP liabilities (1) - accounting for PPP assets and direct liabilities 8 • Need to decide whether PPP commitments should be recognized (formally recorded in financial statements as a liability) or not – the later may create a bias in favour of PPP or influence the PPP structure. • Two standards specifically address accounting for PPP projects: ̵ IPSAS Standard 32: PPP assets and liabilities should be included in the government’s balance sheet if (i) the government controls or regulates what services the operator must provide with the PPP asset, to whom, and at what price; and (ii) the government controls any significant residual interest in the asset at the end of the contract. o Under this definition, government-pays PPPs would appear on the government’s balance sheet; the treatment of user-pays PPPs is less clear, and may depend on the details of the contract ̵ Eurostat guideline: Requires European governments to recognize PPP liabilities in debt statistics where the government does not transfer to the private sector “the majority of risks”, including construction risks and either demand or availability risk. • Donors may require compliance with their own accounting and reporting standards © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 110 Accounting for PPP contingent liabilities 8 • Most accounting and reporting standards do not require governments to recognize contingent liabilities, including those arising from PPP contracts. ̵ Exception: IPSAS standards for governments implementing accrual accounting require contingent liabilities to be recognized if it is likely that the underlying event will occur and the amount of the obligation can be measured with sufficient reliability. oThe net present value of the expected cost of the contingent liability should be recognized as a liability (a provision) and as an expense when the contract is signed. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 111 Disclosing PPP liabilities 8 • Even when PPP commitments are not recognized as liabilities, they should be disclosed in notes to the accounts and reports. • Disclosing useful information on contingent liabilities is complicated. ̵ The expected value of payments is useful but difficult to predict. ̵ It is also useful if the magnitude and the likelihood of a liability being incurred are disclosed. –Examples: –Australia and New Zealand disclose contingent liabilities including for PPPs in notes to financial statements available online. –Chile’s Budget Directorate of the Ministry of Finance publishes an annual contingent liabilities report which includes information on contingent liabilities from revenue and exchange rate guarantees to PPPs. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 112 Controlling Aggregate Fiscal Exposure to PPPs 8 • In addition to considering fiscal exposure on a project-byproject basis, some governments introduce targets or rules limiting aggregate exposure. ̵ These limits help to ensure the government’s total exposure to PPP costs and risks remain within manageable limits. –Examples: Peru’s restricts PPP commitments and measurable contingent liabilities to a percentage of GDP; Hungary and Brazil (at Federal level) limit total financial commitments undertaken in PPP contracts to a percentage of government’s annual net revenue. oHowever, PPP specific limits can create incentives for agencies to choose public procurement over PPP even when PPP would provide better Value for Money. oAn alternative is to incorporate limits on PPP commitments within other fiscal targets, for example within targets or limits on public debt by placing a limit on “debt plus PPP commitments”. • When aggregate exposure is limited, each PPP will have to be tested against such overall limits during the appraisal. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 113 Quiz - Accounting for PPP assets and liabilities 14-There is a government-pays PPP contract for a hospital, in which government clearly defines the services to be provided by the private partner and the calculation of the price to be paid to the private partner. Payments are related to level of performance in the form of availability of the facility. During an unavailability event, as defined in contract, the payment will be zero unless the event is resolved within a rectification period. Payments will not be adjusted for construction cost changes (except where the change is a result of a very short list of unlikely and unavoidable events). There is no risk for the private partner related to volume / level of use of the hospital (but if occupancy is much higher than expected there will be compensation for increased variable costs incurred). At the end of the contract period, the asset will revert to the government for no payment. Based in the information provided about this PPP project, which is true? A. According to IPSAS 32 and Eurostat guidelines, the asset should be regarded as a public asset and incorporated in the government´s balance sheet. B. According to either guideline the asset may be treated as off the balance sheet of the government. C. The asset should only be regarded as a public asset under IPSAS 32, as government has clear control and an interest in the residual value, but risk appears to be sufficiently transferred for the asset to be off balance sheet according to the Eurostat guidelines. D. The asset should only be regarded as a public asset according under Eurostat, because risk is not sufficiently transferred but government does not have sufficient control of the asset according to IPSAS. © K-Infra & Foster Infrastructure 2020 | Frameworks #6 Public Financial Management 114 7 Oversight of PPP Programs Guide Sections #9 115 Oversight of PPP Programs - Introduction 9 • PPP projects are usually implemented by the Executive branch of government. • The following entities and groups can also play a role in ensuring good governance of the PPP program: ̵ The legislature: Often defines the PPP framework; May approve PPP projects; may exercise ex-post oversight, scrutinizing PPP commitments. ̵ Auditing entities: May consider PPP commitments as part of their regular audit responsibilities; May also investigate particular points of concern or review PPP project performance or the VfM of the program as a whole. ̵ The public: Can be involved through consultation; Serious issues may also influence elections. ̵ Other mechanisms: Can include probity advisors to identify and minimize any real or perceived conflicts of interest and public procurement watchdogs to monitor the procurement process. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 116 Oversight of PPP Programs – The role of the Legislature Defining the PPP legal framework and policy: 9 •The PPP framework is often established in specific PPP legislation. •A PPP law enables the legislature to set rules for how PPPs will be developed and implemented, against which those responsible can be held accountable. Defining limits on PPP commitments: •The legislature may limit total PPP fiscal commitments the amount taken on in a year, or otherwise govern the risk and inter-generational equity issues that PPPs can create Approving PPP projects: •PPP projects may require parliamentary approval •This requirement can be limited to PPP projects above a certain size. The risk that parliament will not approve entry into a PPP contract may decrease investor appetite to bid for PPPs in the country. Program oversight: • Information on the program may be included in budget documents and financial reports. • Project or contract summaries may be tabled in parliament after financial close, enabling it to scrutinize PPP commitments. • Parliament may also receive auditors’ reports on the PPP program. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 117 Oversight of PPP Programs – Audit Entities and Ex Post Evaluation 9 • The mandate of supreme audit entities varies by jurisdiction, but should generally : ̵ Regularity audits which can include auditing the financial statements of government entities and of the government as a whole, and auditing decision-making processes for compliance and probity ̵ Performance or Value for Money audits, reviewing the government’s effectiveness and efficiency. These audits can be conducted at the PPP program or project level. • Audit entities’ remits typically extend only to government agencies and entities wholly or majority owned by the government, not PPP companies. ̵ To enable auditors to access relevant information, the PPP contract can include requirements that the PPP Company provide audited accounts and any other relevant data the government may require. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 118 Oversight of PPP Programs – Types of Audits 9 Regularity auditing for PPPs • When carrying out regularity audits of contracting authorities, audit entities will typically check that PPP commitments are appropriately reflected in the accounts, and that PPP processes have been followed. Audits can occur at any stage of the PPP process, including during project preparation or after procurement. Performance auditing of PPP projects and PPP programs • May be audits of particular PPP projects or broader PPP programs, checking whether processes have been appropriately followed, or whether the project is providing VfM. • The International Organization of Supreme Audit Institutions (INTOSAI) recommends that performance audits be conducted soon after procurement, and further reviews should be carried out over the project lifetime, covering the following information: All major aspects of the deal that have a bearing on Value for Money, such as required actions, outputs, and timing of delivery; How the PPP was identified; How the transaction process was managed; The tender process that was adopted; How the contract was finalized; and Ongoing management of the PPP contract © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 119 Oversight of PPP Programs – The role of the Public 9 PPP program development • The government can engage the public from the onset by involving them in the development of the PPP policy framework and continuing to seek feedback as the program is developed PPP project development • The government can introduce stakeholder consultation in the PPP development process, so that public concerns can be taken into consideration when structuring and implementing PPPs PPP contract monitoring • The government can build mechanisms for user feedback and grievance resolution into contract agreements and management frameworks. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 120 Oversight of PPP Programs – Promoting transparency of the program 9 • Many governments make information about the PPP program publicly available. ̵ This enables the media to report on the program, and allows the public to develop informed opinions on the government’s performance in implementing PPPs. • International standards require disclosure of financial commitments to PPPs in national accounts. • Performance audits and reports are also commonly publicly available. • It is possible to also require disclosure of key contract clauses, or entire PPP contracts. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 121 Oversight of PPP Programs – Disclosure Frameworks: World Bank Guidance (1) 9 • Key aspects of a framework related to information disclosure: ̵ Accounting and reporting for PPP liabilities. ̵ Transparency of the procurement process. • The private sector will only be interested in PPP programs on a significant scale if the procurement rules provide and protect transparency and fairness in selection, as well as access to meaningful information and studies on the projects to enable potential bidders to assess the opportunity in an efficient manner. • For government to be accountable for procurement decisions, information must be available to be audited, including information related to the fairness of the process itself and the performance of the PPP project. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 122 Disclosure Frameworks: World Bank Guidance (2) – Types of Disclosure Proactive disclosure and reactive disclosure Pre-procurement disclosure and Postprocurement disclosure Proactive: Disclosed by governments either voluntarily or under a mandate provided by legislation or policy. Pre-procurement: Disclosure prior to the signing of the contract. Reactive: In response to a request for information, usually under a Freedom of Information or Right to Information Act. Post-procurement: After the signing of the contract. © K-Infra & Foster Infrastructure 2020 | Frameworks 9 #7 Oversight of PPP Programs 123 Oversight of PPP Programs – Disclosure Frameworks: World Bank Guidance (3) 9 • Benefits of Disclosure: ̵ Increased appetite from the private investor community. ̵ Increased public confidence in how tax payers’ money is being spent and whether the government is achieving Value for Money. ̵ A proper disclosure approach is extraordinarily helpful to tackle corruption. • Elements to induce Better Disclosure Practices: ̵ Freedom of Information Acts, preferably with requirements for proactive disclosure. ̵ PPP specific legislation/guidance. ̵ Guidance on confidential information. ̵ Provision of standard contract clauses. ̵ Templates for disclosing information. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 124 Promoting Procurement and Good Governance, and Reducing Corruption 9 • High value transactions attract the risk of corruption. ̵ Private players may attempt to improperly influence transactions ̵ Public officials may attempt to extract private profit from public office. • Corruption in PPPs can be minimized oversight mechanisms, plus: ̵ Probity advisors and auditors / Fairness / Conflict of Interest Advisors o Can ensure organizations act with integrity and impartiality, that suppliers are treated equally, that there are consistent and transparent processes, that intellectual property remains confidential, that conflicts of interest are resolved, and that procurement processes are aligned with capability. – Examples: Probity advisors used in Victoria, Australia; Fairness and Conflict of Interest Advisors in British Colombia, Canada ̵ Government procurement agencies oCan check that procurement processes have been followed. – Examples: Jamaica; Romania. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 125 Quiz - PPP Oversight 15-Which of the following is incorrect regarding the potential role of audit entities, the public, the legislature or other agents such as probity advisors? A. B. C. D. Audit entities may conduct “regularity audits” (for example auditing decision-making processes for compliance and probity) and “Performance or Value for Money audits”, reviewing the government’s effectiveness and efficiency when developing a PPP program or specific projects Corruption in PPPs can be minimized by oversight mechanisms, but also by using probity advisors as well as fairness and conflict of interest advisors There is a role for the public in PPP programs and projects, including participating in consultation during the PPP project development process, with the intention that the public vote and decide whether the project deserves to proceed The legislature usually has a role in approving PPP legislation (including potentially establishing limits on fiscal commitments in a law) and in some countries the legislature’s role may also include the approval of PPP contracts © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 126 Quiz - PPP Oversight 16-Which of the following is correct? A. PPP contracts should require the private partner to give the government party access to financial information and other data about the private partner. B. Auditors-General usually have no role in relation to PPPs, as PPPs are delivered by the private sector. C. As the actual cost of a PPP may not be known until the tender process has been completed, the government should not make information about the project available to the public prior to awarding the contract. D. Parliamentary scrutiny of PPPs is best implemented by requiring parliamentary approval for each PPP contract. © K-Infra & Foster Infrastructure 2020 | Frameworks #7 Oversight of PPP Programs 127 In collaboration with Contact Andres Rebollo arebollo@k-infrastructure.com Richard Foster richard@fosterinfrastructure.com This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. It may be only used by the client referred to on the front page of the document. Dissemination of this material to any third party other than the client is not allowed. 128 Knowledge Infrastructure, S.L. © Foster Infrastructure Pty Ltd © October 2020 This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. Dissemination of this material to any third party by candidates or by the institution is not allowed without prior consent by K-Infra in writing. The APMG PPP Certification Program is a registered Trade Mark of The APM Group Limited. All rights reserved. This document is subject to intellectual property rights and it its contents cannot be copied, distributed or transferred without prior explicit consent by K-infra. CP3P – Practitioner Course Chapter 3 Project Identification and PPP Screening Prepared by 1 Learning objectives • After studying this chapter, students should understand how to: ̵ Ensure a project has sufficient economic merit to proceed; ̵ Avoid the risk of sinking resources into the analysis and structuring of a non-feasible PPP project; and ̵ Prepare and get ready for the next phase: Appraisal. © K-Infra & Foster Infrastructure 2020 | Identification & Screening 2 Content • Objectives and Overview of the Project Identification and Screening Phase. • Identifying Needs: Entry Routes to the Pipeline and Project Prioritization. • Option Analysis and Selection Techniques. • Technical Outline of the Selected Solution and information requirements. • Economic Soundness. Introduction to Cost-Benefit Analysis. • Scoping the PPP Project and Testing PPP Suitability. The screening report. • Project Management Plan and Project Governance. Identifying Stakeholders and Developing the Communication Strategy. • Assessing Capabilities and Needs, Building the Project Team and Hiring Advisors. • Outcomes of Project Identification and Screening Phase. © K-Infra & Foster Infrastructure 2020 | Identification & Screening 3 1 Objectives and Overview of Project Identification and Screening Guide Sections #1, #2 4 Objectives of the Project Identification and Screening Phase • The PPP process is composed of a number of phases, requiring a significant amount of time and resources. • By carefully choosing which projects are included in the PPP pipeline and developed to feasibility level, governments can: ̵ ensure that resources are well-spent. ̵ reduce the likelihood of failure. ̵ guarantee the procurement process will run more efficiently. • A two-step approach can ensure that resources are well spent: 1. 2. Preliminary analysis is developed within the Screening Phase. Full appraisal is then conducted on those projects that pass the screening process. • This avoids the risk of unnecessarily consuming resources in the Appraisal Phase. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #1 Objectives and Overview 5 Screening and Appraisal – The two step approach Project 1 Project 1 Project 2 Project 1 Project 3 Project 4 Project Identification and Screening: Many different projects are identified and screened Project 4 Project 3 Project Appraisal: Based on the identification and screening process, some projects appear sufficiently worthwhile to move to full appraisal © K-Infra & Foster Infrastructure 2020 | Identification & Screening Project 4 Procurement: Appraisal determines that some projects are suitable for procurement. #1 Objectives and Overview 6 Overview of the Project Identification and Screening Phase - main tasks Test the economic sense and soundness of the project using CostBenefit Analysis. Test whether the project makes sense as a PPP. Conduct financial analysis to pre-test affordability. The project has been identified and pre-defined, is suitable to be a PPP, and information gaps, uncertainties and key stakeholders have been identified. Information should be recorded in a screening report, on the basis of which a decision is taken whether to move forward to the Appraisal Phase Scoping the project and collecting information Preliminary economic feasibility Testing PPP suitability and affordability Readiness of the project: Project management plan Screening report and decision to move forward Focus on the performance and capacity of the completed asset (output specifications), not how the project will be constructed (input specifications). The Guide states that Cost-Benefit Analysis should be used to test economic feasibility, even if another technique was used to select the technical solution. Project management plan should include an appraisal staffing plan, proposed advisor support, budget estimates and a funding plan for hiring external expertise. A full appraisal (of technical, environmental, socio-economic, and financial aspects) will take place in the next phase of the PPP cycle. Any process to procure public goods or services should start with identification of the need. Identify the technical solution that best suits the identified need. Identify the benefits created by satisfying the needs. Needs and option analysis: Select the project The Guide assumes that a need has already been identified. Note that the PPP scope may be a subset of the technical scope – some elements of the project might be delivered separately from the PPP. Central figure (in blue) © The World Bank Group, 2015 All rights reserved. Source: https://ppp-certification.com/certification © K-Infra & Foster Infrastructure 2020 | Identification & Screening #1 Objectives and Overview 7 Quiz – (an easy warm-up question!) 1-Which of the following is not a task carried out in the Project Identification and Screening Phase? A. B. C. D. Testing of economic feasibility. Assessing affordability. Allocating risks between the public and private sectors. Developing a project management plan. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #1 Objectives and Overview 8 2 Identifying Needs: Entry Routes to the Pipeline and Prioritization Guide Sections #3, #4 9 Identifying Needs: Entry Routes to the Pipeline (1) • The first step is to identify the need (the PPP Guide assumes this is already done) • A government can respond to identified needs in two ways: 1. o 2. By identifying an individual project. The project may have one or more infrastructure components that should be tested for PPP suitability. By developing a comprehensive plan that identifies a range of proposed projects. o The plan may be for a single sector or across a range of sectors, and it may be for a single geographical area or for the entire country. – Example: The Indonesian government has developed a pipeline of infrastructure projects based on its Master Plan for Acceleration and Expansion of Indonesia Economic Development 2011–2025. This calls for developing six “economic corridors” — regions that focus on specific industries. Investment projects are then developed based on the type of infrastructure, such as roads or ports that would be needed to support those industries. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 10 Identifying Needs: Entry Routes to the Pipeline (2) ENTRY ROUTE 1: Ad Hoc Projects ENTRY ROUTE 2: Plan Department investigates / identifies a need Government defines strategic needs / objectives THE PROJECT CYCLE: Specific project needs are identified A common process for all projects that enter the PPP Pipeline Figure © The World Bank Group, 2015 All rights reserved. Source: https://ppp-certification.com/certification © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 11 Rationale of Plans and project Pipelines • The list of identified projects, responding to individual needs or forming part of a plan, is called a pipeline. • Connectedness of projects should not be overlooked: ̵ The effectiveness of one project might be increased significantly if another project is also undertaken. • A pipeline is important to attract investors: ̵ Investors prefer to invest in a market that has a recognizable pipeline. ̵ A pipeline suggests a structured approach is being followed. ̵ A pipeline offers the potential to invest in a spread of projects in the same market, and to benefit from lessons learned and a similar context. ̵ Gives comfort that sufficient PPPs are likely to be forthcoming. • A government's project pipeline should contain all of its major projects, regardless of procurement method. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 12 Unsolicited proposals • Unsolicited proposals are an alternative source of projects for the pipeline. • An unsolicited proposal should fit with strategic objectives or respond to a clear need already identified by the public sector and should be included in the project list or the plan. ̵ Unsolicited proposals should not bypass the system. ̵ If the government wishes to consider unsolicited proposals, it should make them part of the system. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 13 Quiz - Entry routes to the pipeline 2-Which of the following are correct? 1. 2. Investors prefer to invest in a market that has a recognizable pipeline. Projects should only be identified as part of a coherent plan that identifies a range of proposed projects for a specific sector. A. B. C. D. Neither 1 nor 2 are correct. Only 1 is correct. Only 2 is correct. Both 1 and 2 are correct. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 14 Factors affecting Prioritization and Selection of projects • Governments need to undertake a prioritization exercise to choose between different projects. Why? oCurrent or future budgets may be restricted (this is usually the case). oThere are limits to society's ability and appetite to make user payments. If there are a large number of new projects with significant user charges, this may have an unacceptable impact on people's cost of living or the cost of doing business in the region. • Project prioritization enables the government to choose the right alternatives when there are numerous economically and technically feasible projects that address public needs. oThe main objective is to ensure that public funds are well spent and produce the highest benefit for society, even if budgets or users’ capacity to pay are restricted. oPrioritization may require the government to abandon a project for the time being, or postpone/move it to later. oEconomic analysis typically used to prioritize: higher economic Net Present Value (eNPV) or economic Internal Rate of Return (eIRR). © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 15 What is needed for rigorous project prioritisation? Areas of focus for rigor People and systems • Governments should train the right people and develop the appropriate systems for conducting these evaluations. • One approach is to create new units within a government that have the experience and tools to conduct the analyses. • Initially, it may make sense to tap outside experts to lead the effort while training in-house staff. Cost benchmarks • Governments should develop benchmark databases that collect cost information on both public and PPP infrastructure projects. • This should include not only the capital expenditures for developing a project but also the cost of operating the project. Standardized methodologies • Governments should develop standardized methodologies for making these assessments and identify a source of common key assumptions (e.g. , what the financing costs would look like under a public-sector approach versus a private-sector approach). © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 16 Quiz - Project Prioritisation 3-Which of the following are correct? 1. Project prioritisation enables the government to deliver all proposed projects in the correct sequence. 2. Governments do not need to prioritise projects with user charges, as these projects do not consume any of the government’s budget capacity. A. B. C. D. Neither 1 nor 2 are correct. Only 1 is correct. Only 2 is correct. Both 1 and 2 are correct. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #2 Identifying Needs 17 3 Option Analysis and Selection Techniques Guide Sections #5 18 Option Analysis and Selection Techniques (1) • There are multiple techniques for identifying the best technical solution for a project i.e. which projects best meet public needs • Common techniques: ̵ Cost Benefit Analysis. ̵ Cost Effectiveness Analysis. ̵ Multi-Criteria Analysis. • The government should have a policy of using a particular technique so that all projects are compared consistently. • Screening on a case-by-case basis using different techniques would lead to invalid comparisons between different projects. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #3 Option Analysis 19 Option Analysis and Selection Techniques (2) Cost Benefit Analysis Cost Effectiveness Analysis Multi-Criteria Analysis Basis of comparison Compares options by testing which shows highest Net Present Value (NPV) in economic terms or highest economic Internal Rate of Return (eIRR) Compares options by examining cost relative to a measure of project objectives (its key outcomes or benefits) Example: Dollars per time saved on various public transportation systems Compares options by reference to an explicit set of objectives with measurable criteria (often quantitative analysis of qualitative impacts – e.g. numerical scores are given against qualitative criteria) Advantages • • Disadvantages • • • Quantifies the socioeconomic impact of the project The most appropriate technique for the economic feasibility assessment • Can be intensive and complex Some cost information may not be available Benefits may be difficult to quantify • • • Less intensive and complex than cost benefit analysis Provides an alternative technique if valuing benefits in monetary terms is too difficult • Useful when defining monetary values for all the major costs and benefits is impractical Assessment of effectiveness relies on subjective judgment Some cost information may not be available • May require consideration of multiple conflicting criteria Can be sensitive to the weighting of the criteria © K-Infra & Foster Infrastructure 2020 | Identification & Screening #3 Option Analysis • 20 Options Analysis – Putting the theory into Note to candidates: this will be discussed in class practice (1) • The following slide contains scenarios for training participants to discuss in groups. • Review your scenario and answer the following questions: 1. 2. 3. If you were analysing the options using cost benefit analysis, what benefits would you quantify, and how? If you were analysing the options using cost effectiveness analysis, what units of effectiveness would you measure? If you were analysing the options using multi criteria analysis, what criteria would you use? © K-Infra & Foster Infrastructure 2020 | Identification & Screening #3 Option Analysis 21 Options Analysis – Putting the theory into practice (2) – Scenarios Note to candidates: this will be discussed in class Scenario 1 – Transport Project Scenario 2 – Water Project Scenario 3 – Aged Care Project Scenario 4 – Justice Sector Project • The need: • Reduce transport congestion in a key transport corridor between a residential area and an industrial are. • The need: • Supply potable drinking water to a coastal community that currently only has access to polluted river water. • The need: • Provide adequate care for a growing elderly population with insufficient income to meet the costs on their own. • The need: • Relieve pressure on an over-crowded prison system. • Options being analysed: • Add new lanes to an existing road between the residential area and the industrial area. • Build a metro rail line between the residential area and an industrial area. • Options being analysed: • A sea water desalination plant and an associated water distribution network. • A water treatment plant processing river water and an associated water distribution network. • Options being analysed: • Payment of direct subsidies to the aged to enable them to pay for care in their existing homes. • Construction of government subsidised aged care homes operated by the private sector. • Options being analysed: • Construction of a new prison • Justice reinvestment – provide services to prisoners during and immediately after their time in prison to help them become law abiding citizens and prevent them reoffending and returning to prison. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #3 Option Analysis 22 Quiz - Option Analysis 4-Which is a true statement about the Cost-Effectiveness Analysis technique used for option analysis and selection? A. It uses monetary terms as the denominator. B. It is the most appropriate technique for the economic feasibility assessment. C. It divides the total cost of a project by the total expenditure to produce a cost effectiveness ratio. D. The output is a non-valued ratio which leaves a subjective judgement. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #3 Option Analysis 23 Quiz - Option Analysis 5-Identify the missing words in the following sentence: Multi-Criteria Analysis uses [ ? ] criteria in the evaluation of an alternative. A. B. C. D. Only quantitative. Only qualitative. Both quantitative and qualitative. Monetary values for all. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #3 Option Analysis 24 4 Technical Outline or Technical Scope of the Selected Solution, and Information Requirements Guide Sections #6, #7 25 Technical Outline of the Selected Solution (1) – Considerations and Benefits • The next step after defining the technical solution is to describe and clarify the technical scope, including a detailed description of the project and set of requirements for the most important aspects of the project (that is, a technical outline of the project → see next slide) ̵ The project should be described with sufficient certainty to enable government to respond to the PPP screening questions. ̵ Good scoping clarifies the information needed - note that good quality of information is crucial. • Additional time and effort may be required to adequately define the PPP project scope if, at the outset, one or more of the following factors are prevalent: ̵ Lack of a clear specification of what is required. ̵ Novelty or lack of experience of this particular activity. ̵ Complexity in terms of the number of influencing factors and associated interdependencies. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 26 Technical Outline of the Selected Solution (2) – Content of the Outline Sector Physical conditions • Distance etc. for transport projects • Area etc. for buildings Site Geographical location Affected / benefited population Photo © Foster Infrastructure. All rights reserved. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 27 Information Requirements / Data Checklist (1) – Introduction • Most projects have constraints and dependencies that must be clarified before beginning the full appraisal (e.g. , land availability, environmental studies) ̵ Key consideration: Identify potential difficulties or obstacles that will have to be considered during the full appraisal. ̵ Uncertainties regarding constraints and dependencies should be listed in the screening report. ̵ A list of legal and regulatory issues that need to be further tested in the full appraisal should be included in the screening report to inform the next phase. • The list should also provide a description of any information or data weaknesses, recommending, if necessary, further analysis or research to correct these weaknesses. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 28 Information Requirements / Data Checklist (2a) – Possible uncertainties Land availability Construction risks •For example, dependence on geotechnical conditions Technology requirements Significant site risks •For example, a need to use new or untested technology •Such as a lack of information in relation to utilities or hazardous materials Environmental concerns Permits Unavailable information Photo © Foster Infrastructure. All rights reserved. © K-Infra & Foster Infrastructure 2020 | Identification & Screening •Access to other permits such as those to be issued by other governments •General concerns about the availability of information for the appraisal #4 Technical Outline 29 Information Requirements / Data Checklist (2a) – Possible uncertainties Note to candidates: this will be discussed in class – Discussion • The photo on the previous slide is of a toll road. When the project was first identified, what uncertainties might there have been in respect of: ̵ Land availability? ̵ Construction risks? ̵ Technology requirements? ̵ Significant site risks? ̵ Environmental concerns? ̵ Permits? ̵ Unavailable information? © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 30 Information Requirements (3a) – Typical Information required The following is the typical information needed to conduct the economic assessment and to screen PPP suitability. • Name and position of the proponent: ̵ Person in charge/department within the Public Sector. • Project description: ̵ Technical outline. • Cost estimate (Capital expenditures – CAPEX): ̵ At this stage, the Capex estimation is preliminary and subject to change. ̵ Some governments resist public release of this estimate to avoid creating unrealistic expectations about project costs. • Construction term. • Affected area/population. • Operation and maintenance (O&M) cost estimates: ̵ Including life-cycle/refurbishment costs that will be incurred during the possible term of a PPP contract. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 31 Information Requirements (3b) – Typical Information (cont.) • Consideration of whether, and to what extent, user fees can be charged: ̵ Revenue estimates (may require demand studies, such as traffic forecasts) • Timetable objectives: ̵ Desired procurement dates • Estimated public support / contributions required, if any • Explanation/justification of the project’s suitability in relation to the public sector’s general policies / strategic plan • Description of the need being fulfilled by the project: ̵ Main economic impact factors and socio-economic benefits of the project • Options and suitability of the proposed solution: ̵ Are there other technical options? ̵ Have these options been considered? If not, explain why. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 32 Information Requirements (3c) – Typical Information (cont.) • Description of potential interest from the private sector and availability of private skills for such a project: ̵ Potential sources of finance. ̵ Likely sources of bidders, including whether local firms will be interested in or capable of bidding alone (or as part of a consortium), and whether regional or global firms will be interested. • Similar precedents: ̵ Both successful precedents and unsuccessful precedents. • Site/land availability, if relevant • Environmental considerations: ̵ Describe environmental requirements / difficulties if significant. • Status and readiness: ̵ Describe studies that have already been carried out or that are in process, if applicable • Other relevant information in relation to suitability, economic soundness, project readiness, risk of failure in project delivery/implementation, and so on. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 33 Information Requirements (4) – Information sources • Some basic information can be collected directly from the project management team. • Data related to estimates of costs can be collected in a variety of different ways. ̵ It may be possible to directly estimate the costs of delivering the project scope. ̵ It is important to compare these costs to market parameters for similar projects. ̵ A database of comparator projects can greatly assist the project team to assess the reasonableness of these estimates. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 34 Quiz - Technical Outline and Information Requirements 6-Why are constraints and dependencies part of the information requirements in the Project Identification and PPP Screening Phase? A. Legal and regulatory issues must be resolved before a project moves forward to appraisal. B. A project containing constraints should not move forward to appraisal. C. A project containing dependencies is not suitable as a PPP. D. Potential difficulties or obstacles may influence a project moving forward to appraisal. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #4 Technical Outline 35 5 Economic Soundness. Introduction to Cost-Benefit Analysis Guide Sections #8 36 Economic Soundness: Introduction to Cost-benefit Analysis • Cost-Benefit Analysis (CBA) is the most refined form of economic analysis ̵ It assesses the social cost-benefit equation: oIf the benefits for society are higher than the costs to the public, the project is worthy of proceeding. ̵ It aims to include all relevant costs and benefits. oThis is done with a long-term perspective. oThe period considered should reflect the useful economic life of the asset. • Uses of CBA: ̵ CBA may be used to identify an option (from several technical solutions for the same need) when there are several options under discussion. ̵ If the best technical option has already been identified, CBA may be used to confirm the investment decision [according to the Guide it is the most appropriate tool for economic feasibility analysis] oIn this scenario, CBA is comparing the “project” and the “do nothing option”. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 37 Introduction to Cost-benefit Analysis: The Analysis Process Projecting Financial Data with Conversion / Adjustment Adding Externalities Adding (other) socioeconomic benefits & costs Relative price adjustments and bias / risk adjustments Defining Base Case, Discounting and Calculating eIRR Incorporating Uncertainty: Sensitivities Closing the Analysis and reporting •Tax Adjustments •Shadow prices and opportunity costs adjustment •Construction of the model •Defining term and residual value •Defining list of externalities (positive and negative) •Monetizing / inferring value for relevant benefits and costs •Considering / qualifying other unvalued benefits and costs •Relative price •Bias & risk adjustments •Discount rate definition •Calculation of eNPV and eIRR. •Test the strength of the proposed Business Plan and present the effect of variations •Include the assumptions and results in the Screening Report This graph has been edited for improvement. We start with the financial data, adjust for taxes and market imperfections (convert to ecomomic flows) and construct the projections. Then we add pure economic values/drivers that are not tangible and direct (those previously converted) as well as all benefits, some of which could be regarded as externalities* Figure © The World Bank Group, 2015 All rights reserved. Source: https://ppp-certification.com/certification © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 38 Introduction to Cost-benefit Analysis: Some key concepts (i) • Benefits [and costs] have to be considered in the broad sense: direct or indirect, internal and external [as well as tangible and intangible] ̵ Most of the costs are direct costs –and benefits- (such as the cost of the investment itself, the public works), but the project may have other indirect costs and benefits as well as positive and negative “externalities”. ̵ External benefits (or “externalities”) and costs are those that affect or benefit third parties beyond the population to which the project is addressed in a first instance o externalities: “the effect of production or consumption of goods and services imposes costs or benefits on others which are not reflected in the prices charged for the goods and services being provided”. • When valuing project costs and benefits [other than tangible and direct], a quantification problem can arise. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 39 Introduction to Cost-benefit Analysis: Some key concepts (ii) • Willingness to Pay: Willingness to pay represents the perceived value of the benefits to users of the infrastructure • Financially Viable Projects: Projects in which the expected revenues exceed the costs of the project. Don’t confuse with: • Economically Viable Projects: Projects in which the benefits that society derives from the project are greater than the costs to society • Dealing with Inflation: Cost-benefit Analysis is generally conducted using projections of prices in real terms – that is, excluding inflation. Future prices should be adjusted to remove any variation reflecting inflation. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 40 Introduction to Cost-benefit Analysis: Valuing costs and need for adjustments • Costs should reflect the best alternative use of the goods (opportunity cost) to the extent to which it is possible • Market prices are the best way to reflect the opportunity cost ̵ But in some circumstances they may not do so accurately due to market imperfections (e.g. monopolistic situation), especially when it is a regulated market or item. ̵ In this situation, shadow prices should be estimated and used instead of the market price. Examples: o If electricity prices are capped by regulation below the economic cost of producing electricity, use the economic cost, not the capped price. o Salaries are above the real economic price of the factor in high unemployment context with minimum salary regulations. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 41 Introduction to Cost-benefit Analysis: Valuing costs and need for adjustments (ii) • Other opportunity cost adjustments ̵ There may be a cost to society even if there is no direct cash cost. o Example: Public land or public property provided at not cost to the project should be valued at market price to reflect the opportunity cost for government. o If there is no alternative use for the asset, the cost is deemed to be zero (“sunk cost”, not recoverable). • The effect of taxes should be removed ̵ Taxes are part of the nominal cost (in terms of cash flows), but are not a cost to society (but in fact are a revenue for the government). o Example: Value-added tax on construction materials should be excluded, import duties, corporate taxes. o Exception: There can be justification for including a tax used to correct an externality (for example, a pollution tax), but also adjust the externality to avoid double counting. • Assigning a monetary value to many intangible variables (such as quality of life, security of a neighbourhood) is not an easy ̵ One approach is to determine willingness to pay: o This depends on the perceived economic value and on the utility of the good © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 42 Introduction to Cost-benefit Analysis: Types of costs and valuation approaches [in a transportation project*] Tangible Costs Intangible Costs Direct Costs Indirect Costs Examples: • Personnel • Materials and supplies • Rentals (facilities/equipment) • Capital purchases • Land • Volunteers Valuation approaches (a selection)*: • Wages and benefits • Current expenses • Fair market rents Examples: • General overhead • Spillovercosts to third parties • Environmental damage • Compliance/client costs Examples: • Fear of harm Valuation approaches: • [None given in the Guide] Examples: • Loss of aesthetics Valuation approaches: • [None given in the Guide] Valuation approaches (a selection)*: • Estimation of impact or mitigation cost * Full list is provided in guide table 3.1 © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 43 Introduction to Cost-benefit Analysis: Valuing benefits • Quantifying benefits is especially challenging ̵ Benefits often relate to the “opportunity cost” concept o For example, time savings generated by transportation projects ̵ In order to estimate direct benefits, the first step would be to research whether there is available market data regarding the specific benefit. ̵ It can be useful to consider values from studies in other countries o Although the value (such as willingness to pay) may differ between countries ̵ In cases in which benefits appear as cost savings, the quantification of a benefit is implicit in the cost estimate of the alternatives under analysis • What if it is decided not to quantify a specific benefit? (For example, because it is not possible to quantify the benefit) ̵ Treat the benefit qualitatively o Include the qualitative information in the analysis in addition to the quantitative results o Explain how the benefit is linked to the authority’s strategic plan and global strategic objectives o [note: in fact the same can be said of some indirect costs] © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 44 Introduction to Cost-benefit Analysis: Types of benefits and valuation approaches Tangible Benefits Intangible Benefits Direct Benefits Indirect Benefits Examples: • Goods and services • Increased production or profits/lifetime earnings • Time saved Examples: • Cost savings • Spill-over impacts to third parties • Multiplier effects Valuation approaches (a selection)*: • Fair market value or willingness to pay • Increased productivity/earnings • After-tax wage rate Valuation approaches (a selection)*: • Difference between before and after action • Estimated impact or mitigation of impact • Additional indirect jobs created Examples: • Lives saved • Healthier citizens • Quality of life • Aesthetics Examples: • Preservation of community • Increased self-esteem Valuation approaches (a selection)*: • Lifetime earnings Valuation approaches: • [None given in the Guide] * Full list is provided in guide table 3.1 © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 45 Introduction to Cost-benefit Analysis: Performance Indicators Economic Net Present Value (eNPV) The projected costs and benefits, discounted using a suitable discount rate. Should be positive, indicating benefits are higher than costs, after allowing for differences in timing. Economic Internal Rate of Return (eIRR) The discount rate that makes the NPV equal to zero. • In some cases, eNPV is not the most appropriate indicator, as it does not consider the volume of resources employed. ̵ If alternatives have significant differences in resource consumption, eIRR may be more appropriate for the selection. In these circumstances, consider the results based on both eNPV and eIRR, as well as any qualitative analysis. • Note1: A third indicator, not discussed in the Guide, is the benefit/cost ratio (BCR), which is the ratio of benefits in net present value terms to costs in net present value terms, and should be greater than 1 (that is, benefits should outweigh costs). © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 46 Introduction to Cost-benefit Analysis: The Discount Rate • Selection of the discount rate is a key issue to ensure the eNPV is properly calculated in terms of opportunity costs. ̵ There is no universal consensus on the determination of this discount rate. ̵ It may be appropriate to conduct sensitivity analysis using a range of different discount rates. ̵ Some governments identify and publish a standard rate to be used and, in some cases, also publish the appropriate range for sensitivity analysis. –Example: In Australian transport projects a standard practice is to use a 7 percent real discount rate as the base case, and to conduct sensitivity tests using 4 percent and 10 percent real discount rates. ̵ “As CBA evaluates the economic merit of a project regardless of how it is delivered, the fact that the project might become a PPP does not affect the discount rate used”. ̵ Note: although not mentioned in the Guide, it is important to use a consistent discount rate method across projects. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 47 Introduction to Cost-benefit Analysis: Usual approaches to the Discount Rate Use the opportunity cost of capital • The analysis is dealing with public assets, so the discount rate could be the public debt interest rate (at the longest term available). • Remove inflation to establish the rate in real terms. Use an approximation of the Social Time Preference Rate • This is “the value that society attaches to present, as opposed to future, consumption”. • This approach is advised or prescribed in a number of countries such as the United Kingdom. Use estimated or targeted future real GDP growth • Implies that only projects which increase society’s welfare (at least equal to the economy’s expected or targeted growth rate) will be developed • All projects with a positive NPV are expected to at least help the GDP grow as forecast. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 48 Introduction to Cost-benefit Analysis: Note to delegates: this will be discussed in class Example for discussion • Considering the Australian standard described before, consider the following cost benefit analysis from a hypothetical road project ̵ How would you interpret this analysis? ̵ What aspects of the analysis might have offered particular challenges? ̵ Is this project worthy of proceeding? Present Value ($m) Costs Benefits At 4% Discount Rate Capital Costs $ 3,480 O&M Costs (30 year evaluation period) $ 304 Total Costs $ 3,784 Travel Time Savings $ 3,801 Vehicle Operating Cost Savings $ 1,478 Crash cost savings $ 315 Reduced pollution $ 80 Increased economic activity $ 1,820 Residual Value $ 125 Total Benefits $ 7,617 Net Present Value (NPV) © K-Infra & Foster Infrastructure 2020 | Identification & Screening $ 3,833 At 7% Discount Rate $ 3,283 $ 287 $ 3,570 $ 2,534 $ 985 $ 210 $ 53 $ 1,213 $ 83 $ 5,078 $ #5 Economic Soundness At 10% Discount Rate $ 3,053 $ 267 $ 3,320 $ 1,267 $ 493 $ 105 $ 27 $ 607 $ 42 $ 2,539 1,508 -$ 781 49 Introduction to Cost-benefit Analysis: Incorporating risk and uncertainty • The risks that are inherent to a project have to be considered and included in the appraisal. ̵ Can be done through: oProper adjustments by probability. oShowing the ranges of values for certain sensitivities/future movements . oShowing deviations on critical factors and variables. ̵ For this purpose, risks have to be quantitatively evaluated, incorporating the "expected values" of the risks into the analysis . oThe expected value of a risk is the product of the likelihood of the risk occurring by the size or amount of the outcome (in monetized terms). oThis should be done for all relevant or "critical" risks whose likelihood and outcome can be reasonably estimated. • See further Chapter 4 of the Guide and The Green Book by HM Treasury (UK). © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 50 Quiz - Introduction to Cost-benefit Analysis 7-Using the Cost-Benefit Analysis technique, which is the best technical solution for a project? A. Lowest Net Present Value in economic terms or lowest economic Internal Rate of Return. B. Highest Net Present Value in economic terms or highest economic Internal Rate of Return. C. Lowest Net Present Value in economic terms or highest economic Internal Rate of Return. D. Highest Net Present Value in economic terms or lowest economic Internal Rate of Return. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 51 Quiz - Introduction to Cost-benefit Analysis 8-Which describes “opportunity costs” in a Cost-Benefit Analysis? A. The value of benefits or costs where no competitive or explicit market prices exist. B. The best alternative use of assets or capital. C. Those that affect third parties beyond the population to which the project is addressed in the first instance. D. The cost of the investment itself. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #5 Economic Soundness 52 6 Scoping the PPP Project and testing PPP suitability (PPP screening) Guide Sections #9, #10, #14 53 Scoping the PPP Project: considerations and benefits • Scoping the PPP project means defining the work to be done by the future private partner to deliver the project objectives: ̵ Some portions of the project’s technical scope may be removed from the PPP project. –Example: In a bus rapid transit project, the future PPP may include the bus way, bus stops and depots but exclude the vehicles. ̵ It includes defining the scope of the service or business that will be the private sector’s responsibility. –Example: Does it include or exclude tariff collection? ̵ This should be expressed as a service standard defining what will be done, to what quality levels, and by whom. • Many projects fail due to poor scoping in the early phases. • A definitive decision on the contract scope is sometimes postponed to appraisal phase. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 54 Scoping the PPP Project: Example • The Delhi Airport Metro Express was conceived as a dedicated metro line between the city and its airport. • The Delhi Metro Rail Corporation, which was the government authority responsible for the project, proposed to undertake all the civil works itself, including construction of the necessary viaduct, tunnels and the stations. • DMRC proposed a PPP for the delivery and operation of the operating systems—primarily the track, signals, power. distribution system and rolling stock—and for paying operating expenses. • Hence the civil works were a significant part of the project, but were outside the PPP scope. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 55 Scoping the PPP Project: Reducing uncertainty • Robust PPP scoping delivers benefits by reducing uncertainty: ̵ More accurate risk calculations; ̵ Reduced control costs; ̵ More effective teams (through improved confidence); and ̵ Improved planning. • Questions to assist in defining PPP scope : ̵ Who are the parties ultimately involved? ̵ What do the parties want to achieve? ̵ What is it that each party is interested in? ̵ Which way (how) is each party’s work to be done? ̵ What resources are required? ̵ When does it have to be done? © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 56 Testing PPP Suitability and Affordability: Introduction • If a project is economically sound, the government must determine whether the project makes sense as a PPP ̵ This avoids the risk of sinking resources into the analysis and structuring of a non-feasible PPP project. ̵ The result of the suitability test may be one of the following; oThe project appears to be sound as a PPP and can move on to the next stage. oThe project is not suitable as a PPP. Appraising the project for traditional. procurement methods if a public budget is available. oThe project is missing relevant information, or there is a need to clarify some uncertainties. Record the project’s weaknesses and recommend further analysis. • Screening for PPP suitability and affordability ensures that: ̵ the project is better prepared for procurement. ̵ uncertainties are identified. ̵ necessary resources and schedules are duly accommodated for a more reliable procurement process. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 57 Testing PPP Suitability and Affordability: Process PPP Suitability Test Project is suitable to be a PPP Go to Appraisal Project is not suitable to be a PPP Dismiss as a PPP and appraise its implementation as a publicly funded project Information is missing or there are uncertainties requiring clarification Recommend additional studies before moving to the next stage Figure adapted from PPP Certification Guide © The World Bank Group, 2015 All rights reserved. Source: https://pppcertification.com/certification © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 58 Testing PPP Suitability and Affordability: Determining PPP suitability ̵ Key questions for determining PPP suitability: o Are there any significant risks or uncertainties that cannot be managed by a private partner? –Examples: Non-availability of the land/right of way and land acquisition cost overrun o Can the project be accommodated within the legal framework as a PPP? Have all relevant laws been taken into consideration? o Is the project’s size big enough to justify PPP transaction costs? Is it not too big for the market? Can local construction companies take it on? Can it be financed? o Would there be investor market appetite? What precedents transactions are there in the country/region/similar countries? o Does it make sense to bundle construction and operations and/or maintenance in a single contract? o Are the output requirements clearly identifiable? ̵ Extra note (not described in the PPP Guide): –Many of these questions don’t have a simple answer but it is a question of degree and judgement. Also, the project may be made suitable for a PPP by refining the scope of the contract or the risk allocation. –Some countries opt for a semiquantitative approach through MCA, scoring these and/or other criteria and looking for a final score © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 59 Testing PPP Suitability – Example: A waste incineration project (1) • Are there any significant risks or uncertainties that cannot be managed by a private partner? ̵ ? Can a private partner take the following risks? (If not, we should see whether they can be assumed by the government). oThe risk that the composition of the incoming differs from that expected. oThe risk that the chosen technology does not perform to expectations. oThe risk that emissions from the plant breach environmental limits. • Can the project be accommodated within the legal framework as a PPP? Have all relevant laws been taken into consideration? ̵ ? Does the law allow private operation of an incineration plant? ̵ (if not, we should abandon –or starting a legal change process) © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 60 Testing PPP Suitability – Example: A waste incineration project (2) • Is the project’s size big enough to justify PPP transaction costs? Is it not too big for the market? Can local construction companies take it on? Can it be financed? ̵ ? What are the expected capital and operating costs? Are they too big for the construction and finance markets, or too small to justify a PPP? ̵ (if a project is too big to be privately financed, we should see whether the government can assume directly financing a part of the CapEx) • Would there be investor market appetite? What precedents transactions are there in the country/region/similar countries? ̵ ? Has a market sounding been conducted? ̵ ? Have international PPP experts been consulted? © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 61 Testing PPP Suitability – Example: A waste incineration project (3) • Does it make sense to bundle construction and operations and/or maintenance in a single contract? ̵ In a technically challenging project, it is beneficial to have the technology provider and the proposed operator work together through the construction and start-up of the project to ensure that it will operate as expected. • Are the output requirements clearly identifiable? ̵ The requirements can be defined as capacity for treating a specified volume of waste meeting specified environmental performance outcomes and certain energy production per Ton treated. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 62 Testing PPP Suitability and Affordability: Determining Affordability • If the project is developed as a PPP, can the public sector afford the necessary payments (Capex and Opex)? Consider: 1. o 2. – 3. – Are the required user charges and/or long-term call on the government budget are affordable? This is relevant regardless of the chosen delivery method, and should be considered prior to PPP screening. If the answer to question 1 is “No”, are innovative structures available that can make the project affordable if delivered as a PPP? Example: synergistic commercial development opportunities in a PPP model If the project is affordable in the long term, what about the short term? Are there constraints on government financing such that, even though the project is affordable in the long term, the government cannot finance its investment in the project in the short term? Example: Borrowing restrictions oIf the answer is “yes”, can a PPP can be structured to overcome that issue? © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 63 The Screening Report • It is good practice to complete a report containing at least the following sections before entering the full appraisal process and, specifically, before committing staff and/or hiring advisors. Executive summary and recommendations Project description: Outline of technical solution Needs/benefits of the project and suitability of the solution proposed PPP suitability: Justification for the use of a PPP process Affordability: Economic and financial pre-analysis Legal and regulatory issues Readiness of the project and its status, including stakeholder identification Information availability Outline of the project management plan © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 64 Quiz - Scoping the PPP Project and testing PPP suitability (PPP screening) 9-What does ‘Scoping the PPP project’ mean? A. Screen the project for PPP suitability. B. Test the project for economic sense and soundness. C. Define the work that must be done by the future private partner to deliver the project. D. Conduct a preliminary financial analysis to pre-test affordability. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #6 Scoping the PPP Project 65 7 Project Management Plan and Project Governance. Stakeholders identification and communication Guide Sections #11, #12 66 Project Management Plan and Project Governance Considerations • Before a decision is made to move to the next stage (appraisal), a list of tasks and a schedule should be developed. This will: ̵ Serve as the basis for the Request for Proposals for external advisors, if needed; and ̵ Assist the government, in the Appraisal Phase by identifying any consequences or risks associated with the proposed schedule. • Stakeholder management and communication are paramount: Early engagement with the decision-makers is a key factor in the success of the final approval process (especially in terms of timing) [→ see “identifying stakeholders”] • The availability of a project team must be confirmed. The need for external capabilities should be clearly identified and the costs of such services estimated so as to provide a budget estimate → see #8 assessing capabilities and hiring advisors. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 67 Project Management Plan: Contents Detailed work program for Appraisal Process • List of tasks. • Estimated Timelines. • Target dates. • Intermediate dates. • Duration of the next phase. • Resources required (staff, advisors) and budget estimate. Precedent Conditions and risk • Describe precedent conditions such as: • Permits. • Environmental approvals. • Land availability. • Legal due diligence required. • Sort out weaknesses of information and determine main risks and plan risk strategy. © K-Infra & Foster Infrastructure 2020 | Identification & Screening Preliminary program of process to Contract Award • Overall timetable. • Benchmark against precedents. • Enables inclusion of the project properly in overall PPP pipeline. Approval Process • Sign-offs/engaging with decisionmakers. • Identify / plan Approvals. • Identify other stakeholders and develop communication strategy/plan. #7 Project Management Plan 68 Quiz - Project Management Plan 10-Which of the following should be included in a Project Management Plan prepared during the Project Identification and Screening Phase? 1. 2. 3. 4. A overall timetable to contract award. The proposed risk allocation for the PPP contract. Information on land availability. Information on resources required for the Appraisal Phase. A. B. C. D. Only 1, 2 and 3 should be included. Only 1, 2 and 4 should be included. Only 1, 3 and 4 should be included. Only 2, 3 and 4 should be included. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 69 Identifying Stakeholders and Developing the Communication Strategy (1) • Identify critical stakeholder groups early in the project process • Communication with stakeholders is essential to: ̵ Facilitate their understanding of the process. ̵ Gain social, business and political support for the project. ̵ Attract potential investors. ̵ Reduce risks for the project. • Map stakeholders’ needs, concerns, worries, and interests: ̵ This enables project managers to communicate the appropriate information which addresses each stakeholder’s needs.. • The number of stakeholders and their interests will change through the project. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 70 Identifying Stakeholders and Developing the Communication Strategy (2) • Citizens often expect active involvement in projects: ̵ Affected groups may be sufficiently opposed that they take action and can delay or even halt a project. ̵ Academic conferences, citizens' summits, etc. can be used to enlarge public support. ̵ If managed well, stakeholders can be eager promoters of projects –Example 1: Alandur Sewerage Project, India » Early involvement of the public through surveys and citizens’ committees coupled with targeted outreach explaining the project costs, benefits, and tariffs. » The project proceeded smoothly, with citizens agreeing to pay a one-time connection fee, and thereby contributing 29 percent of the financing. –Example 2: Timarpur-Okhla Integrated Solid Waste Management Project, India » Incineration of waste and raised questions about air pollution. » Public hearings addressed substantial doubts held by the public regarding the project. » This education process ensured that the public appreciated the benefits of the project. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 71 Who are the Stakeholders? Benefits of Stakeholder Identification & Communication External Stakeholders • • • • • • • • • • • • Banks Investment funds Government and multilateral funders Public service users Society in general The press Other government agencies • Municipal/State government • Federal government • Auditors and state monitoring agencies • Regulatory agencies • Legislators Party leaders Associations Labour unions Non-governmental organizations [developers/contractors] © K-Infra & Foster Infrastructure 2020 | Identification & Screening Internal Stakeholders • Public sector officers and employees linked, directly or indirectly, to the project cycle and who will monitor or interface with the project. • Directly involved in the project, rather than an interest to be satisfied. Benefits of Stakeholder Identification & Communication • Prevention of delays in project implementation. • Evidence is provided of government commitment to the project. • Evidence is provided of process credibility. • Stakeholders' contributions can be considered in the project’s design. • Support of stakeholders is more likely. • The government can effectively provide information in response to queries. #7 Project Management Plan 72 Communicating with Stakeholders • Different stakeholders need different approaches. • It may be necessary to communicate with stakeholders about the fact that the project is a PPP and the implications of this. ̵ Some key stakeholders might neither know nor care that the project is a PPP, but communication with them to gain their support can be vital. ̵ In other cases, delivery of the project as a PPP may be a cause of considerable concern for some external stakeholders. • Lack of or poor communication can feed false rumours and concerns which may undermine the success of a project. ̵ Bring information to the forefront and properly evaluate and transmit it. • Ensure all stakeholders receive equal information and no potential bidder is unintentionally provided with an unfair competitive advantage. ̵ Communication must be carefully coordinated and transparent. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 73 The Communication Strategy • The communication strategy is very important to promote engagement and mitigate opposition to the project. ̵ A communication plan should be designed at an early stage of the screening exercise. ̵ It should be implemented by a dedicated and experienced team. • Successful implementation of the communication plan can immensely reduce the political risks and attract the stakeholder support necessary for effective procurement. © K-Infra & Foster Infrastructure 2020 | Identification & Screening Content of the Communication Plan • Identification of all the interest groups to which communication should be directed. • Explanation of the main concepts to be communicated, drawing on project elements such as: • Project outcomes • The need being meet • The people being served • Identification of the media used to reach the groups identified. • The main characteristics of the communication pieces, preferably specific to each group identified. • Identification of project team members who will be prime sources of information for the general public. • A basic strategy for maintaining good relationships with the press. #7 Project Management Plan 74 Stakeholder Communication in this Phase – An Example • The large and complex Melbourne Metro project (capital cost approx. USD 6 billion) was first proposed in March 2008. • During the project’s options evaluation and refinement phases in 2009-2010, a twostage engagement process was undertaken to seek external views and feedback: ̵ Stage 1 (October 2009 to June 2010) focused on seeking feedback to the question: “Given the alignment and station locations set out in the government’s transport plan, what are your views on this?” Feedback was gathered primarily through direct meetings with key stakeholders and land users in the vicinity of the proposed stations. ̵ Stage 2 (July to September 2010) provided the public and stakeholders with the opportunity to learn more about the preferred alignment and station locations and provide comment. The project website made high-level project materials available for viewing and download. A 10 part questionnaire was provided online for the community to provide direct feedback. This resulted in more than 340 responses with more than 93 per cent supporting the project overall. A series of stakeholder briefings with peak bodies and community groups were also held to outline the proposed options and gather direct feedback to assist in design development. Source: Victoria State Government, Melbourne Metro Business Case, available at http://metrotunnel.vic.gov.au/library/businesscase © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 75 Quiz - Stakeholder Communication and Identification 11-Which of the following are benefits of stakeholder communication and identification during the Project Identification and Screening Phase? 1. 2. 3. 4. Evidence is provided of government commitment to the project. Support of stakeholders is more likely. Prevention of delays in project implementation Communicating with stakeholders early removes the need to communicate with them in the more intense later phases of the project. A. B. C. D. Only 1, 2 and 3 are benefits. Only 1, 2 and 4 are benefits. Only 1, 3 and 4 are benefits. Only 2, 3 and 4 are benefits. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #7 Project Management Plan 76 8 Assessing Capabilities and Needs, Building the Project Team and Hiring Advisors Guide Sections #13 77 Assessing Capabilities and Hiring Advisors – Introduction. Project leader • During the screening, a “project team” for the Appraisal Phase (and potentially for structuring) should be defined: ̵ Otherwise, costs for advisors or an inability to conduct the necessary studies during appraisal may prevent the project moving ahead as a PPP. ̵ A detailed staffing plan and the process of hiring advisors will be developed after the decision is made to move forward. • The public sector will need to appoint a project leader: ̵ The project leader must have the expertise to manage its advisors and the stakeholder processes professionally. o Poor management of these aspects is a common cause of project failure. ̵ The project leader should have the following roles and capabilities: o Coordinate all studies from the different fields of expertise. o Control and oversee the results of the studies. o Coordinate between external advisors and the procuring authority (when the appraisal is led by a PPP unit); and o Manage public sector decision-making processes to obtain decisions in a reasonable timeframe. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 78 Process for Assessing Capabilities and Needs • What capabilities are needed? • Are there sufficient internal capacities within the procuring authority? ̵ If so, can internal capabilities be dedicated to the appraisal, or are there other higher priorities? ̵ If not, is there a resource (or resources) available to lead the appraisal? • Which consultants should be hired, and for what tasks? ̵ This requires terms of reference. ̵ How should they be hired? o Separate contracts for each discipline, or one multidisciplinary team? • What will the cost be (time and fees) to properly analyze and procure the project? © K-Infra & Foster Infrastructure 2020 | Identification & Screening Do I have the internal capacities to deliver the appraisal? Yes Do I have resources to dedicate to the appraisal? Yes No No* Do I have an appropriate person available to lead the appraisal? Yes No Launch a tender to hire external advisors Launch a tender to hire a team leader and external advisors Proceed with appraisal Figure adapted from PPP Certification Guide © The World Bank Group, 2015 All rights reserved. Source: https://ppp-certification.com/certification *This arrow faces the wrong way in the Guide. #8 Assessing Capabilities and Needs 79 Common Capabilities Needed to Develop the Appraisal Studies Technical: Environmental: Economic: Financial: Legal: • In charge of the project’s design, with expertise in the type of infrastructure that is the subject of the contract • Expertise in the technical aspects of the services involved. • Appraises environmental impacts • Should have relevant expertise / experience in environmental analysis. • Expertise in economic appraisal, preferably in the same sector/ infrastructure or service type. •Expertise in PPP financial analysis, preferably in the same sector/infrastructure or service type •Knowledge of financing similar PPP projects •Expertise in contract risk structuring and payment mechanisms, preferably in the same sector/infrastructure or service type. •Expertise in public law / administrative framework •Experience in drafting PPP contracts. Although drafting will not occur yet, knowledge of PPP contracts enables proper assessment of the existing legal framework •For a PPP of existing operations, must also look at existing contracts, legal actions, loan contracts, etc. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 80 Requests for Advisors and ways to fund • The screening report should describe the capabilities needed for the full appraisal and justify the need for advisors. • It is essential that advisors have previous PPP and general infrastructure experience. ̵ They should have a clear understanding of current market conditions. • When planning to engage advisors, the public sector should: ̵ Describe the scope of the required advisory roles and expertise, and the person, or persons, to act as team leader(s) ̵ Suggest a budget for hiring the advisors and analyse funding options o Don’t underestimate the costs of project preparation. o Development Finance Institutions and donor organizations have established facilities in many regions to meet project preparation costs including the hiring of advisors. o A revolving project development fund established and managed by the government is another approach, with the possibility of with donor support. The winning bidders refund the costs at contract signing, recycling funds back to other public authorities. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 81 Hiring Advisors – Structure of the Procurement / scope of contracts • Advisors can be procured as a group/consortium under a single contract, or procured separately ̵ A single integrated team ensures cohesion and coordination of all the tasks. ̵ Separating the procurement allows government to select the best advisor in each discipline, but demands more government time and resources. ̵ Time constraints may make it advisable to appoint a single team under one contract. ̵ A single team may be better coordinated, more efficient and better prepared to work together from the outset. ̵ When technical advice is important (for example, if the authority plans to undertake detailed design work), it may be best to separate that task to ensure that the best technical solution is designed and the selection of technical experts is not influenced by the procurement of PPP advisors. ̵ Some authorities select a separate technical team but a joint financial and legal team, as these two areas are more clearly linked and overlap. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 82 Structure of the Advisory Team – Examples • The Philippines: ̵ The government generally appoints integrated teams of advisors for its PPP projects, rather than appointing each advisor individually. ̵ The central PPP Unit has established a panel of transaction advisors who can be appointed to advise on projects supported by the government’s Project Development and Monitoring Fund. oMost of the panel members are consortia made up of several firms. oIn some cases, the consortium is a mix of Philippines and international advisors, in other cases the consortium consists entirely of international advisers. • Thailand: ̵ Advisors engaged by government must be on a register maintained by the Thai Consulting Center, which was established by the Ministry of Finance. ̵ The government generally appoints a single advisory firm, which subcontracts other firms as required to provide the full advisory skill set required for the project . © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 83 Hiring Advisors – Term and Timing of the Advisors’ Appointment • The authority can: ̵ Enter into one contract to cover all the processes through to contract execution, or ̵ Appoint advisors only for the Appraisal Phase and decide later on the selection of advisors for later phases. • It is often more appropriate to enter into one contract for all processes: ̵ PPP preparation through structuring and tendering is a progressive process. • If there are no time constraints or there are doubts as to whether the project is suitable to be a PPP, it may be sensible to limit the advisory contract or contracts to the Appraisal Phase: ̵ This also removes the potential conflict of interest that exists because advisors engaged for the entire project will benefit if the project proceeds. ̵ Alternatively, provide an option for the procuring authority to retain the advisors for the next stage and give some flexibility for advisory firms to change team members. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 84 Hiring Advisors – Other issues • The selection process should consider the advisors' technical capability and experience of working on similar projects in addition to price: ̵ International experience is a must, especially in countries in the early stages of PPP development. oThis has to be enriched with adequate local knowledge. • There will always be some things that a third party adviser cannot do, such as approving advisors’ invoices on behalf of the procuring authority: ̵ The procuring authority must always have staff to perform these functions. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 85 Selecting the Advisory Team – Examples • The Philippines: ̵ Advisors submit separate technical and financial proposals. ̵ The technical proposals are opened first and evaluated against a set of requirements. ̵ The financial proposals for all advisors meeting the technical requirements are opened . ̵ The advisor with the lowest cost amongst those meeting the technical requirements is awarded the role. • Thailand (current process in early 2017): ̵ The government’s expected cost of the advisory work is publicly disclosed before the advisors bid for the role. ̵ The advisors’ technical responses are evaluated against a set of criteria. ̵ The price offered by the advisor with the highest ranked technical proposal is then considered. ̵ If necessary (for example, because the price offered exceeds government’s expected cost), the price is negotiated between the government and the advisor. o If the negotiations fail, the government can consider the price offered by the advisor with the second ranked technical proposal. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 86 Quiz - Assessing Capabilities and Needs, Building the Project Team and Hiring Advisors 12-Which of the following statements about the role of the Project Leader during the Appraisal Phase are true? A. An experienced external advisor should be appointed as Project Leader to lead the appraisal. B. The Project Leader is responsible for managing the decision-making processes between the procuring authority and its private partners. A. B. C. D. Only 1 is true. Only 2 is true. Both 1 and 2 are true. Neither 1 or 2 is true. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #8 Assessing Capabilities and Needs 87 9 Outcomes of the Project Identification and Screening Phase Guide Sections #15 88 Outcomes of the Project Identification and Screening Phase • There are three possible outcomes of this phase: ̵ Move on to the next stage (the project appears to be economically sound and is a suitable PPP candidate); ̵ The project is not suitable to be a PPP; or ̵ Since some relevant information is missing, or there is a need to clarify some constraints or dependencies, further analysis should be undertaken. • The key outputs from the process are: ̵ Outline of technical solution; ̵ Economic and financial pre-analysis (which might be a full analysis depending on the available information, enabling the decision to invest); ̵ Screening report or justification of PPP choice; ̵ Outline of project management plan (work program); and ̵ Schedule for the pre-tender work, team structure, stakeholder identification, and other project governance strategy matters. © K-Infra & Foster Infrastructure 2020 | Identification & Screening #9 Outcomes 89 In collaboration with Contact Andres Rebollo arebollo@k-infrastructure.com Richard Foster richard@fosterinfrastructure.com This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. It may be only used by the client referred to on the front page of the document. Dissemination of this material to any third party other than the client is not allowed. 90 Knowledge Infrastructure, S.L. © Foster Infrastructure Pty Ltd © October 2020 This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. Dissemination of this material to any third party by candidates or by the institution is not allowed without prior consent by K-Infra in writing. The APMG PPP Certification Program is a registered Trade Mark of The APM Group Limited. All rights reserved. This document is subject to intellectual property rights and it its contents cannot be copied, distributed or transferred without prior explicit consent by K-infra. CP3P – Practitioner Course Chapter 4 Appraising PPP Projects Prepared by 1 User guidelines • [For digital version in LMS] You will have to go through all slides and attempt all quizzes. You will have three attempts for solving satisfactorily the quizzes with a minimum overall mark. • Slides in light blue colour are examples or extra information not included in the PPP Guide. Slides dedicated to quizzes are in light brown colour. • Some extra info or extra explanations (not included in the Guide) are provided in the form of “notes”. • Remember that as in the exam and as related to the examples of PPP Guide, the information of examples are not subject to exam. • Some additional explanations or own nuances to the original PPP Guide are provided in [brackets]. © K-Infra & Foster Infrastructure 2020 | Appraisal 2 Learning objectives • The main activities required to detail the scope of the PPP project, design its technical requirements, and assess technical risks • The main issues involved in estimating the costs of the private partner and adjusting them for risk, whenever appropriate • The basic elements required to design a preliminary contract structure • The general tasks related to developing a financial model, from the government’s perspective • The basic techniques and good practices required to produce a series of feasibility assessments of the technical, commercial, economic, environmental, social, legal, and fiscal dimensions of the project • The basic structure of alternative procurement routes and how they relate to the outcomes of the tender process © K-Infra & Foster Infrastructure 2020 | Appraisal 3 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Money Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal 4 0 Objectives and overview Guide Sections #1, #2, #3 5 Contents Objectives and overview Detailing scope, designing technical requirements and assessing costs Fiscal Feasibility • Where we are in the process • Objectives of this Phase • Overview of Appraisal Phase Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 6 Where we are in the process Identifying projects Appraising projects Structuring tender & contract Tender & award Delivering & commissioning Operating & maintaining • The contract is prestructured and Financial Model and Technical Requirements are designed • The project’s feasibility is tested in several dimensions such as affordability and commercial feasibility • The project’s socioenvironmental impacts are identified • PPP suitability is confirmed (VfM) • The procurement route is decided • The decision to procure is made (“green light decision’) © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 7 Objectives of this Phase Appraising means answering the following • Is it sensible, from an economic perspective, to implement the project? • Is it practical to procure the project as a PPP? How much will it cost? Is it affordable from the government’s perspective? • Is there adequate market interest and capability to deliver this project? • What are the main obstacles for the project’s implementation (both the implementation of the technical solution and implementation of the preferred delivery method which may be a traditional delivery or delivery as a PPP)? Can they be overcome in a cost-effective manner? How? © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 8 Objectives of this phase (2) • Appraisal is naturally progressive ̵ Some pieces have already been developed in identification ̵ Some will be detailed during structuring • Appraisal helps to filter out projects against the feasibility criteria (The gateway process avoids sinking resources into poor projects or failing in delivery) • Projects may be feasible (economically, technically) but not suitable for PPP delivery • We are contributing to the structuring and moving towards the contract definition → see later slide “deliverables” [related to contract production] • The procurement and investment decisions are made in this phase → see slide 10 © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 9 Objectives (3) - Deliverables of this Phase • The technical requirements of the project, produced as a part of the technical feasibility exercise • The financial model, which organizes the financial assumptions and forecasts relevant financial information, used for the commercial feasibility exercise and for some other evaluations • The preliminary contract structure, which identifies and allocates risks as well as defining the essential aspects of the revenue regime and the payment mechanism • A procurement strategy that identifies the competitive selection process that will be refined during the Structuring Phase © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 10 Objectives (4) - Procurement Decision To confirm the procurement decision (worth procuring and worth procuring as a PPP), the team need to: • Confirm that the project is worth procuring (the investment decision) • Identify whether the project, implemented as a PPP, is likely to deliver Value for Money • Develop a reliable feasibility assessment (often referred to as the “business case”) that allows the government to make an informed and defendable decision to move forward (or to abort the project) • Ensure that the project faces no definitive or blocking obstacles to its launch and, if it faces major threats, develop a general plan of action to be put in place to overcome those barriers • Establish the basics of the contract structure that will be refined during the Structuring Phase © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 11 Overview of Appraisal Phase • The Appraisal Phase consists of a set of multidisciplinary assessments to evaluate the project against a set of feasibility criteria © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 12 Overview (2) • Key elements describing the project are progressively detailed ̵ Technical requirements ̵ Contract pre-structure ̵ Financial model • These elements are tested through several inter-related feasibility assessments • During this phase, a number of activities are carried so as to “prepare” the Project (advancing matters and mitigating project risks) ̵ Preparation activities will continue during the structuring phase • Appraisal guidelines provide a benefit by enabling a robust and consistent approach © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 13 Quiz - Objectives of Appraisal Phase 1-Which is NOT true about this phase (Appraisal)? A. Appraisal is naturally progressive B. It helps to filter the Project: the gateway process avoids sinking resources into poor projects and failing in delivery C. Projects that are feasible are also suitable for PPP delivery D. The procurement decision is taken in this phase © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 14 Quiz - Deliverables 2-Which one describes deliverables of appraisal phase? A. Technical requirements, financial model, preliminary contract structure and request for proposals B. Technical requirements, financial model, preliminary contract structure and procurement strategy C. Technical requirements, financial model, preliminary contract structure and request for qualifications D. Technical requirements, financial model, the contract in draft and procurement strategy © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 15 Quiz - Objectives of appraisal 3-Which is NOT a deliverable of the appraisal phase? A. B. C. D. Financial model Technical requirements Preliminary contract structure The RFP and RFQ © K-Infra & Foster Infrastructure 2020 | Appraisal #0 Objectives 16 Detailing scope, designing technical requirements and assessing costs Guide Sections #4 17 Contents Objectives and overview Detailing scope, designing technical requirements and assessing costs Designing a Preliminary Structure of the PPP • Developing the Scope of the contract • Designing the Technical Requirements • Consideration of Risk matters • Estimating Risk-Adjusted Costs • Main outputs and Key Points on Project Scope, Technical Requirements and Cost Fiscal Feasibility Impact on deficit and Debt Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 18 #1 Developing the Scope of the contract • The basic scope is provided in the Identification Phase • Remember: certain obligations or services may be given to other parties or reserved to the public sector ̵ Health/hospitals: clinical services may or may not be included in the contract scope ; soft services may or may not be included ̵ Transport/rail: operations may or may not be included; the scope may include full infrastructure or only certain elements • The scope decision/definition ̵ Delineates the boundaries and interfaces between the public and private sectors ̵ Defines the general framework from which to outline the technical and performance requirements ̵ Provides the context to decide upon the revenue regime which will form the basis of the financial and risk structure of the PPP © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 19 #2 Designing the Technical Requirements • Technical requirements lie at the heart of the contract design • The project team should develop enough technical detail to allow precise definition of the design of the infrastructure, without being too prescriptive • Costs are assessed based on the technical requirements, providing a key input to the commercial feasibility • Detailed Technical Requirements allow bidders to accurately assess the technical risks and price the service • Benchmark projects (when available) are a convenient source of information on requirements and costs • The technical requirements: ̵ should be consistent with applicable regulatory standards and policy directives oe.g. minimum size of a classroom; safety regulations in roads ̵ Depend on the project type/sector, [scope defined], contract type, and legal requirements ̵ Are typically composed of a project design, construction and performance requirements © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 20 #2 Designing the Technical Requirements - Project Design & Construction Requirements • The procuring authority can choose from a number of design approaches: ̵ functional design ̵ reference design ̵ full design and construction prescriptions • The first two approaches are most common: ̵ They are consistent with PPPs focusing on outputs/services, allowing flexibility for innovation and efficiency ̵ Too much prescription hinders innovation o Prescription may be appropriate if: –the project is simple in technical terms or –the Procuring Authority knows the optimal means and methods of meeting the need o Requires further work during Structuring Phase • A minimum level of detail is always needed to allow for: ̵ Identification of the key design requirements that will later be included in the PPP contract as the specifications for construction of the infrastructure, including time requirements ̵ A reasonably precise estimate of cost data to feed into the financial model © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 21 #2 Designing the Technical Requirements - Performance Requirements & O&M Specifications The Performance Requirements and O&M Specifications should include: • A very accurate description of the scope and minimum characteristics of the services to be delivered by the private sector • Outputs generated by the delivery of the service in terms of effective benefits for users and the wider community • The main responsibilities, related to the service to be delivered, to be retained in the public sector • The preliminary requirements for an effective performance evaluation system that will create adequate and effective incentives during the life of the contract • The minimum requirements for an infrastructure maintenance plan ̵ These should not prescribe the means, but should allow space for innovation • Specific requirements about the service hand-over to government at the end of contract © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 22 #2 Designing the Technical Requirements - Other Technical Matters and Preparatory Activities Technical preparation [and research] should include: • Identification of the land expropriation required, including mapping of the areas, identification of owners, and estimation of costs and time needed for the expropriation ̵ [extra note: provisional site identification and assessment of its availability should usually be done in identification] • Field surveys of the project site ̵ E.g. topographical, geotechnical, [hazardous], etc. • Assessment of potential resettlement issues • Assessment of linked infrastructure requirements, such as availability of utility services or connecting roads • Archeological and/or anthropological surveys to map the potential archeological and/or anthropological findings, if appropriate • For linear transport infrastructure, the track or the layout should be identified and defined, the location of utilities should be mapped, and relocation needs should be assessed • Environmental assessment [→developed later] © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 23 #3 Consideration of Risk matters • Risk identification and assessment provides input for: ̵ Constructing the financial base case for feasibility ̵ Value for Money calculations ̵ Initial consideration for risk allocation • Risk identification must be exhaustive during the Appraisal Phase • A comprehensive risk register should be developed • Risk assessment includes: ̵ Quantitative assessment to develop risk-adjusted costs [→next subtask] ̵ Qualitative assessment for the purpose of preliminary risk allocation [→explained in “pre-structuring” task later] © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 24 #4 Estimating Risk-Adjusted Costs • Risk-adjusted costs are a central output of the Technical Requirements design, and feed into the Financial Model • Typical sets of cost estimates produced at this stage: ̵ Capital costs and their distribution in time ̵ Operational and maintenance costs during the lifetime of the project • Adjustments for efficiency may be made to recognize private sector efficiency gains compared to typical public sector costs ̵ But avoid / take care of optimism bias • Adjustments for risk are made by adding expected risk values to the baseline costs – the expected risk value is calculated by multiplying the probability of a certain additional cost occurring by its financial impact Expected risk value (expected loss) = probability X potential impact e.g. 30% of a cost deviation of 10M$ =3 M$ Risk adjusted cost = Base line + risk value/adjustment e.g. 100 M$ (Baseline) + 3M$ = 103 M$ © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 25 #4 Estimating Risk-Adjusted Costs (2) • Alternative options to calculating expected values: ̵ Consider the most likely cost/scenario and use sensitivities ̵ Probabilistic analysis – Monte Carlo simulations oUses many iterations to create a distribution function of impacts and resulting percentiles* oOnly useful when reliable data is available • Only project specific risks should be addressed in cost adjustments ̵ not systemic risks, which should be treated within the equity IRR • Cost analysis at this stage is from the private-sector’s perspective (subsequent VFM analysis also considers the value / estimates of retained risks) © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 26 #5 Main outputs and Key Points on Project Scope, Technical Requirements and Cost •Assessment This group of tasks sets up the conditions to be met by the private sector for the asset and the service to be acceptable ̵ Used to specify the private sector´s obligations, design the instruments to assess performance and build the mechanisms for effective incentives, through incorporation in the contract ̵ Remember: avoid over-specification/prescriptiveness • These tasks provide the baseline assumptions for constructing the base case that will be used in most feasibility assessments • As a result of this work, the following is produced: ̵ The construction and design requirements, as well as performance requirements, to be included in the contract (noting that not all aspects of the design will be binding / prescriptive) ̵ An assessment of technical risks and estimate of the costs of construction and related costs adjusted for risk when appropriate (these are the most relevant inputs to the financial model and therefore the related financial assessments) © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 27 Quiz - Project scope definition 4-Which is NOT true regarding the scope definition? A. Scope definition delineates the boundaries and interfaces between the public and private sectors B. Scope definition is intended to determine the precise space or geographical area in which private partner will deliver the service C. Scope definition defines the general framework from which to outline the technical and performance requirements D. Scope definition provides the context to decide upon the revenue regime which will form the basis of the financial and risk structure of the PPP © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 28 Quiz - Technical requirements 5-What is NOT true with respect to project design and construction requirements: A. They are usually in the form of a functional design or a reference design, so as to allow the bidder / private party to enjoy a higher return B. Providing a functional design or a reference design to bidders is consistent with a PPP focusing on outputs/services, allowing flexibility for innovation and efficiency C. A minimum level of detail is necessary to allow for identification of the key design requirements that will later be included in the PPP contract as specifications for construction D. The Procuring Authority could provide a fully prescriptive design when it has certainty of the optimal means and methods of meeting the need © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 29 Quiz - Designing technical requirements 6-What is NOT true regarding the design technical requirements? A. It is necessary to check applicable regulatory standards and policy directives like minimum size of a class or safety regulations in roads B. Detailed Technical Requirements allow bidders to accurately assess the technical risks and price the service C. They should state and describe clearly the full design of the infrastructure as expected and required by the authority D. While defining technical requirements, costs will be assessed so as to provide a key input to the commercial feasibility which is to be done in this phase © K-Infra & Foster Infrastructure 2020 | Appraisal #1 Technical Requirements 30 2 Designing a Preliminary Structure of the PPP Guide Sections #5 31 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP • Financial structure: Revenue Regime and payment mechanism • Preliminary Risk Allocation Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #2 Preliminary Structure 32 Designing a Preliminary Structure of the PPP- Intro • A preliminary structure of the contract must be defined, in terms of the financial structure (from public perspective – revenue regime, contract term, co-financing etc.) and risk allocation • The preliminary structure influences several feasibility exercises: commercial feasibility, value for money and affordability • The preliminary structure is refined and further detailed in the Structuring Phase Financial model / base case & Commercial feasibility Financial structure from the government perspective • • This is the definition of the means of public compensation or payments to be granted to the private partner in the contract and its conditions (…) It includes: • Other potential public party participation in the provision of financing (…) • The resulting profile of payments in terms of net present value and yearly public expenditure (…) © K-Infra & Foster Infrastructure 2020 | Appraisal PPP structure Affordability #2 Preliminary Structure PSC & Value for Money 33 #1 Financial structure: Revenue Regime and payment mechanism • The revenue regime is the source of revenues collected by the project company: ̵ User-charges (user-pays PPPs) o Neutral in budgetary terms o Typical in economic infrastructure (but not always). Examples: toll roads; user-fees in metro/light rail. o There should be economic sense for requiring users to pay o In over-feasible projects there may be payments to the PA – concession fees → see chapter 5.4.8) –In contrast, in unfeasible projects there is a viability gap – see below ̵ Government service payments (government-pays PPPs) o Social infrastructure (e.g. hospitals, schools, prisons …) o Also used in economic some infrastructure projects –To solve viability gaps –To remove / retain demand risk ̵ Co-financing and mixed revenue regimes – Two forms: Mistake in the Guide: The Guide refers to user-pays PPP when 100% of the revenue comes from users and government-pays PPP whe 100% comes from the budget (rather than “all or the majority”) o Grants (co-financing) made [or committed/earned] during the construction phase o Complementary service payments (hybrid payment mechanism) made over the operational phase © K-Infra & Foster Infrastructure 2020 | Appraisal #2 Preliminary Structure 34 #2 Financial Structure: Revenue regime and Payment Mechanism (2) • A choice needs to be made to define the revenue regime ̵ [If there are identifiable users: should they be charged or not?] ̵ [If charged, should government assign the revenue to the private sector or retain demand risk?] • If there are government payments (service payments), the basic characteristics (the payment mechanism) should be defined in this phase. These include: ̵ Triggers – based on different elements e.g. infrastructure availability, demand or output ̵ The start of payments – usually only once service is operational ̵ The payment profile and timing o Payments are usually regular during the contract time, but can be designed to meet bankability requirements o [timing: quarterly, monthly , …] ̵ Note: service payments may coexist with co-financing • It is necessary to test commercial feasibility / acceptance and consider other financial assessment matters before deciding to proceed with the project (these matters include affordability, impact on public debt, and VfM) © K-Infra & Foster Infrastructure 2020 | Appraisal #2 Preliminary Structure 35 #2 Preliminary Risk Allocation • Risk allocation underlies most of the PPP’s potential advantages • Define which party will suffer the financial consequences of risk events (and reflect these changes in values within the business case) • Details of the risk allocation are developed in Structuring (→ chapter 5) but Appraisal requires a preliminary allocation, so as to permit o Risk adjustment of baseline costs o Estimation of the required return on equity [and financial terms for debt] so as to conduct commercial feasibility [and consequently estimate payments / fees] o Adjustment to the Public Sector Comparator • Risks should be allocated to the party that is “best able to manage” them – see examples of Guide in box 4.4. • Mechanisms to allocate risks: (i) revenue / payment mechanism; (ii) specific contract provisions (compensations and “re-equilibrium”) • There is no need for a detailed description of contractual instruments at the Appraisal phase, but a risk allocation matrix should be developed © K-Infra & Foster Infrastructure 2020 | Appraisal #2 Preliminary Structure 36 Quiz - Preliminary structure 7-What is not true with respect to the preliminary structure? A. The preliminary structure involves preliminarily defining the structure of the contract in terms of financial structure and risk allocation B. The preliminary structure influences commercial feasibility, value for money and affordability C. The structure will be refined or further detailed in the Structuring Phase D. It allows to the procuring authority to proceed straight forward with contract drafting once the project receives the green light at the end of the phase © K-Infra & Foster Infrastructure 2020 | Appraisal #2 Preliminary Structure 37 Quiz - Preliminary structure / Risk Allocation 8-What are true regarding preliminary risk allocation? 1. 2. 3. A. B. C. D. Appraisal requires a preliminary allocation, so as to permit risk adjustment of baseline costs needed for constructing the financial model, estimate the required return on equity so as to conduct commercial feasibility and make the needed adjustment for risk to the Public Sector Comparator for conducting VFM It aims to define which party will suffer the financial consequences of a risk eventuating, which means changes in values within the business case The mechanisms to allocate risks are the revenue / payment mechanism and specific contract provisions All are true Only 1 and 2 are true Only 2 and 3 are true Only 1 and 3 are true © K-Infra & Foster Infrastructure 2020 | Appraisal #2 Preliminary Structure 38 3 Developing the Financial Model Guide Sections #6 39 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Developing the Financial Model Assessing the Technical Feasibility • Macroeconomic Assumptions • Inputting Estimates of Capital Expenditures • Inputting Operating Costs and Reinvestments • Financial Structure of the Project Company • Incorporating revenues • Accounting Issues • Defining contract term • Cash Flow • Base Case, Sensitivities and Scenarios Environmental feasibility Social feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 40 # Developing the Financial Model - Introduction • Project needs to be accurately described in financial terms to allow for financial [and economic] feasibility assessments Financial Assessment Exercises Assessment What is Assessed? Economic feasibility [this is All costs and benefits of the project to society not a financial assessment per se, but is influenced by the financial description] Commercial feasibility Private sector cash flows for the project under PPP delivery Fiscal feasibility / affordability Public sector cash flows for the project under PPP delivery [and a measure of the impact on fiscal sustainability] Impact on government debt and deficit Impacts of the project as a PPP under the applicable public sector accounting regulations Value for Money Public sector (or user) cash flows for the project under PPP delivery in comparison to public sector (or user) cash flows for the project under traditional delivery Financial Model: A spreadsheet computer file that incorporates all the private sector’s investments, revenues, costs and related assumptions so as to produce the “financial base case” of the Project. © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 41 # Introduction (2) - Sources of Information • Sources of information for developing the financial model include: ̵ Financial data from the Cost Benefit Analysis that may be used as the starting point of some financial values such as estimated potential revenue, total costs, taxes, etc ̵ Costs estimated in the process of defining the technical requirements that provide estimated values of investment, maintenance, and operations costs ̵ Descriptions of benchmark projects identified in the Technical Feasibility stage and the respective historic data available ̵ Current data on demand, costs, and revenue of any existing infrastructure ̵ Studies already conducted to assess the need for the project On the basis of these and new sources including expert judgement, the team will develop a set of data and assumptions so as to build the financial model and produce an accurate estimate of the PPP project cash flows. Further information may be developed for other assessments such as VfM and fiscal impact © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 42 “Hipótesis” / data sheet © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 43 #1 Macroeconomic Assumptions • The following macroeconomic assumptions are necessary for developing long-term estimates: ̵ General inflation o It is convenient to work in nominal terms (some cost items are not affected by inflation – such as debt service) ̵ Relative inflation o price/cost evolution of some cost factors may differ from general inflation ̵ Base interest rates o the financial market interest rate [the interbank rates] or cost of funding for the lender ̵ Risk-free interest rates: rates of relevant public debt instruments o These are [sometimes] used to build up investor´s rate of discount for valuing cashflows [→ see section 8] o Used to calculate and compare government values / payments in NPV (affordability, VFM) ̵ Exchange rates – required when: o Foreign capital / foreign [cross border] financing is considered o Some CapEx is in foreign currency [i.e. subject to forex risk] © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 44 #2 Inputting Estimates of Capital Expenditures • Capital expenditure consists of expenses incurred by the private partner until commissioning, usually including ̵ Construction costs ̵ Design costs ̵ Bidding costs ̵ Project company costs (general costs of the SPV including staff) ̵ Environmental compensation costs ̵ Costs of insurance (premiums) and guarantees ̵ Costs of obtaining licenses and permits ̵ Costs associated with the financing (lender fees and interest during construction) ̵ Utility relocation and archaeological removals ̵ Expropriation and land acquisition costs ̵ Taxes (including VAT, corporate taxes – which may create a tax shield - and taxes related to the grant of a concession) © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 45 #3 Inputting Operating Costs and Reinvestments • Operating costs and reinvestments consist of expenses incurred by the private partner after commissioning, usually including: ̵ Direct project company costs (general costs of SPV) ̵ Ordinary maintenance costs ̵ Major or extraordinary maintenance (reinvestment and renewals) – usually pre-funded by means of reserves funds ̵ Operation costs ̵ Cost (premia) of insurances and guarantees ̵ Communication costs ̵ Taxes © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 46 #4 Financial Structure of the Project Company • Where will the money for the initial investment (financing) come from? ̵ A part may come from governments, related to viability gap funding [in user-pays] and other forms and context of co-financing o Such as grant financing, revolving cofinancing/co-lending, public equity – this has been explained in chapter 1 and is further developed in chapter 5 ̵ Private financing by the SPV o Equity (equity shares & shareholders’ subordinated debt) o Debt (loans, project bonds → see slide “sources”) • Private finance structure = mix of equity and debt. Parameters/factors ̵ The level of leverage: % of debt assumed to be raised ̵ Debt repayment term ̵ Repayment profile ̵ Cost of debt • Parameters of the financial structure (in their maximum values) are imposed by lenders • [Some are also KPIs used to measure bankability as part of the commercial feasibility assessment] © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 47 #4 Financial Structure of the Project Company (2) – parameters The level of leverage: % of debt assumed to be raised • The more debt, the higher the leverage, and the higher the equity IRR • [The debt volume depends on Ratios and Term] • There is an upper limit on the % of debt / minimum % of equity required by lenders (and sometimes by the PPP contract) Debt repayment term • A longer term results in higher accrued interest but lower repayments [debt service] per year • [the longer the term the higher the leverage] Repayment profile Cost of debt © K-Infra & Foster Infrastructure 2020 | Appraisal • The repayment profile sets out how much debt is repaid each period • The profile may consist of flat repayments, constant principal and interest amortization (and hence decreasing debt service) or a “sculpted” profile to meet covenants [ratios, DSCR] so as to maximize debt volume • Interest rate charged = interest base rate + margin • The cost of debt also includes fees (structuring, arranging, availability) and the interest rate hedging cost (implicit in the form of interest rate swap mechanisms) #3 Financial model 48 Leverage 𝑟𝑟𝑒𝑒 𝑟𝑟𝑝𝑝 × 𝐸𝐸 + 𝑟𝑟𝑝𝑝 − 𝑟𝑟𝑑𝑑 × 𝐷𝐷 = 𝐸𝐸 100% -100 11 60% -60 -60 -40 3 3 8 40,00% 111 60 3 63 48 11,00% project IRR 5% Internal rate 20,00% Equity IRR Leverage Leverage is 60:40 1,5 times 1% de decrease in interest rate / debt cost equals 1,5% increase in equity IRR 40 60 20,00 5,00 DEUDA/CAPITAL *simplification; not counting tax and accounting effect TIPO/TIRE debt equity © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 49 Debt Service Cover Ratio • DSCR: number of times that the CFASD contains the debt servic in a certain year RCSD DSCR= (Rev-expenses-taxes) / (int.+principal) 20 0 1 2 3 4 5 6 7 8 9 10 11 12 13 -20 -40 -60 -80 -100 -120 capex DSCR 70,0% 30,00% 100 ing O&M CFADS 2% 30% -100 1,30 70 debt initial 30 amort 2,0% int Debt Service equity CF -70 Series1 15 4,5 10,5 15,3 4,6 10,7 15,6 4,7 10,9 15,9 4,8 11,1 16,2 4,9 11,4 16,6 5,0 11,6 16,9 5,1 11,8 17,2 5,2 12,1 17,6 5,3 12,3 17,9 5,4 12,5 18,3 5,5 12,8 18,7 5,6 13,1 8,1 8,2 8,4 8,6 8,7 8,9 9,1 9,3 9,5 9,7 9,8 10,0 70 6,7 1,4 63,3 7,0 1,3 56,4 7,3 1,1 49,1 7,6 1,0 41,5 7,9 0,8 33,6 8,2 0,7 25,3 8,6 0,5 16,7 8,9 0,3 7,8 7,8 0,2 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 8,1 8,2 8,4 8,6 8,7 8,9 9,1 9,3 7,9 0,0 0,0 0,0 2,4 2,5 2,5 2,6 2,6 2,7 2,7 2,8 4,4 12,5 12,8 13,1 Series2 © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 50 Leverage & DSCR → Required DSCR • Compared to a DSCR of 1.4, a DSCR of 1.2 will free cash flow, allowing for an increase in the volume of debt, therefore an increase in leverage and a higher equity IRR, which in turn allows the prospective bidder to decrease the revenue requested. DSCR = 1,4x • More predictable and stable cashflows lower DSCR higher leverage. Income O&M yearly costs Debt service DSCR = 1,2x Decrease in revenue requested Income O&M yearly costs Increase in debt ̵ Availability projects – up to 90% ̵ User pays projects in which the private partner faces demand risk – down to 60% • The range slips to 50%-80% in EMDEs Debt service Figure © The World Bank Group, 2015. All rights reserved. Source: https://ppp-certification.com © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 51 Leverage & DSCR → debt term • More tenor for amortizing debt will decrease DS so will free more CF • More capacity to SD so more capacity to raise debt (for the same requested DSCR) • This generates more leverage /higher equity IRR so more space to decrease Price offered © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 52 #4 Financial Structure of the Project Company (3) – sources and instruments of finance • Sources and instruments of finance include: ̵ Loans by commercial banks/lenders o[local lenders vs international lenders (cross border)] ̵ Loans provided by the government (or a State-Owned Enterprise) ̵ Project bonds (funded/acquired by institutional investors, retail, lenders…) ̵ Loans from institutional debt providers e.g. pension funds ̵ Multilateral development bank financing ̵ Export credit agency financing ̵ Supplier credits, lease finance, or Islamic finance The team responsible for the Appraisal need to be aware of the availability of finance providers and likely conditions When there is public financial support (grants, loans or even equity) it should be included in the financial model See chapter 1 section 7 for more information on sources and instruments of finance © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 53 Quiz - Financial structure of the Project Company 9-Pick the incorrect statement A. Debt repayment profile may be flat repayment, constant amortization (and decreasing debt service) and “sculpted” to meet covenants so as to maximize debt volume B. There is not a minimum % of equity required by lenders but leverage is always defined mathematically through the debt service ratios C. The cost of the debt includes the base interest rate, the margin over the base rate, bank fees (e.g. structuring, arranging, availability of finance) and the costs of interest rate hedging D. To properly develop the financial model, it is important to be aware of the availability of finance providers and likely conditions © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 54 #5 Incorporating revenues • Revenues represent the inflows used by the project company to meet its costs • Government payments are an output of commercial feasibility (also determined by affordability analysis) • User charges involve estimation ̵ Estimating user-pays revenues involves estimating demand, estimating elasticity and considering a reference price [the level of tariff or fare] ̵ Estimating demand is a challenge, especially in greenfield projects and depends on the estimate of price elasticity (usually through evaluation of willingness to pay) ̵ Defining the reference price: o The reference price is usually regulated by the public authority (defined or capped) o The price may be an outcome of the tender process (usually under a cap) o When there is freedom to establish the tariff or toll (for example, in road projects), the reference price is usually that which maximizes revenue (subject to the caps). In such cases the procuring authority may set a ceiling on the price that can be bid • The potential revenue generated is used to determine the floor for payments to the procuring authority (the concession fee) or the ceiling for co-financing or any other public payment / support • Other revenues (from third-parties or collateral businesses) should also be estimated The financial model and the construction of the financial base case are not finalized until we finish the commercial feasibility assessment and: • in government pays and user pays projects with VGF, we input the right figure for public payments • in self-feasible user-pays projects, we decide the tariff or define a payment from the private partner to the Procuring Authority if there is significant excess revenue. © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 55 #6 Accounting Issues • Free Cash Flow for equity is a financial concept rather than an accounting concept ̵ [however the accounting treatment influences the cash flows] • The financial model must project financial statements consistent with applicable accounting policies, including a yearly income statement and balance sheet, as: ̵ Project taxes are based on accounting net profit or earnings ̵ The financial statements may be necessary to estimate the project’s impact on public debt and assess bankability ̵ The financial statements are needed to assess ability of project company to effectively distribute dividends to its shareholders ̵ Accounting / book values are sometimes used for calculating compensation under the PPP contract © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 56 #7 Defining the contract term Issues / factors to be considered in defining the contract term (further developed in chapter 5) • Life-cycle management and effective risk transfer • Private financial structure optimization • Affordability • Commercial feasibility (especially in user-pays projects) • Political pressure • Budget management • Rigidity • Flexibility to accommodate risk and uncertainty • Relationships with other projects and other contracts The Contract Term is preliminarily defined in this phase and adjusted during the commercial feasibility and affordability exercises (especially when there are public payments/financing) – it will be subject to refinement during structuring © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 57 #8 Cash Flow • Free cash flow of the project ̵ Represents all revenues less expenses ̵ Is usually negative during the first years of the contract (construction) [defining the needs for funds] ̵ Pays all operational expenses, taxes and a cash amount is free to service debt [the “cash available for debt service”] and after that the remainder is potentially available to be distributed to equity holders through dividends [or as amortization and interest payments for subordinated debt] if there are no obstacles (subject to regulatory limitations, requirements for certain reserves, and loan covenants • Free cash flow of the equity investor ̵ Inflows and outflows of resources from the investors’ (shareholders’) perspective only ̵ Depicts only the amount of capital expenditure financed by shareholders and money effectively repaid to investors in the form of dividends or other equity repayments Free cash flow and equity investor cash flow calculations are central for calculating or controlling the value of the key ratios and indicators in the commercial feasibility exercise © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 58 “Extra”: Free Cash Flow / CFADS Free Cash Flow would be Ing-O&M-taxes* Taxes* not considering financial structure (the tax shield) →EBIT * t This equals (basically) to CFADS. It would defer in the value of taxes to be substracted © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 59 #9 Base Case, Sensitivities and Scenarios (1) •Base Case: the Financial Model’s most likely/expected case (based on most likely assumptions) – it is defined iteratively ̵ [Example: a grant financing of 20% of capex and term of 25 year are considered initially but the first results may indicate a need to consider a longer contract term and/or higher co-financing for the project to meet the commercial feasibility KPI of a minimum equity IRR] •Uncertainty is inherent to financial modelling and financial analysis: thus, “sensitivities” are needed to qualify the results and measure the robustness of the base case © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 60 #9 Base Case, Sensitivities and Scenarios (2) • Sensitivity represents a switch in the value of one or more variables to observe its impact on the Financial Model’s key performance indicators: ̵ Variations in construction costs ̵ Delays in completion ̵ Eventual peaks in operational costs, in any given year of the contract ̵ Variations in the demand ̵ Fluctuations of revenue due to performance deductions or other changes in drivers of commercial revenue ̵ Changes in the debt conditions ̵ Specific risks which result in cost overruns or delays ̵ The most relevant macroeconomic assumptions such as exchange rates • A “Scenario” represents a complete new or different ‘case’ with new values defined for one or more key variables © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 61 Quantitative analysis (impact) / sensitivities - example • CapEx deviates / increase by 20% • Impact in equity IRR TIR proyecto TIR accionista RCSD medio 5,72% 8,04% 1,487 7,96% 13,80% 1,42 Caso base Impacto desv. capex 20,0 20,0 10,0 10,0 0,0 -10,0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0,0 -10,0 -20,0 -20,0 -30,0 -30,0 -40,0 -40,0 -50,0 -50,0 -60,0 -60,0 Free Cash Flow incremento 20% coste -28% variac TIR p -42% variac TIR Acc = RCSD CF accionista SD 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 -70,0 Free Cash Flow CF accionista SD • Equity investor has to fund the capex deviation → for the same operational CF equty IRR decreases 40% • DSCR not affected © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 62 Quantitative analysis (impact) / sensitivities – example (2) • Decrease in revenues / increase in O&M= lower CF (e.g. by 20%) TIR proyecto TIR accionista RCSD medio 7,96% 13,80% 1,42 Caso base Impacto desv. ingreso/CF 20,0 20,0 10,0 10,0 0,0 -10,0 1 2 3 4 5 6 7 8 -20% decremento ingreso/CF -33% variac TIR p -41% variac TIR Acc -15% RCSD 5,30% 8,19% 1,208 9 10 11 12 -20,0 13 14 15 0,0 -10,0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 -20,0 -30,0 -30,0 -40,0 -40,0 -50,0 -50,0 -60,0 Free Cash Flow CF accionista SD -60,0 Free Cash Flow CF accionista SD • Revenue descrease 20% will contract CF by more tan 30% so effective / projected DSCR (for the same original financial structure) decreases (getting close to default) and equity IRR suffes by more tan 40% • Loss in Equity IRR would be exhacerbated if capital inyection is needed to meet DSCR/debt amortization © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 63 Quiz - Financial model / miscellaneous 10-Pick the incorrect statement A. User charges involve estimation but service payments / government payments are a result/output B. Potential revenue estimated will be used to determine the floor for payments to the procuring authority (the concession fee) or the ceiling for the public payments required if there is a viability gap C. Estimating demand is a challenge, especially in greenfield projects, and depends on estimates of price elasticity (usually through evaluation of willingness to pay) D. There is no a need for the Financial Model to reflect applicable accounting policies as the exercise being done is for the use of the public sector © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 64 Quiz - Financial model / miscellaneous 11-Pick the incorrect statement A. Free cash flow represents revenues less expenses. After expenses including taxes we will have the cash available for debt service. B. The Base Case is the Financial Model’s most likely/expected case (most likely assumptions) and it is defined iteratively. That means that, for example, the contract term may be extended or public support may be increased (or decreased) to meet the targeted value of the equity IRR. C. Scenarios represent changes in a key variable while a sensitivities represent a complete set of new values for key variables D. The contract term is dependant on factors such as affordability and commercial feasibility © K-Infra & Foster Infrastructure 2020 | Appraisal #3 Financial model 65 4 Assessing the Technical Feasibility Guide Sections #7 66 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility • Relevant Technical Risks Associated with Infrastructure Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #4 Technical Feasibility 67 Assessing the Technical Feasibility Technical feasibility is naturally present during the design of the technical requirements. However the procuring authority should also conduct specific analysis of technical feasibility, considering the following criteria Does the infrastructure design meet the need specified during the Identification Phase? Are the engineering and architectural requirements achievable and at a price comparable with similar infrastructure? Is the proposed technology proven or can the associated risks be properly managed or allocated? Does the technical description of the project avoid, as far as possible, significant geo-technical risks? Does it avoid other unbearable technical risks? Is there a complete assessment of geo-technical conditions that can affect the project, in terms of costs and time? (Particularly relevant for transport infrastructure) Is the scope of service viable from a regulatory perspective? Can the service be specified in terms of outputs and measured adequately though performance indicators? Can technological changes in the service delivery be satisfactorily estimated? © K-Infra & Foster Infrastructure 2020 | Appraisal #4 Technical Feasibility 68 Relevant Technical Risks Associated with Infrastructure • Significant technical risks exist in the following circumstances: ̵ Projects with technological complexities, such as novel technology that has not been significantly tested, or that will adapt technology that is not fully operational in the same conditions as the project under analysis ̵ Projects requiring difficult engineering innovations, such as complex transport structures (tunnels or bridges) ̵ Projects built in particularly uncertain geo-technical conditions with consequences for a major part of the project costs (that is, a tunnel project or a large sea bridge) ̵ Projects in areas with extraordinary natural risks in terms of weather or earthquakes ̵ Projects with other complexities and uncertainties concerning the reliability of costs and time of construction, such as unknown or very old utility locations © K-Infra & Foster Infrastructure 2020 | Appraisal #4 Technical Feasibility 69 5 Assessing Commercial Feasibility Guide Sections #8 70 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Assessing Commercial Feasibility Market sounding • Assessment criteria - Lenders’ Perspective • Assessment criteria - Investors’ Perspective • Assessing Commercial Feasibility in User-Pays PPPs • Assessing Commercial Feasibility in Government-Pays PPPs • Outputs of the Commercial Feasibility Assessment Value for Moneey Procurement Strategy and tender process types Planning, Reporting, Approving and checking Confirming Economic Feasibility © K-Infra & Foster Infrastructure 2020 | Appraisal Legal feasibility #5 Commercial Feasibility 71 # Assessing the Commercial Feasibility – Intro • A project is considered commercially feasible if: expected revenues (inflows) under a reasonable scenario are sufficient to cover all expected costs (outflows) and pay back invested equity with a reasonable return • In user-pays projects, the focus of the exercise is on: ̵ The project’s capability to raise funds ̵ The capability of free cash flow to service debt and equity • If the project is “over feasible”, an output of the analysis is the ability of SPV to pay a concession fee and an estimate of the size of such fee • If the project is not financially self-sustainable, an output of the analysis is the size of public resources required to make project commercially feasible (Viability Gap Funding) • If there are no user charges, the focus is on directly estimating government contributions (the price to be paid) © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 72 #1 Measuring commercial feasibility. Assessment criteria - Lenders’ Perspective • Debt Service Coverage Ratio (DSCR) ̵ Indicates the extent to which a project’s operating profits cover debt service obligations in each year ̵ Helps potential lenders determine the credit risk associated with the project ̵ A higher DSCR means there is more operating surplus to cover debt, therefore less risk ̵ Lenders stipulate a “lock-up” value and a “default” value for the DSCR • Loan Life Coverage Ratio (LLCR) ̵ The Net Present Value of Cash Flows Available for Debt Service (CFADS) divided by the Outstanding Debt over the loan period ̵ CFADS is only measured up to the maturity of the debt ̵ This ratio provides an estimate of the project’s credit quality from the lenders’ perspective • Project Life Coverage Ratio (PLCR) ̵ The Net Present Value of the Cash Flows Available for Debt Service (CFADS), available over the project’s remaining life, to the Outstanding Debt balance in the period © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 73 #1 Lenders’ Perspective (2) • Debt Sculpting: shaping the debt repayment profile to optimize the size of debt (read example in box 4.7.) 120 100 Operating Profit 80 Maximum debt service to a DSCR of 1,4 60 Debt service projected in a constant amortization system (Debt $360) 40 Debt service projected in a constant amortization system (Debt $270) 20 120 1 2 3 4 5 6 7 8 9 10 100 80 Operating Profit 60 Maximum debt service to a DSCR of 1,4 Debt service after debt sculping ($360) 40 20 - 1 2 3 4 © K-Infra & Foster Infrastructure 2020 | Appraisal 5 6 7 8 9 10 #5 Commercial Feasibility 74 #2 Measuring commercial feasibility. Assessment criteria - Investors’ Perspective • The project must be bankable and provide an acceptable return for the risk [risk/return ratio] • There are two techniques for assessing the return from an investor’s perspective: ̵ Net Present Value (NPV), based on discounted cash flow (has to be > 0) ̵ Internal Rate of Return (IRR) of the equity cash flow (has to be > than the hurdle rate or minimum equity IRR required) • Investment must provide a return over time that is equal to or higher than the return on an alternative and comparable investment © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 75 #2 Investors’ Perspective (2) - Net Present Value • NPV = the sum of the equity cash flow values in today’s currency • CFt = the net equity cash flow value resulting from each period’s revenues, expenses, debt service, and other parameters defined in the model • i = the discount rate or the cost of capital for equity investors over time • t = the number of the period in which the value is being discounted, and • n = the total number of periods in the cash flow The key driver is the rate of discount (cost of equity) → see next slide © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 76 #2 Investors’ Perspective (3) - Required Internal Rate of Return and estimating hurdle and discount rate • The IRR is the discount rate that makes the NPV equal zero • The project’s equity IRR has to be higher than the investor’s required IRR (hurdle rate) • Factors affecting the required Internal Rate of Return (or the discount rate) The project’s specific risks Guarantee s by governme nt The return obtained for similar projects Required IRR Systemic risks for the specific sector Country risk (similar risk) © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 77 #2 Investors’ Perspective (4)- Capital Asset Pricing Model (CAPM) Ke Rf β Rm Ke=Rf+βx(Rm-Rf ) • Is the Cost of Equity • Is the Return on a riskless asset • The interest rate on relevant public debt (debt issued by the government and for the closest term possible to the term of the investment) • Volatility of the [sector of the] analyzed company in relation to the market • to adjust the estimated volatility/return of the general market to that of the representative sector* • [general] Market return *Mistake in the Guide (Box 4.8. about CAPM): Rm should be described as the general market return and not the one for specific sector. β is that representative of the specific sector © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 78 #2 Investors’ Perspective (5) - Other Drivers for Investors Analysis •Investors will also consider the following: ̵ Project IRR oThe project IRR considers the return of the Project Cash Flow, as opposed to the equity IRRR which considers Equity Cash Flow ̵ Payback period (nominal or discounted) oThe payback period represents the period required before the accumulated cash flow equals zero, in either nominal or discounted terms ̵ Absolute size of the investment © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 79 KPIs / indicators KPIs level required KPI value observed max debt term 8,00 8,0 min. DSCR 1,5 1,53 min IRR 15% 16,22% © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 80 #3 Assessing Commercial Feasibility in User-Pays PPPs • In user-pays PPPs, the commercial feasibility exercise examines capacity of the project to generate enough cash resources to meet its expenses • The exercise considers several scenarios for prices charged to users (if possible) or a given price (typically when is regulated) ̵ In absence of regulation / cap tariff will be the one that maximizes revenue ̵ [revenue is maximized when the net effect of marginal increase in tariff and consequent decrease in volume is negative] • Three possible outcomes: ̵ Project revenue is expected to be sufficient to meet costs ̵ The project is “Over-feasible” - It is expected to generate inflows much higher than those required to be commercially feasible. The procuring authority can: o Consider reducing the reference price (if possible) o Stipulate payments to be made by the private party ̵ Project revenue may not be sufficient o Options to consider: cancel the project; revise the scope, adjust the technical requirements, provide government support (viability gap funding – see chapter 1) © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 81 #4 Assessing Commercial Feasibility in GovernmentPays PPPs • In government-pays PPPs, the commercial feasibility exercise aims to define the amount of government financial support required to meet investors’ and lenders’ needs [for the defined pre-structure] • The analysis produces a direct forecast of revenues to feed the financial model and a fiscal commitment structure to be tested in affordability • Consider the need for satisfying the indicators of commercial feasibility ̵ e.g. with respect to indexation regimes ̵ [in relation to risk transfer, e.g. considering a portion of availability payment as fixed or considering bands in volume payment schemes] © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 82 #5 Outputs of the Commercial Feasibility Assessment • For user-pays PPPs, it provides the following: ̵ An assessment of the capacity of the project to attract investors and lenders, from a financial perspective ̵ An estimate of the government payments (grant financing or supplementary service payments) required if the project is not otherwise feasible ̵ An estimate of the potential payments to the procuring authority if the project is “over-feasible”, or other parameters to take advantage of the “over-feasibility” such as a reduction in the contract term or a reduction in the user charges ̵ Information that can be used to assess a range of financial structuring matters such as whether potential payments to the procuring authority should be required up-front or deferred ̵ [a measurement of potential guarantees for minimum revenue/minimum traffic] © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 83 #5 Outputs of the Commercial Feasibility Assessment (2) • For government funded PPPs, the feasibility assessment: ̵ Indicates the level of financial support, such as service payments and grants, required to obtain a commercially attractive and bankable project ̵ Provides information that can be used to assess a range of financial structuring matters, such as whether the government payments should be on an availability or volume basis ̵ Note that oFeasibility must be assessed against a range of sensitivities oMarket sounding will test the assumptions and conclusions [the structure and other inputs may be revisited and adjusted following market sounding] © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 84 Quiz - Commercial Feasibility 12-Pick the incorrect statement A. A feasible project is a project whose expected revenues (inflows) under a reasonable scenario are considered sufficient to cover all costs (outflows) and pay back invested equity with a reasonable return. That is what is tested with commercial feasibility B. When dealing with user-pays projects, we first observe the capability of the project to raise funds on the basis of the charges to users, i.e. to what extent the funds needed for financing the project may be repaid with an adequate return (interest and equity IRR). C. In a user-pays project, when the charges to users might not be sufficient to repay the finance needed to meet the CapEx, the project is not feasible and we may not proceed with it as a PPP D. In a government pays project, the first objective is to estimate the price to be paid by the government © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 85 Quiz - Commercial Feasibility / assessment criteria 13-Pick the incorrect statement A. From a lender´s perspective, the key drivers or KPIs to observe (to assess whether the project is feasible) are the ratios, like DSCR, LLCR and PLCR, assuming a certain leverage and cost of debt as an input. B. The equity IRR to be considered as the target in the exercise should be defined for the specific project, and will depend on several factors including the expected nationality of the investor and the expected size of the company that will invest. C. The debt repayment profile should be sculpted to maximize the size of debt (i.e. the leverage), which basically means to sculpt the repayment profile according to the cash flow so as to meet the level of ratio considered as a requirement. D. CAPM is an approach to estimate the equity internal rate of return expected to be requested by the investors for investing in the project assessed. © K-Infra & Foster Infrastructure 2020 | Appraisal #5 Commercial Feasibility 86 6 Market sounding Guide Sections #9 87 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Market sounding • Key Aspects • Top 10 Tips for Successful Market Sounding • Strategic Issues • Transparency and Governance Procurement Strategy and tender process types Planning, Reporting, Approving and checking Confirming Economic Feasibility © K-Infra & Foster Infrastructure 2020 | Appraisal Value for Moneey #6 Market sounding 88 Market Sounding • Market sounding during the Appraisal Phase is an early structured dialogue between the private and public sector • Market sounding can ensure that the commercial feasibility captures potential investors’ perspectives, value drivers, and their main financial and operational constraints • Many governments encourage a series of soft market tests or market soundings during the Appraisal Phase • This helps ensure the project will attract bidders and helps to communicate the project to the private sector • The government can obtain valuable feedback that may affect the financial model, technical requirements and the preliminary contract structure © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 89 Key Aspects • When should government conduct the market sounding? ̵ Optimum moment: the middle of the Appraisal Phase onot too soon, as there needs to be clarity on fundamental aspects, and not too late as there needs to be time to accommodate the market’s feedback ̵ Market sounding can be repeated during the Structuring Phase • Who to consult (sound out)? ̵ Dialogue with experienced providers, prospective bidders ̵ Lenders • How should government conduct the market sounding? ̵ Prepare a project information memorandum (Project Note or project summary) ̵ The government can post the project information memorandum online, conduct a project open day (“industry meeting”), conduct one-to-one meetings, run polls or deliver a questionnaire © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 90 Key Aspects • What issues should be sounded? ̵ Test all significantly uncertain aspects of the project. Common points include: oThe scope of the project oThe main technical risks identified that might affect the ability of potential bidders to deliver the infrastructure and the services oExpected capital and operational expenditures (CapEx and OpEx) oThe payment mechanism and other revenue schemes envisaged oThe general aspects or risk allocation already defined oFinancial assumptions such as the debt conditions and cost, and the tax and accounting assumptions oThe proposed timetable for the period from procurement to the commencement of services oThe proposed contract structure, including risk allocation © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 91 Top 10 Tips for Successful Market Sounding 1. Ensure that the market sounding exercise is in line with any relevant procurement rules. 2. Prepare thoroughly for any interface with the market to get the most out of the exercise, and give the best account of the public authority to the world at large. 3. Consider market sounding exercises at an early stage in the project. 4. Invest time in preparing the background documentation. Be clear about the issues to be discussed with the market to ensure that the market has something to respond to. Formulate and word questions carefully, avoiding jargon. 5. Be clear about the process to be used to select organizations to help with the market sounding exercise, such as selecting organizations to interview or inviting organizations to make written submissions. 6. Consider the use of a one-on-one format with the selected organizations; be sensitive to the fact that they might not be at ease with a process that involves simultaneous discussion with two or more potential competitors, but reassure all parties that no one is being singled out for special treatment in any subsequent procurement. © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 92 Top 10 Tips for Successful Market Sounding 7. Involve more than one individual on the side of the public authority. Be consistent about what you say to respondents, and ensure that meetings are documented; make use of market information and feedback, which is the ultimate purpose of the market sounding exercise. 8. Do not waste time receiving sales pitches; the point of the exercise is to find out what the market thinks of the proposal so far. Equally, avoid being seduced into shaping the project to suit a particular proposal. 9. Do not restrict the scope of the market sounding in any way; aim for a broad selection of the market such as inviting both operators / construction-related firms and funders, if appropriate. Keep an open mind, focusing on outcomes rather than on one particular means of achieving them. 10. Do not use procurement language such as “bidders” or otherwise give the impression that the market sounding is a procurement opportunity; this stage only seeks to gather information and encourage respondents to be at ease providing critical feedback rather than to feel that they need to be accommodating as potential bidders. © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 93 Strategic Issues • Ensure no confusion about the role of the sounding: companies are not bidding or providing formal expression of interest ̵ Participation in the market sounding should not offer any advantage in subsequent procurement process ̵ Do not provide participants with any information that disrupts a level playing field for future bidders • Interpreting feedback ̵ Filter the private sector’s recommendations and biases to avoid manipulation of the project structure • The sounding team must have expertise, be knowledgeable about the project, and be respected by the market ̵ Governments commonly use external advisers to help conduct the market sounding © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 94 Transparency and Governance • Document all the meetings, decisions, and procedures • Provide access for the public to all documents shared or produced, including a specific web page where interested parties may offer their comments and suggestions (provided that they are previously identified as professionals or participants in the industry) • Leave a clear audit trail of all the feedback provided by the private sector • Invite audit institutions to participate in the process, including in the meetings with the private sector • Consider recording the meetings with individual companies on video, for the exclusive use of audit Institutions © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 95 Quiz - Market Sounding 14-Pick the incorrect statement A. Transparency is a factor to consider when designing and conducting a market test, it being appropiate to provide access for the public to all documents shared or produced, including a specific web page where interested parties (industry players) may offer their comments and suggestions B. Is important to filter the feedback as this could be biased C. Companies participating in a market sounding may logically deserve a special treatment in the bidding process in exchange of their interest D. Is good practice to consider market sounding exercises at an early stage in the project, and to consider a procurement appraisal process before formulating the procurement plan in detail © K-Infra & Foster Infrastructure 2020 | Appraisal #6 Market sounding 96 7 Confirming Economic Feasibility Guide Sections #10 97 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking • Refining the Cost-Benefit Analysis © K-Infra & Foster Infrastructure 2020 | Appraisal #7 Economic Feasibility 98 Confirming Economic Feasibility: Refining the Cost-Benefit Analysis • Economic feasibility, usually in the form of a cost-benefit analysis, is conducted in full in this phase, or updated in more precise terms if it was previously conducted during the identification phase. In conducting the analysis, the following should be considered: ̵ The detailed description of the project scope in terms of infrastructure design and services → this can help to refine the identification of the service users and other stakeholders whose socio-economic costs and benefits should be considered ̵ The “willingness to pay” evaluations, eventually done as part of the estimation of demand, allowing a clearer projection of economic benefits ̵ The technical specifications, providing a much more precise estimate of the whole-life costs of the project ̵ The risk assessments, providing adjustments to the economic data © K-Infra & Foster Infrastructure 2020 | Appraisal #7 Economic Feasibility 99 8 Fiscal Feasibility Guide Sections #11 100 Contents Objectives and overview • Assessing Fiscal Feasibility (Affordability) • Outputs of the Fiscal Feasibility Analysis Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #8 Fiscal Feasibility 101 Assessing Fiscal Feasibility (Affordability) • Fiscal feasibility (affordability analysis) examines the government’s ability to accommodate the project within current and future budget constraints. The analysis should consider: ̵ Direct liabilities – where the project is fully or partially funded by government ̵ Contingent liabilities – risks retained or allocated to the government • Three different perspectives can be considered: ̵ Compare the cash flow of commitments to the government’s total projected tax revenues (using GDP as an approximation) o Outputs the commitment as a yearly percentage of tax revenues [GDP] ̵ Compare the cash flow of commitments to the procuring authority’s or sector’s projected budget appropriations o There is no common specific international threshold ̵ Assess the compliance with eventual overall budgetary limits and constraints o There may be specific caps (for examples, in terms of percent of GDP) for aggregated exposure of specific agencies or governments o Some countries do not include or consider contingent liabilities in such analysis, but only direct liabilities Note: this chapter refers to exposure in annual / yearly terms but calculations in NPV terms are also common (stock values versus flow value terms) © K-Infra & Foster Infrastructure 2020 | Appraisal #8 Fiscal Feasibility 102 Outputs of the Fiscal Feasibility Analysis • Fiscal feasibility analysis provides two essential outputs: ̵ First, it estimates the fiscal effect of the project in terms of direct and contingent exposures on the public budget → This is a central piece of information on its own for an informed green light decision ̵ Second, it tests the compliance of the project with the regulatory aspects specific to each jurisdiction that limit PPP expenditures Fiscal feasibility analysis is highly interrelated with other assessments, especially commercial feasibility → it may be necessary to reconsider the structure, scope, and technical requirements so as to develop a base case that is commercially feasible and affordable (as well as providing VfM) © K-Infra & Foster Infrastructure 2020 | Appraisal #8 Fiscal Feasibility 103 Quiz - Fiscal feasibility (Affordability) [scenario] 15-The procuring authority is assessing a PPP Project based on government service payments (availability payments), 20 year term. According to the financial model and the provisional results of the commercial feasibility, the project requires yearly fiscal direct commitments / direct liabilities (after 3 years of construction) of 50 million US$ per year (in real terms) during 17 years. We have the following information relevant for the affordability assessment: • National Guidelines require that ̵ total PPP commitments / liabilities of a particular procuring authority, in flow terms (payments estimated for each year), can not represent more than 10% of the projected budget of the respective procuring authority for each year. ̵ There is cap on total PPP fiscal commitments/liabilities of the country in flow terms (total payments projected/liabilities from all PPPs estimated for each year) equal to 0,5% of GDP on a yearly basis. • 50 million represents 2% of the projected budget of the procuring authority in the first year of operations • The total projected PPP commitments/liabilities of the procuring authority in annual flow terms (payments estimated for each year related to PPP contracts already in place), including the project being assessed, would represent 9,75% of the projected budget allocations for the authority per year for the next 20 years. • All government PPP commitments (total liabilities) together estimated for the first year of operations of the project ) represent 0,52% of the national GDP of the current year (the year of the analysis). © K-Infra & Foster Infrastructure 2020 | Appraisal #8 Fiscal Feasibility 104 Quiz - Fiscal feasibility (Affordability) 16-Considering the description of the previous scenario, Which is true? A. The Project is in compliance with regulatory limits to PPP exposure because 50 million represents only 2% of the budget of the procuring authority in first year B. The Project is in compliance because total PPP commitments of the authority (those related to PPP contracts already in place) will represent, when adding the project, in year terms, 9.75% of the projected budget appropriations per year C. The Project is NOT in compliance because all government PPP commitments together including the project (all payments estimated for each year) represent 0.52% of today´s GDP, which is above the 0.5% D. We can not conclude whether the project is in compliance because we need to know the value of contingent liabilities © K-Infra & Foster Infrastructure 2020 | Appraisal #8 Fiscal Feasibility 105 9 Impact on deficit and debt Guide Sections #12 106 Contents Objectives and overview Detailing scope, designing technical requirements and assessing costs Designing a Preliminary Structure of the PPP Fiscal Feasibility • Analysis of Impact on Government Deficits and Debt • Two Major International Standards • International Public Sector Accounting Standards (IPSAS) Number 32 • Eurostat Standards: ESA2010 Impact on deficit and Debt Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 107 # Analysis of Impact on Government Deficits and Debt • Dependent on country’s specific rules and accounting practices ̵ Should the PPP asset be recorded as a public asset in the national accounts? ̵ Should the related liabilities be recognized and recorded as public debt? • This analysis influences the green light decision ̵ Country debt restrictions may affect whether the project can proceed ̵ There may be a bias in favor of PPPs to circumvent deficit and/or debt restrictions © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 108 # Two Major International Standards • There are two major international standards that are applied to PPPs (although some countries have their own variations): ̵ International Public Sector Accounting Standard (IPSAS) 32 or similar account approaches oUnder this standard, when the public party controls the asset it will be regarded as a public asset for accounting purposes with the corresponding recording of public liabilities oUsually, all government-pays PPPs and some user-pays PPPs will be consolidated in the national accounts ̵ European System of Accounts (ESA) 95 / ESA2010 statistical treatment or similar regulations oUnder this standard, when the majority of the risks are born by the public partner, the asset will be regarded as a public asset with the corresponding recording of public liabilities oUsually, a user-pays PPP would not be regarded as a public asset (where more than 50 percent of the revenue comes from users) and a government-pays PPP may or may not be registered, depending mostly on the risk allocation © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 109 #1 International Public Sector Accounting Standards (IPSAS) Number 32 • IPSAS 32 describes service concession agreements as long-term contracts between a government and a private party whereby: ̵ The operator uses a public asset to provide a public service for a specified period of time on behalf of the government ̵ The operator is compensated for its services • This covers both government-pays and user-pays PPP contracts • IPSAS 32 states that all contracts with the following characteristics should have consequences for government’s balance sheet in terms of gross debt ̵ The government controls or regulates what services the operator must provide with the asset, to whom it must provide them, and at what price ̵ The government also controls any significant residual interest in the asset at the end of the term of the arrangement © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 110 #2 Eurostat Standards: ESA2010 • The European System of Integrated Economic Accounts (ESA 2010) provides regulations on how the EU member states prepare national accounts and produce fiscal information • The Manual on Government Deficit and Debt provides further explanation • There is a clear distinction between user-pays and governmentpays PPPs ̵ User-pays PPPs (referred as “concessions”), where more than 50% of revenues are user-payments, are generally treated as out of the government balance sheet ̵ Government-pays PPPs, where more than 50% of revenues come from the public budget, are assessed based on risk transfer principles – for a project to be off the government balance sheet, two conditions must be met: oConstruction risk (most of it) should be transferred AND oThe majority of the demand risk or availability risk should be transferred. © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 111 #2 Eurostat Standards: ESA2010 (2) • The contract should transfer the construction risk and either the availability or volume risk to the private party ̵ This does not imply a full risk allocation, but it is necessary that “most of the risk” is transferred ̵ There is no precise definition of when the majority of the risk has been transferred • Situations that generally require classification of the asset in the government accounts: ̵ Any project where more than 50% of the financing is public finance ̵ Government-pays projects based on volume or availability, where variations in demand or failures to meet performance requirements do not impose a material financial impact on the project company and/or where there is a floor limit or a minimum guaranteed level of payments that cover a substantial part of the financial package regardless the actual level of demand ̵ Government-pays PPPs in which the PPP project company is public and it is not constituted as an independent company with its own set of accounts and its own management materially independent of the government © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 112 # Additional points • There is a great deal of divergence across countries in terms of accounting practice • There are countries with their own rules that are far from any of these standards • There are countries with no regulation regarding accounting treatment • The accounting treatment may result in a re-definition of the project, especially in countries subject to deficit and public debt constraints ̵ [including revisiting/redefining risk allocation in ESA 2010 countries so as to meet the risk criteria, which may impact on VFM] © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 113 Quiz - Debt impact 17-There is a government-pays PPP contract for a road, in which government clearly defines the services to be provided by the private partner and the calculation of the price to be paid to the private partner. Payments are related to volume of use of the road, and there is a guarantee in the contract so that a minimum revenue covering 50% of the debt is assured. (If traffic goes below certain a threshold, the government covers the difference. The threshold is structured so as to cover approximately 50% of the debt). At the end of the contract period, the asset will revert to the government for no payment. Based in the information provided about this PPP project, which is true? A. According to IPSAS 32 and Eurostat / 2010 guidelines, the asset should be regarded as a public asset and incorporated in the government´s balance sheet, as the government has clear control and an interest in the residual value (IPSAS) and because government is guaranteeing 50% of the debt (ESA 2010) B. According to either guideline the asset may be treated as off the balance sheet of the government C. The asset is to be regarded as a public asset only under IPSAS 32, but it may be validly considered off balance sheet according to Eurostat / ESA 2010, as risk appears to be sufficiently transferred according to the Eurostat guidelines D. The asset should only be regarded as a public asset according to Eurostat, but not according to IPSAS. © K-Infra & Foster Infrastructure 2020 | Appraisal #9 Debt Analysis 114 10 Environmental Feasibility Guide Sections #13 115 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Developing the Financial Model • Assessing Environmental Feasibility • The Process of Assessing Environmental Feasibility • Outputs of the Environmental Feasibility Analysis Environmental feasibility Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #10 Environmental 116 Assessing Environmental Feasibility • Environmental impacts of a project: ̵ May be both positive and negative ̵ May arise from construction or operations ̵ May affect more than the immediate project area and may affect other populations (secondary impacts) • Environmental impacts and approvals are a common source of delays in PPP projects • Mitigation strategies and measures imposed by environmental agencies may result in a significant cost • A comprehensive assessment is needed to ensure environmental considerations are explicitly addressed and incorporated into the green light decision • Environmental issues also affect a project’s eligibility for finance ̵ Compliance with the “Equator principles” is a requirement of many lenders and MDBs, and may be more demanding than national requirements ̵ Some financial institutions may require specific standards © K-Infra & Foster Infrastructure 2020 | Appraisal #10 Environmental 117 The Process of Assessing Environmental Feasibility • Is there any specific aspect of the project that makes environmental approvals impossible or the costs to obtain them prohibitive? The following 4 steps are necessary to assess environmental feasibility: Step #1 •Identify all legal and regulatory aspects relevant for obtaining environmental approvals Step #2 •Thorough due diligence (Environmental Impact Assessment) effort to identify, describe and quantify the environmental impacts on the project © K-Infra & Foster Infrastructure 2020 | Appraisal Step #3 •Definition of a strategy to mitigate the specific effects #10 Environmental Step #4 •Obtain the environmental permits and final approvals needed for construction of the infrastructure 118 The Process of Assessing Environmental Feasibility • Step #1: Identify all legal and regulatory aspects relevant for obtaining environmental approvals: ̵ What are the stages for environmental approval? ̵ What is the level of detail required in each of those phases? ̵ What is the content of the environmental assessment needed for the approvals? ̵ What are the sector-specific requirements? ̵ How long will the process take, given the size and sector of the project? • Step #2: Thorough due diligence (Environmental Impact Assessment) to identify, describe and quantify the environmental impacts on the project – typically includes: ̵ A full description of the physical and biological characteristics of the area ̵ Analysis of the project’s impact on the area ̵ Identification of the consequences of construction of the asset in terms of main inputs (e.g. water usage, energy sources consumed) ̵ Full description of the physical and biological aspects of the area after construction and operation of the infrastructure © K-Infra & Foster Infrastructure 2020 | Appraisal #10 Environmental 119 The Process of Assessing Environmental Feasibility • Step #3: Definition of a strategy to mitigate the specific effects: ̵ Focus on the most significant environmental effects ̵ Identify mechanisms to minimize them ̵ Identify measures to compensate for any inevitable environmental consequences • Step #4: Obtain the environmental permits and final approvals needed for construction of the infrastructure: ̵ This is not always possible during the Appraisal Phase ̵ The costs to obtain full studies and file for approvals can be exceptionally high ̵ It is good practice to obtain environmental permits, at least in a preliminary or “provisional” mode, before launching the project ̵ At the Appraisal Phase, the government should be able to answer: o What are the total costs for environmental licensing and future investigations? o What are the costs of compensation measures? o What is the estimated time to obtain full environmental licensing? © K-Infra & Foster Infrastructure 2020 | Appraisal #10 Environmental 120 Outputs of the Environmental Feasibility Analysis • The key output of the environmental feasibility analysis: a sound recommendation about the environmental viability of the project – can it obtain the necessary approvals, and, if so, at a reasonable cost? • The assessment contributes to the sustainability of the initiative by offering input into the design of the technical requirements, reducing environmental footprint of the project • For simpler/smaller projects, the assessment produces a full and definitive environmental approval • For larger, more complex projects, the assessment provides a roadmap for obtaining approval • [results may influence the financial base case / commercial feasibility and all other financial assessments as per increase / variation in the cost of the project] © K-Infra & Foster Infrastructure 2020 | Appraisal #10 Environmental 121 11 Social Feasibility Guide Sections #14 122 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Assessing the Technical Feasibility • Assessing Social Feasibility • Scope of Social Impact Analysis (SIA) • Six Principles of the Social Impact Assessment (SIA) • The Process of Analysing Social Impacts • Outputs of the Social Impact Assessment Social feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 123 Assessing Social Feasibility • Social feasibility analysis examines the project’s impact on the lives of people that live and work in the project’s area of influence • This analysis greatly reduces the overall risks of the project – it helps to reduce resistance, strengthens general support and creates better understanding of costs and benefits • Full analysis can be very expensive and time consuming ̵ It is not justifiable in all projects but ̵ All projects demand a review of project data at the Appraisal Phase to identify if any material social impacts exist Social feasibility analysis helps the government to anticipate adverse effects and avoid, minimize or offset the impacts © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 124 Scope of Social Impact Analysis (SIA) • The social impact analysis can address a very broad set of issues. The issues and their impact depends on the nature, size and location of the project • Minimum set of issues to be addressed: ̵ Will the project produce any population or demographic movement? ̵ Will the project significantly alter the economic structure of the local economy or generate any significant change in relative prices, such as land value? ̵ Will there be a significant change in the general access that the communities have to natural resources, such as drinking water and energy? ̵ Does the local community have effective governance mechanisms to deal with the long-term effects of the project? ̵ Will the project increase or decrease the demand for public goods or services, such as education or health? ̵ Are there groups who will be differentially impacted by the project? ̵ Will the project interfere with the local labor market during or after construction? ̵ Does the background of project staff differ significantly from local communities and provide potential for misunderstanding and conflict? ̵ Will an influx of newcomers seeking opportunities associated with the project disrupt traditional social structures and create undesirable effects? © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 125 Six Principles of the Social Impact Assessment (SIA) 1. Achieve extensive understanding of local and regional populations and settings to be affected by the proposed action, program, or policy 2. Focus on the key elements of the human environment related to the proposed action, program, or policy 3. Base the analysis upon sound and replicable scientific research concepts and methods 4. Provide quality information for use in decision-making 5. Ensure that any environmental justice issues are fully described and analyzed – identify the disadvantage and minority populations 6. Undertake project, program, or policy monitoring and evaluation, and propose mitigation measures if needed Source: Principles and Guidelines for Social Impact Assessment in the USA, The Inter-organizational Committee on Principles and Guidelines for Social Impact Assessment. (2003) © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 126 The Process of Analysing Social Impacts • Sometimes integrated with the Environmental Impact Assessment, the Social Impact Assessment typically includes 4 steps: Step #1 • Thorough identification of the people residing and/or working within a project’s area of influence Step #2 • Establish a social baseline that indicates the status of the issues to be considered before the implementatio n of the project © K-Infra & Foster Infrastructure 2020 | Appraisal Step #3 • Estimate the impacts of the project in the communities identified within the area of influence #11 Social Feasibility Step #4 • Identification of the mitigation strategies for the adverse impacts identified in previous steps 127 The Process of Analysing Social Impacts • Step #1: Thorough identification of the people residing and/or working within a project’s area of influence: ̵ A mapping of the communities and their social, economic, and cultural connection with the site in which the project will be implemented ̵ Includes the listing of the social issues to be considered (at least the “minimum set of issues” described before) • Step #2: Establish a social baseline that indicates the status of the issues to be considered before the implementation of the project → issues identified should be incorporated in a social description of the communities affected ̵ Methods of obtaining data for social baseline include (see PPP Guide Box 4.12) Secondary data Public consultation © K-Infra & Foster Infrastructure 2020 | Appraisal Participatory techniques and stakeholder analysis Qualitative methods #11 Social Feasibility Quantitative methods 128 The Process of Analysing Social Impacts • Step #3: Estimate the impacts of the project in the communities identified within the area of influence: ̵ Project the existing baseline into the future with and without the PPP project ̵ Compare and assess how the issues that were identified as relevant for the specific project evolve against the original baseline ̵ Classify impacts in terms of their relative importance, considering the number of people affected and the reach of the damage produced ̵ Order, or prioritize, the impacts in terms of their relative social significance ̵ Note: some impacts require careful investigation: e.g. Land expropriation and forced relocation, especially indigenous communities © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 129 The Process of Analysing Social Impacts • Step #4: Identification of the mitigation strategies for the adverse impacts identified in previous steps: Developing a social action plan and a basic estimation of costs and schedule ̵ Sequence the strategy of social actions as suggested by IFC´s good practice note: oFirst, give priority to impact avoidance. –Social impacts can often be avoided by ‘at source’ changes, such as the selection of an alternative site for the project or the modification of the design oSecond, focus on the reduction or minimization of impacts that cannot be avoided. –The reduction of impacts is achieved through the implementation of customized measures, such as soundproofing houses within the noise footprint of an airport, regulation of construction traffic, etc. oThird, where adverse impacts are unavoidable, people affected by the project must receive adequate compensation © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 130 Outputs of the Social Impact Assessment • Social Impact Assessment should identify the impacts of the project in the community and classify them in terms of significance ̵ Note that resulting consultations play an important role in creating legitimacy of the project among the communities in which it directly engages • Social Impact Assessment should provide recommended actions that can avoid, minimize, or compensate for adverse social impacts of the project. Mitigation actions ̵ may be developed during appraisal [or before launching] – like changes in technical requirements, project design, etc. and revised cost estimates for input to the financial model ̵ may be taken by the private sector [requested by government through the PPP contract] → government should estimate the cost and input it in the financial model • The assessment should indicate the total adverse social consequences that can not be mitigated → for consideration in the green light decision © K-Infra & Foster Infrastructure 2020 | Appraisal #11 Social Feasibility 131 12 Legal Feasibility Guide Sections #15 132 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Assessing Commercial Feasibility • Assessing Legal Feasibility • The Process of Analyzing Legal Feasibility • Outputs of the Legal Feasibility and Conducting Legal Due Diligence Legal feasibility Value for Moneey Market sounding Procurement Strategy and tender process types Confirming Economic Feasibility Planning, Reporting, Approving and checking © K-Infra & Foster Infrastructure 2020 | Appraisal #12 Legal Feasibility 133 Assessing Legal Feasibility • Detailed legal due diligence is necessary to ensure all foreseeable legal requirements are met • Legal feasibility assessment aims to: ̵ Ensure that the project is legally doable ̵ Facilitate risk management, identifying legal obstacles for developing the project • Some limits or restrictions might require changes in law or regulations • Steps: ̵ Step #1: Analysis of the applicable legal framework ̵ Step #2: Assessment of the legal readiness of the procuring authority ̵ Step #3: In-depth legal analysis of the main project issues © K-Infra & Foster Infrastructure 2020 | Appraisal #12 Legal Feasibility 134 The Process of Analysing Legal Feasibility • Step #1: Analysis of the applicable legal framework, including ̵ The enabling PPP legislation (if any), especially looking for particular requirements imposed on projects such as a minimum capital value and maximum contract duration ̵ The public procurement law which may be partially applicable, especially in a search of general contractual and procurement guidelines ̵ Legislation referring to foreign investment, property, and labor issues ̵ Legislation related to land use planning and environmental laws ̵ Sector specific legislation ̵ Legal aspects of dispute resolution and intellectual property ̵ Legislation relating to the granting of ownership/control of public assets or of responsibility for the delivery of public services to third parties ̵ Legal treatment of revenue sources associated with the concession [e.g. restrictions on the private partner’s right to charge end users] These reviews will provide a list of requirements that feed other feasibility exercises such as the technical requirements and commercial feasibility © K-Infra & Foster Infrastructure 2020 | Appraisal #12 Legal Feasibility 135 The Process of Analysing Legal Feasibility • Step #2: Assessment of the legal readiness of the procuring authority ̵ Does the promoting authority and other institutions involved have the legal authority to launch the project? ̵ Do they have the legal authority to proceed with the approval? Who has formal responsibility for the appraisal exercises? Which authorities and government bodies should be involved in approvals and to what extent? © K-Infra & Foster Infrastructure 2020 | Appraisal #12 Legal Feasibility 136 The Process of Analysing Legal Feasibility • Step #3: In-depth legal analysis of the main project issues ̵ The financial aspects of the project o Legal feasibility of public support o Limitations on charging users ̵ Issues considered relevant to commercial viability, including the bankability of the project o Legal feasibility of step in rights and security packages ̵ Land and property assets issues o Use of land and land availability – in some countries there is a need for a legal change between “public use” to “disposable use”; sometimes legal authorization to transfer the control of the asset to private is required [typically embedded into the contract title] o Potential alternative ownership claims on the land and rights of other users (e.g. oil company, electricity transmission) o Responsibility for relocating people ̵ Foreign investment and currency exchange o Restrictions on FDI, repatriation of capital, foreign staff etc ̵ Employment issues o As for public sector employees ̵ Tax and accounting issues considered in the financial model o Including import duties, tax exemptions etc. ̵ Environmental issues – what clearances are requested? © K-Infra & Foster Infrastructure 2020 | Appraisal #12 Legal Feasibility 137 Outputs of the Legal Feasibility and Conducting Legal Due Diligence • The key output of the legal feasibility assessment is a detailed recommendation for the approval of the project based upon: ̵ The existence of no significant legal obstacles for the future development of the project, or ̵ If any obstacle exists, the strategy to be followed to overcome it as well as the estimation of time and resources necessary to do it © K-Infra & Foster Infrastructure 2020 | Appraisal #12 Legal Feasibility 138 13 Value for Money Guide Sections #16 139 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Market sounding • Value for Money Assessment – purpose and timing • VfM methods- Quantitative Value for Money Analysis • VfM methods- Qualitative Value for Money Analysis Procurement Strategy and tender process types Planning, Reporting, Approving and checking Confirming Economic Feasibility © K-Infra & Foster Infrastructure 2020 | Appraisal Value for Moneey #13 Value for Money 140 #1 Value for Money Assessment – purpose and timing • Compares the relative merits of PPP procurement against one or more other procurement routes, usually traditional public finance (represented by the Public Sector Comparator (PSC)) ̵ Does the PPP option provide higher net economic benefits / incremental efficiency? • For some countries, this is not a required assessment or may be skipped if there is no alternative ̵ This reinforces the need for meaningful economic analysis (taking care to avoid PPP bias) • The assessment can incorporate both quantitative analysis and qualitative analysis, addressing issues not quantifiable • Timing (see next slide) ̵ The assessment is typically done in appraisal but revisited if necessary in structuring / before launching ̵ It is also convenient to check VfM following the tender process on the basis of the winning bid / contract signed* ̵ A value for money assessment should be run again for material contract changes (especially changes affecting the risk allocation) © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 141 #1 VfM purpose and timing (2) - alongside the PPP Process Phase Scope (source of data) Purpose Appraisal VfM using available data Indicative for the green light decision Structuring VfM may be revisited if necessary (e.g. following a material change in the contract structure) Decision to issue Request for Proposal Following contract award Full VfM, considering the final contract after procurement Feedback for future projects Contract management Full VfM, considering contract Guidelines for conducting enhancements and reviewed risk negotiation with the private allocation sector © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 142 #2 VfM methods- Quantitative • Depending on the country, the analysis may be quantitative, qualitative or both • Quantitative analysis usually involves 6 steps Step 1 – Produce a raw Public Sector Comparator (PSC) Step 2 – Turn the raw PSC into an adjusted PSC to permit a fair comparison Step 3 – Estimate the costs of the PPP project Step 4 – Achieve a comparable value from these two cost structures with different time profiles Step 5 – Indicate which option represents the best alternative to implement the project Step 6 – Test the robustness of the VfM exercise with a sensitivity analysis © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 143 #2 Quantitative Value for Money Analysis (2) • Step 1 – Produce a raw Public Sector Comparator (PSC) ̵ Document the costs and revenues, from the base case in the commercial feasibility, in a spreadsheet ̵ All efficiency gains generated by the private sector involvement are excluded at this point because the PSC reflects direct delivery by the government ̵ The PSC reflects the net fiscal impact of the project (costs less revenues), therefore all non-fiscal [non-tax] revenues considered in the PPP option should be included in the PSC calculations ̵ If the revenues generated by a traditionally procured project are different, the values in the PSC calculations should reflect this adjustment –For example because the tariff to be charged to users will be lower © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 144 #2 Quantitative Value for Money Analysis (3) • Step 2 – Turn the raw PSC into an adjusted PSC to permit a fair comparison ̵ Change costs to incorporate value of risks that the government retains in a traditional procurement but that are transferred in PPP project estimates – (unless value of retrained risks in PPP are added in PPP project) ̵ Allow for differences in social and economic benefits –[An adjustment for potential loss in benefits could make sense (e.g. if most likely construction term includes a certain delay, value of the benefit missed or delayed should be included as adjustment] ̵ Neutralize cost differences which do not reflect true efficiency differences (e.g. tax effect) → neutrality adjustment © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 145 #2 Quantitative Value for Money Analysis (4) • Step 3 – Estimate the costs of the PPP project: ̵ Using data from the commercial feasibility assessment and affordability exercise ̵ Estimate cost for the government, regardless of user payments ̵ Governmental payments can assume different triggers and profiles, but a common payment structure produces constant availability payments throughout the contract, once the project is operational ̵ Include costs of project contract management and transaction implementation (extra cost oversight, named sometimes “regulatory costs”) ̵ Consider other types of public financial support that may only be possible through the PPP alternative, and might represent an indirect cost to taxpayers © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 146 #2 Quantitative Value for Money Analysis (5) • Step 4 – Achieve a comparable value from two cost structures with different time profiles: ̵ Compare the Net Present Value of each alternative, applying a discount rate to the projected alternative costs ̵ The discount rate directly affects the conclusion of the VfM assessment ̵ Common approaches to the discount rate: oUse of the opportunity cost of government funds for both the PPP and the PSC cost structure oUse of a particular rate for each project corresponding to the degree of project risk oUse of the social time preference rate as the standard real discount rate for both the PPP and the PSC o Note that the approach for calculating the rate of discount should we defined in advance and embedded in the framework © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 147 #2 Quantitative Value for Money Analysis (6) • Step 5 – Indicate which option represents the best alternative to implement the project: ̵ The PPP is said to offer a better Value for Money when the costs are lower than the PSC ̵ The calculation formula is: • • • • • VfM = Value for Money YCt = Yearly cost of the PPP scheme in year t (for instance, availability payments) ARCt = Adjustment for regulatory costs [contract oversight] r = Discount rate CCt = Construction costs of the PSC in year t Note: the formula in the Guide is wrong: It is the other way around © K-Infra & Foster Infrastructure 2020 | Appraisal • • • • • OMt = Operation and maintenance costs of the PSC in year t RRt = Renewal and replacement costs of the PSC in year t ARt (ACO)= Adjustments for risk in year t (adjustments for costs overrun) ACNt = Adjustments for competitive neutrality in year t ASEt =Adjustments for differences in socio-economic consequences of the project in year t #13 Value for Money 148 #2 Quantitative Value for Money Analysis (7) • Step 6 – Test the robustness of the VfM exercise with a sensitivity analysis: ̵ Quantitative VfM assessment is based on unproven assumptions ̵ Sensitivity analysis test the assumptions related to PSC cost projections, cost overruns, income generated, the discount rate used in the NPV calculations, and so on ̵ The conclusions should be read for reference only oA positive Value for Money does not necessarily imply that a PPP route should be used; qualitative factors should be considered in the decision as well oA negative Value for Money does not mean that a PPP route is worse than traditional procurement. Sensitivities of important inputs should be developed in order to test the robustness of the results © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 149 #3 Qualitative Value for Money Analysis • • This involves checking whether the general concept of the project fits the model of private sector investment Non-financial benefits of PPPs should be taken into account (EPEC) • Accelerated delivery • Enhanced delivery • Wider social impacts • • Non-financial benefits must not be ‘double counted’ if they have already been incorporated in the adjustments of the PSC Identify problems associated with involving a private sector player into the specific PPP contract, followed by proposed strategies to mitigate them • e.g. PPPs can result in a lack of policy flexibility, or specific potential difficulties in monitoring • Inevitably, this analysis is subjective → view it alongside quantitative analysis © K-Infra & Foster Infrastructure 2020 | Appraisal #13 Value for Money 150 #3 Qualitative Value for Money Analysis (2) • Different countries use different criteria • United Kingdom (UK) Treasury defines: Suitability criteria: Unsuitability criteria: • Long-term, predictable need for service • Ability to allocate risk effectively • Likely ability of private party to manage risk and take responsibility for delivery • Presence of stable and adequate policy and institutions • Competitive bidding market • • • • © K-Infra & Foster Infrastructure 2020 | Appraisal Project too small or complicated Sectors needs are likely to change Risk of obsolescence Contracting authority is inadequately skilled to manage a PPP #13 Value for Money 151 VFM exercise Calculate the VFM © K-Infra & Foster Infrastructure 2020 | Appraisal xxxx Financial Costs xxxx Risk premia/contingencies xxxx Base costs (net of taxes to PPP and comercial revenues) Socio Ec. adjustments xxxx Competitive neutrality adj. xxxx Adjustments for risk xxxxx Base costs net of user revenues Base Case costs (capex+opex) in PPP financial model •Step 1 – Produce a raw Public Sector Comparator (PSC) •Base Case PPP costs in NPV are $65M, but includes $10M of contingencies and $5M for user revenues •Step 2 – Turn the raw PSC into an adjusted PSC to permit a fair comparison •Value / estimate of risks transferred to private in PPP (and retained in PSC) is $30 M . •Extra Taxes in PPP are NPV=$5M •Cost benefit: most likely delay in PSC is 6 months (each month value is $0.5 M) •Step 3 – Estimate the costs of the PPP project •Is the NPV of net payments (net of user revenues) and net of taxes •For more detailed information, financial costs are $15M •Step 4 – Achieve a comparable value from these two cost structures with different time profiles •Is calculating NPV of the two payment streams •[Step 5 – Indicate which option represents the best alternative to implement the project] •[Step 6 – Test the robustness of the VfM exercise with a sensitivity analysis] 13 VFM xxxx PPP net costs *comercial revenues are considered to be transferred(assigned xxxxx Total NPV Total NPV PSC PPP #13 Value for Money 152 VFM exercise Traditional Delivery Socio Economic adjustments Competitive neutrality Adjustments for risk Base Costs (net of revenue) TOTAL © K-Infra & Foster Infrastructure 2020 | Appraisal $3 M $5 M $30 M $50 M $88 M PPP Financial costs Risk premia/contingencies Base Costs (net of revenue) TOTAL $15 M $10 M $50 M $75 M VfM $13 M #13 Value for Money 153 14 Procurement Strategy and tender process types Guide Sections #17 154 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding • The Procurement Strategy • Main Procurement / Tender process types • Extra: Processes in sequence Planning, Reporting, Approving and checking Confirming Economic Feasibility © K-Infra & Foster Infrastructure 2020 | Appraisal Procurement Strategy and tender process types #14 Procurement Strategy 155 The Procurement Strategy • The procurement strategy determines how the private sector partner will be selected • Focus on obtaining the best Value for Money • Create incentives for all players involved • The details will be designed in Structuring Phase • Issues to be dealt with during Appraisal: ̵ Approach to qualifications oWhen to issue the request for qualifications (in advance of, or same time as, the RFP) oWhether to pre-select (short list) bidders or only apply pass/fail criteria ̵ Approach to Request for Proposals oTiming of the finalization and issue of the RFP and contract ̵ Approach to bid submittal and evaluation oAre negotiations or iterative proposals allowed? © K-Infra & Foster Infrastructure 2020 | Appraisal #14 Procurement Strategy 156 Main Procurement / Tender process types Open tender or onestage process Open tender with pass/fail prequalification (or twostage open tender) Negotiated process (short listing with negotiations) © K-Infra & Foster Infrastructure 2020 | Appraisal Restricted procedure (shortlisting with one bid) Dialogue or interaction process #14 Procurement Strategy 157 Main procurement/tender process types Type Open tender or one-stage tender process Features / description Country examples • Spain, most countries in Latin America. • RFP is published at the same time as the contract, and launching implies the invitation to propose, with the tender open for bidding to any potential bidder. The proposal requirements also include the qualification requirements quite common in EU vis a vis competitive dialogue. Open tender with • pass/fail prequalification (or • two-stages open tender) Separating call for qualifications (RFQ) and call for bids Some countries in Latin America for some projects or invitation to propose (RFP issuance). There is an initial stage in which potential bidders are (México, India, Colombia). • Restricted procedure (shortlisting with one bid) As with Open tender with pre-qualification, there is an initial stage in which potential bidders are invited to submit qualifications. Qualifying bidders are ranked and a limited number of the highest ranking are shortlisted. • This short-list of bidders will be invited to submit their bids • invited to pre-qualify (under an open basis), before the issuance of the RFP and contract Issuance of the RFP implies invitation to propose and there is only one round of bidding © K-Infra & Foster Infrastructure 2020 | Appraisal Considered an option under EU regulations, but less commonly used than the former types. #14 Procurement Strategy 158 Main procurement/tender process types (2) Type Negotiated process (shortlisting with negotiations, or BAFO) Dialogue process Interaction process Features / description Based on a previous short listing, bidders are invited to submit their bids and negotiations are open with all of the shortlisted bidders or with a limited number of candidates. Bids are usually iterative before calling for the final offer. In BAFO process stage bids are evaluated as to narrow the number of bidders. Two selected candidates will submit Best-and-Final Offer - BAFO) Short-listing is accompanied by a dialogue period as to define (or refine) RFP and specially contract In the strict sense, only one final bid is submitted. Some processes will consider consecutive bids, usually nonbinding. Country examples Considered in EU by legislation. More marginal method of procurement in EU, although significant tradition in EU. Regulated option by EU legislation, for specific type of projects meeting some features, mainly related to complexity. Used in some states in USA. An option regulated by legislation in Egypt. Whereas the EU’s process focusses on dialogue in relation The standard approach in to defining the final terms of the RFP and the contract, Australia and New Zealand. interaction process focusses on the development of the bidders’ proposals and their interpretation of the RFP. Usual to be a final negotiation phase (with one or more bidders) after the initial evaluation of bids © K-Infra & Foster Infrastructure 2020 | Appraisal #14 Procurement Strategy 159 Extra: Processes in sequence Open tender with prequalification Structuring and drafting RFQ Pre-tender: Issuance of RFQ Contract structure and drafting Qualification period Structuring and drafting RFP SoQ assessment and Prequalified candidates (or assessment and selection in short list process)) Approving contract and tender package Tender issuance: invitations to propose under RFP+contract Bid submission period Bid evaluation Open tender – one stage Contract structure and drafting Structuring and drafting RFQ & RFP Approving contract and tender package © K-Infra & Foster Infrastructure 2020 | Appraisal Tender issuance: invitations to propose under full package of docs Bid submission period #14 Procurement Strategy SoQ assessment + Bid evaluation 160 Extra: Processes in sequence (2) Dialogue or interactive process – EU Competitive Dialogue Structuring & drafting RFQ (for shortlisting) Pre-tender: Issuance of RFQ Contract structure Qualification period Structuring and drafting RFP & drafting contract SoQ assessment and selection (short list) Issuance of invitations to dialogue or negotiate Preapproving contract Dialogue period (negotiating final contract terms) Approving final contract and final tender package Bid preparation Tender: invitations to propose: only RFP+contract Bid submission period Bid evaluatio n Dialogue or interactive process – Australian / New Zealand Interactive Tender Process Structuring & drafting RFQ (for shortlisting) Pre-tender: Issuance of RFQ Contract structure SoQ assessment and selection (short list) Qualification period Structuring and drafting RFP & drafting contract Approving contract and tender package Tender issuance: invitations to propose under RFP+contract Bid preparation Bid submission period Bid evaluatio n Interactive tender process (ensuring bids respond to RFP requirements) © K-Infra & Foster Infrastructure 2020 | Appraisal #14 Procurement Strategy 161 Quiz - Tender processes 18-Pick the incorrect statement A. A process with a separated call for qualifications (RFQ) and call for bids (RFP issuance), in which potential bidders are invited to pre-qualify before the issuance of the RFP and contract, and those that prequalified are invited to submit only one bid represents an one-stage open tender process. B. A process in which there is: i. a separate call for qualifications (RFQ), in which potential bidders are invited to submit qualifications so as to be selected on a short list ii. An invitation to shortlisted bidders to submit their bids and negotiations with all of the shortlisted bidders or with a limited number of candidates iii. Iterative bids so as to narrow the number of bidders iv. Selection of two candidates to submit their final offer is negotiated process with BAFO. C. A process with a short-listing followed by a dialogue period so as to refine the RFP and especially the contract. At the end of the dialogue, the procuring authority calls for bids. This is competitive dialogue. D. A process in which an RFP is published at the same time as the contract, and the tender launch constitutes an invitation open to any potential bidder, to submit proposal, at the same time as requesting qualifications, a one-stage open tender process. © K-Infra & Foster Infrastructure 2020 | Appraisal #14 Procurement Strategy 162 15 Planning, Reporting, Approving and checking Guide Sections #18, #19, #20, #21, #22 163 Contents Objectives and overview Fiscal Feasibility Detailing scope, designing technical requirements and assessing costs Impact on deficit and Debt Designing a Preliminary Structure of the PPP Environmental feasibility Developing the Financial Model Social feasibility Assessing the Technical Feasibility Legal feasibility Assessing Commercial Feasibility Value for Moneey Market sounding Confirming Economic Feasibility • Formal Requirements for the Appraisal of PPPs • Planning Ahead - Update and/or expand the project management plan • Appraisal Report • Obtaining the Final Approvals • Getting Ready: Appraisal Phase Check List © K-Infra & Foster Infrastructure 2020 | Appraisal Procurement Strategy and tender process types Planning, Reporting, Approving and checking #15 Planning, Reporting, Approving and Checking 164 # Formal Requirements for the Appraisal of PPPs • Government’s decision drivers for procuring are often translated into national PPP frameworks • Policy guidelines (binding or indicative) help to diminish failure risks and gain time, efficiency and reliability in the PPP process • In this sense, many countries have formal requirements to demonstrate proper appraisal before committing resources to structuring the PPP deal • Appraisal exercises need to be adapted accordingly © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 165 #1 Planning Ahead - Update and/or expand the project management plan • A Management Plan has been designed at the end of Identification & Screening, and now it should be revisited Update time schedule Review resources available Enlist government support and identify responsibilities Other stakeholder identification and communication strategy • #1 Update the time schedule ̵ Check project schedule for inconsistencies ̵ Information provided during appraisal contributes to a more precise and realistic schedule (e.g. timing for environmental approvals) oIncluding all foreseeable stages of the procurement process ̵ Avoid optimism bias ̵ The time schedule is a driver for the green light decision, which marks the end of the Appraisal Phase © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 166 #1 Planning Ahead (2) • #2 Review the resources available • The Structuring Phase demands a highly experienced team working in a multidisciplinary context with a large and complex infrastructure project • It is fundamental to identify the expertise and resources needed from within and outside government • Legal, technical, environmental, financial • Even in most experienced governmental teams engage transaction advisers and industry experts. Preparation for hiring experienced advisors should begin as early as possible • If resources from the Appraisal Phase are to be used in Structuring Phase, governance mechanisms should be in place to avoid optimistic bias/lack of objectivity • The project team must be fully engaged at the inception of the Structuring Phase © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 167 #1 Planning Ahead (3) • #3 Enlist government support and identify responsibilities ̵ Clarify roles (including quality assurance, auditing and so on) if these are not yet defined ̵ Specify the decision-making roles including approvals of final drafts ̵ When institutional requirements are defined at the framework level, be sure of enlist support of the relevant agencies ̵ When there is no final list of approving bodies, develop a specific governance framework o Incorporate the main stakeholders o Develop a clear governance framework o Including if possible a formal guideline of who decides what • #4 Other stakeholder identification and communication strategy ̵ Update the stakeholder mapping – the stakeholder environment may have changed ̵ Define communication strategies that indicate the types of audiences targeted and the channels to be used in order to establish and maintain relationships © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 168 #2 Appraisal Report The Appraisal Report must present assumptions, discussions and conclusions. Typical contents: • Executive summary of conclusions • Need and options analysis, policy objective and general considerations • Governance considerations • Technical requirements • Commercial feasibility analysis • Market sounding conclusions • Economic analysis • Affordability • Impact on gross debt © K-Infra & Foster Infrastructure 2020 | Appraisal • Environmental assessments and planned impact mitigations • Social feasibility analysis • Legal due diligence • Value for Money assessment • Procurement strategy • Legal and regulatory requirements • Project plan and recommended next steps • Conclusion #15 Planning, Reporting, Approving and Checking 169 #2 Appraisal Report (2) • The Appraisal Report should: ̵ Be evidence-based ̵ Reflect all the work conducted during Appraisal Phase • High levels of technical data are not necessary nor should there be technical jargon in main body • Important technical data should be included in appendices • The report should be written in a style that provides clear, objective and direct recommendations for the decision-making authority • The report is the main tool for allowing the project to move to the next phase of preparation © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 170 #3 Obtaining the Final Approvals • The appraisal report should recommend one of the following four decisions to be made by the governmental body charged with making the final green light decision • Usually more than one public body is involved in approval • Some bodies or agencies may focuses on specific appraisal exercises or reports • The following bodies are typically involved ̵ Ministry of Finance / Treasury ̵ Ministry of Economy / Development / Planning agency © K-Infra & Foster Infrastructure 2020 | Appraisal The project should be procured as a PPP 4 posible outcomes for the decision at the end of Appraisal The project creates economic value but should not be procured as a PPP (a traditional procurement route could be assessed) More information is required to make an effective recommendation The project should not be procured at all #15 Planning, Reporting, Approving and Checking 171 #4 Getting Ready: Appraisal Phase Check List Points to be fully addressed at the end of the Appraisal Phase: The technical requirements are described, in terms of infrastructure design and service specification, to the level of detail needed to accurately estimate Capex and Opex The relevant technical risks, including geo-technical risks, are clearly identified and thoroughly analyzed The project is considered technically feasible, considering the technological assumptions and any outstanding risks associated with the technical requirements of the projects A financial model is functional, allowing for sensitivity analysis of the main technical and financial assumptions A base case is described by the financial model, and the free cash flow for equity is clearly estimated © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 172 #4 Appraisal Phase Check List (2) The project is considered commercially feasible, in the sense that it meets the financial criteria of an appropriate project and equity cash flow A preliminary structure of the project is designed indicating a proposed risk allocation and payment mechanism The project has been submitted to the relevant market players through a structured sounding exercise, and all the issues identified were dealt with The updated financial data has been put into the Cost-Benefit Analysis, and the project is considered to produce positive net benefits to society The eventual financial support to be provided by the government is considered affordable (from the perspective of budgetary appropriations and public financial management) The impact of the project on the government balance sheet can be accommodated © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 173 #4 Appraisal Phase Check List (3) No outstanding environmental risk has been identified and/or such risks have been dealt with The final environmental permit is obtained or the process of obtaining it is clearly mapped out The social impacts of the project are assessed and mitigation strategies are designed and priced A thorough legal due diligence has identified all the relevant legal issues regarding the project and the requirements of the decision-making process The Value for Money analysis indicates, as far as possible, that the project, procured through a PPP, can be efficiently delivered All the regulatory directives of the particular country that must be met for a final approval to procure a project have been considered as a part of the investigations and actions of the Appraisal Phase © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 174 #4 Appraisal Phase Check List (4) A comprehensive plan for the next phases of the PPP process is in place, including the procurement method proposed An appraisal report is finalized containing the conclusions of the appraising exercises All the approvals, which are mandatory at the Appraisal Phase, have been obtained and others, required for the procurement process, have been identified as well as their main issues A multidisciplinary and experienced team is engaged to begin the Structuring Phase © K-Infra & Foster Infrastructure 2020 | Appraisal #15 Planning, Reporting, Approving and Checking 175 16 Outcomes of Appraising phase Guide Sections #13 176 Summary of Outcomes of this Phase • This phase contributes to the preparation of the PPP project ̵ Government is able to ensure that the project can be done and understands the main obstacles ahead and actions to overcome them • The investment decision is made, or confirmed ̵ The Appraisal Phase allows for a deeper understanding of the costs and benefits of the project, as well as its broader consequences ̵ Government decides if the project is worth implementing • The procurement decision made ̵ The Value for Money exercise verifies if the PPP route is the most appropriate delivery method ̵ Commercial feasibility and affordability assessments demonstrate that the project can be effectively implemented, attracting investors and promoting a responsible use of fiscal resources © K-Infra & Foster Infrastructure 2020 | Appraisal #16 Outcomes of Appraisal Phase 177 Contact Andres Rebollo arebollo@k-infrastructure.com Richard Foster richard@fosterinfrastructure.com This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. It may be only used by the client referred to on the front page of the document. Dissemination of this material to any third party other than the client is not allowed. In collaboration with Knowledge Infrastructure, S.L. © Foster Infrastructure Pty Ltd © October 2020 This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. Dissemination of this material to any third party by candidates or by the institution is not allowed without prior consent by K-Infra in writing. The APMG PPP Certification Program is a registered Trade Mark of The APM Group Limited. All rights reserved. This document is subject to intellectual property rights and it its contents cannot be copied, distributed or transferred without prior explicit consent by K-infra. CP3P – Practitioner Course Chapter 5 Structuring and Drafting Tender and Contract Prepared by 1 Introduction and note This is the last ppt / chapter of the Preparation level. In this digital ppt we deal with the foundations of structuring a PPP contract, that is to say, define (or refine) the financial structure and the risk structure of the project that has been preliminary defined in Appraisal. Remember that Appraisal and Structuring are almost a continuous in terms of tasks. The risk assessment and allocation starts necessarily in Appraisal, as well as a preliminary definition of the financial structure (and the procurement strategy/tender process design). However, as you know, PPP Guide Chapter 5 also covers the subject of structuring the tender process (RFQ and RFP) in addition to the contract, and also the matter of drafting all documents (tender documents and the contract itself), but those subjects pertains to the following exam, Execution, which we hope you will be available to take it soon! © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 2 Learning objectives • After studying this chapter, students should understand the following: ̵ The interactions between the Appraisal Phase and the Structuring Phase ̵ The structuring concept and the importance of allowing sufficient time to design the project contract ̵ The composition of tasks that are covered during this Phase ̵ The need for the refinement of other analysis and how preparation may be expanded during this Phase ̵ The concept of financial structuring from the public perspective (defining public support, revenue regimes, payment mechanisms and developing availability payments) ̵ The concept of risk structuring and risk allocation ̵ Early termination approaches © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 3 Contents Objectives and overview of the Phase • Objectives & where we are in the Process Cycle. Interaction with Appraisal • Definitions and types of structuring • Main Tasks of structuring phase – including updating the financial model Financial Structuring (from the Public Perspective): Defining the Financial Structure and Payment Mechanism • Elements and competing objectives • Term Definition • Pure Co-financing • Public Loans: Hard or Soft Public Agency Loans • Filling the Viability Gap of a User-Pays Project • Equity Participation by the Government • Other Ways to Increase Financial Feasibility and Affordability • Categories of Revenue Regimes in PPP Projects • Financial Structuring Matters in User-Pays Projects • Volume-Linked Payment Mechanisms • Availability Payments Risk Allocation and Structuring • Defining Risk: The Risk Management Cycle • Risk Identification • Risk Assessment • Mitigation Measures (early mitigation by the authority) • Deciding on Risk Allocation • Contractual Categories of Risks: Compensation, Relief, and Force Majeure Events • Introducing the Main Project Risks and their Potential Allocation • Incorporating Risk Allocation into the Contract: General Comments [Other matters] • Early termination © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 4 Objectives and Overview of the Structuring and Drafting Phase Guide Sections #1, #2 & #3 5 #1 Objectives and where we are – objectives of Structuring and Drafting (as a complete phase) 1.1 • Ensure that the procurement of the PPP Project will be a success by launching an affordable and feasible project that will deliver the desired levels of service and a VfM outcome, while reducing the risk of failure to a minimum ̵ Qualification criteria define the minimum level for what is required as sufficient capacity to deliver the project and operate it ̵ RFP provides clear instructions to proposers about the documents needed for the assessment of proposals and clear evaluation criteria – comfort regarding transparency and equality ̵ Structuring of the contract must protect and maximize the potential VfM by defining the most appropriate financial and risk structure – includes revenue structure and appropriate risk allocation ̵ Drafting the contract so as to o Incorporate the structure o Ensure effectiveness of contract for contract management o Align investor´s interest to government objectives © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 6 #1 Objectives and where we are (2) – interaction between Appraisal and Structuring Identifying projects Appraising projects Structuring tender & contract Tender & award Delivering & commissioning 1.2 Operating & maintaining • Final definition of contract structure (financial and risk) • Drafting tender package (RFQ, RFP and contract) • Preparation concluded • Checked and announced Appraisal provides Definitive scope and preliminary technical design or detailed project outline Tests for economic sense (CBA), commercial feasibility, affordability, PPP suitability (VfM) Risk assessment and due diligence of legal, environmental and technical risks Preliminary contract structure, in terms of risk allocation, contract term, revenue regime and payment mechanism, public financing and guarantees support, etc Procurement strategy (outline of the tender process) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 7 #2 Overview of the phase – Definitions and types of structuring • PPP Reference Guide - “Structuring a PPP” means allocating responsibilities, rights and risks to each party to the PPP contract and drafting the contract • PPP Certification Guide gives a wider meaning - Not only the contract, but also the procurement process • Three main types of “structuring” 2 Box 5.3 & 5.4 ̵ Financial and budgetary or fiscal structuring ̵ Risk structuring ̵ Tender/procurement structure Structuring the PPP project is the process followed for defining the risk structure, the financial structure (including the payment mechanism) and other key commercial terms of a PPP contract, as well as the structure or main features that will govern the tender process. The "structure" will be implanted into a set of documents — the RFP (and potentially the RFQ), and the contract itself — in a sub-phase or stage that may be called drafting or documenting the tender package (including the contract). © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 8 #2 Overview of the phase (2) - Realistic time to structure and draft 2 • As with appraisal, structuring and drafting is a project in itself – it is crucial to schedule and organize this work properly in advance as in any project management function • The length of this phase depends on the work done in appraisal • Framework and governance are paramount for a smooth + reliable structuring & drafting process • The whole process for final structuring and drafting (as well as finalizing early mitigation measures) may vary from 6 months for simple projects, to 12 or 18 months for more complex projects • Appropriate checks before tendering are paramount for a successful project • This time range assumes the Appraisal Phase produced a well prepared project with sound feasibility tests and a significantly developed preliminary contract structure © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 9 0.Establishing the project team, incorporating advisors and finalising a project management plan 2. Finalizing due diligence and preparation 1. [Defining / confirming the contractual model and Project-contract scope] 3. Further developing the project definition and technical requirements (and refining costs estimates) 6. Refining contract structure: Risk structure and allocation. (Section 5) 8. Marketing and testing the project (section 6) 10. Defining qualification criteria. Structuring & Drafting the RFQ (Section 7) RFQ is separate from RFP in some processes 4. [Revisiting economic analysis] 5. Developing and finalizing the contract structure: financial structure and payment mechanism (Section 4) 7. Updating the financial model and potential reassessment of financial analysis. Setting the ceiling of payments 9. Defining other commercial terms & contract provisions (Section 9) 11. Defining proposal requirements and evaluation criteria. Structuring & Drafting the RFP (Section 8) Tasks expained in detail in this chapter Tasks only described in section 3 (summarised description of the phase) 12. Drafting the Contract 13. Pre-tender interaction: sharing information with potential bidders 14. Control check & approvals (Section 10) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 10 #3 Main tasks of the structuring phase 3 Establish the project team and finalize the project management plan Define/confirm the contractual model and contract scope Finalize due diligence and preparation Further develop the project definition and technical requirements Revisit economic analysis Develop and finalize the contract structure – financial structure & payment mech.(*) Refine the contract structure – definitive risk structuring & allocation (*) Update the financial model & potential confirmation / reassessment of financial assessment matters Test, market and communicate the project (▫) Define and draft other contractual terms and contract provisions (*) Define qualification (and potentially short listing) criteria & draft RFQ (▫) Define the proposal requirements and evaluation criteria & draft RFP (▫) Draft the contract and package the tender documents (▫) Pre-tender interaction (▫) Control check, approvals and authorizations (▫) (*) matters that are the focus of this exam (▫) matters that out of this syllabus © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 11 Quiz - Interaction with Appraisal 1-Appraisal provides relevant information and outcomes that feed into Structuring so as to be refined and further developed. Which of the following are true? 1. 2. 3. A. B. C. D. Appraisal provides definitive scope and preliminary technical design or at least a detailed project outline During appraisal the contract has been preliminary structured including preliminary risk allocation, contract term, revenue regime, payment mechanism, potential co-financing and/or other financial support such as guarantees The procurement strategy is first defined in appraisal including an outline of the tender process All are true Only 1 and 2 are true Both 2 and 3 are true None of them are true © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 12 Quiz - Structuring concept 2-What is true with respect to “structuring” A. There are two main types of structuring: financial and budgetary (or fiscal) and risk structuring B. The "structure" will be implanted into a set of documents — the RFP (and potentially the RFQ), and the contract itself C. The length of this phase does not depend on the work done in appraisal © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 13 Quiz - Tasks of the Structuring Phase 3-Which one does not accurately describe tasks developed in Structuring Phase as described in the Guide? A. Establish the project team and finalize the project management plan, Define/confirm the contractual model and contract scope, Finalize due diligence and preparation, Further develop the project definition and technical requirements B. Develop and finalize the contract structure regarding financial structure & payment mechanism, Refine the contract structure regarding definitive risk structuring & allocation, Update the financial model & potential confirmation / reassessment of financial assessment matters; and Revisit economic analysis C. Test, market/promote and communicate the project; Define and draft other contractual terms and contract provisions; Define qualification (and potentially short listing) criteria & draft RFQ; D. Define the proposal requirements and evaluation criteria & draft RFP; Draft the contract and package the tender documents; Develop pre-tender interaction; Carry a control check and handle approvals and authorizations; Launch the tender © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #1 Objectives & overview 14 2 Financial structuring (from the public perspective) Guide Section #4 15 Contents Objectives and overview of the Phase • Objectives & where we are in the Process Cycle • Overview of the Structuring Phase • Summary Description of Main Tasks to be Carried Out in thus Phase Financial Structuring (from the Public Perspective): Defining the Financial Structure and Payment Mechanism • Elements of FS and competing objectives • Term Definition • Pure Co-financing • Public Loans: Hard or Soft Public Agency Loans • Filling the Viability Gap of a User-Pays Project • Equity Participation by the Government • Other Ways to Increase Financial Feasibility and Affordability • Categories of Revenue Regimes in PPP Projects • Financial Structuring Matters in User-Pays Projects • Volume-Linked Payment Mechanisms • Availability Payments Risk Allocation and Structuring [Other matters] • Defining Risk: the Risk Management Cycle • Risk Identification • Risk Assessment • Mitigation Measures (early mitigation by the authority) • Deciding on Risk Allocation • Contractual Categories of Risks: Compensation, Relief, and Force Majeure Events • Introducing the Main Project Risks and their Potential Allocation • Incorporating Risk Allocation into the Contract: General Comments • Early termination © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 16 #0 Elements of Financial Structuring (FS) and competing objectives - elements #8 Userpays Structure vs #9 Payment mechanism structure #1 Contract Term #2 Pure cofinancing : grant payments & #4 VGF Financial structure & payment profile #8 & #9 Indexation #7 Revenue regime Risk structure #3 Cofinancing: public loans & #5 equity #6 “other means”: Credit enhancem ent & derisking © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) Fig. 5.4 Financial structure, together and integrated with risk allocation / risk structure and scope of obligations forms the heart of the contract structure Contract scope & technical requirements #2 Financial structuring 17 #0 Elements of FS and competing objectives – competing objectives Box 5.5. • Government is aiming to ensure that the procurement of the contract will be a success by launching an affordable and feasible project that will deliver Value for Money • The higher the payments or the longer the payment period, the higher the commercial feasibility – but the greater the fiscal affordability burden on either government or public • Government must find the right balance between objectives (affordability vs commercial feasibility) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 18 Quiz - Elements of Financial Structuring 4-Which does not include an accurate description of elements of Financial Structuring? A. Contract term, co-financing effort by grants, co-financing effort by public loans B. Equity provided by government, instruments of credit enhancement C. Termination scenarios, indexation of payments or user revenues D. Revenue regime definition, Payment mechanism structure © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 19 #1 Term definition • A long term is inherent in PPP contracts: needed for obtaining VfM from life-cycle management and effective risk transfer • Also, a longer contract terms allows for longer debt terms which creates financial efficiency 4.1 oA longer debt term implies higher gearing and lower weighted average cost of capital (therefore higher affordability) – read box 5.6 oLenders require a cushion so the contract term should be longer than the maximum debt term available (the “tail of the loan” as a difference between the debt term and the contract term, so that it is possible to restructure the debt in case of distress) • However there may be term limits defined by legislation and practical limits beyond which there is no additional VfM (which depends on specific market restrictions, mainly of financial nature) oAn additional contract term beyond the potential debt term and a reasonable cushion may not provide the benefit of incremental gearing • How to define the optimum term of a contract? These and other factors are explained in the next slides © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 20 #1 Term definition – main considerations Life-cycle management and effective risk transfer • The term should be long enough to include lifecycle costs but consider the impact of uncertainty (e.g. the risk of needing to upgrade a road) • Longer terms increase risk if the project is highly dependent on technology Private financial structure optimization • The term should allow bidders to maximize their gearing (which lowers wacc / increases affordability) • The contract term therefore should usually be the maximum debt term available in the particular market + a cushion • It can be beneficial to create some space for refinancing (e.g. through miniperm strategy) by expanding the overall term after construction) Affordability • The longer the term, the lower the yearly burden on public expenditure (in government-pays projects), which is especially relevant in large projects • Caution is needed with respect to government’s aggregated fiscal burden/exposure (a longer term implies a higher total financial burden/costs) Commercial feasibility (especially in user-pays projects) • A longer term implies more free cash flow and lower potential viability gap (or higher excess financial value of the project) • This is especially beneficial when users’ affordability is an issue (or there is a social objective of keeping the tariff at acceptable levels) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 4.1 21 #1 Term definition – main considerations (2) Political pressure • There may be political / social concern about “unwarranted profits” with long terms • This may be solved by specific limits (e.g. Chile terminating the contract when an amount of revenue is reached) or other profit sharing mechanisms Budget management rigidity • PPPs imply fiscal management rigidity and priorities may/will change over time Flexibility to accommodate risk and uncertainty • Long terms allow for flexibility to both parties when dealing with risks • However some projects have a risk profile (e.g. significant exposure to technology risk) that can result in poor VfM if the term is long Relationships with other projects and other contracts • Other existing projects may influence the term decision - making expiration of a new PPP coincident with the expiration date of a current contract (such as a new LRT line in addition to an existing line operated under a PPP) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 4.1 22 #1 Term definition – pros & cons of long terms 4.1 Factors in Favour of Longer Terms Factors for Tempering the Term • • • • • • More effective risk transfer and proper life-cycle management. More financial efficiency by higher debt/higher leverage in the respective financial market. Lower yearly burden/higher affordability (in year-by-year budgetary terms). Greater flexibility to accommodate changes and deal with risk events. Greater feasibility due to a longer term for collecting user payments. • • • • • Incremental risk profile in some projects (especially those highly exposed to technological risks) that may reduce commercial feasibility (in terms of risk acceptance) and spoil VfM. Financial market term limits and decremental value of the equity invested. Higher fiscal commitment (in overall/ aggregated terms). Lower flexibility in fiscal policy/ budget management and service delivery. Political pressure against potential unwarranted profits. Lower country creditworthiness (especially in government-pays projects) will demand shorter terms by investors and lenders. © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 23 #1 Term definition - What is the Optimum Term? • There is no standard methodology to determine the optimum term, as it depends on the specific features of a project and country, e.g. 4.1 ̵ fiscal constraints of the relevant country at a certain point of time ̵ the country risk and creditworthiness of the respective government ̵ the access to finance in that market for the specific type of project ̵ the technical and physical nature of the asset and its life-cycle profile • But it is possible to define a minimum term ̵ Don’t extend it significantly unless necessary due to fiscal restrictions / affordability ̵ Don’t compromise Value for Money • The term should be at least long enough to capture key life-cycle costs and enable lenders to provide maximum debt tenor • Term range from 10 years to 50 years or more • Most DBFOM contracts are within a range of 15-30 years • Terms are often shorter in Emerging Markets and Developing Economy (EMDE) countries © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 24 #1 Term definition - What is the Optimum Term? (2) 4.1 Contract terms Water & waste EMDE Social EMDE Transport EMDE Water Developed Social Developed Transport Developed EMDE Countries Developed Countries 0 20 © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 40 #2 Financial structuring 25 #1 Term definition – other considerations • Government can make the term a bid factor 4.1 ̵ A term is proposed by each bidder ̵ Bidders that request lower terms score more highly ̵ This may not incentivize effective risk and life-cycle management • Fixed operating term ̵ The term can be defined as the actual time the construction lasts plus a fixed number of years of operation ̵ This is less effective in transferring construction risk than a fixed total term of the contract (incorporating both construction and operations) ̵ It may undermine the alignment of public and private sector interests – there is less incentive to start operations as soon as practicable • Overall PPP program/standard terms ̵ It may be beneficial to tender the same type of projects with the same term ̵ This provides consistency to the market © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 26 Quiz - Term definition 5-Which is NOT true with respect to term definition? A. The term should be long enough to include lifecycle costs but consider the impact of uncertainty (e.g. the risk of needing to upgrade a road) B. The term should allow bidders to maximize their gearing (which lowers wacc / increases affordability) C. A longer term implies more free cash flow and lower potential viability gap (or higher excess financial value of the project) D. Shorter terms are beneficial when users’ affordability is an issue © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 27 Quiz - Term definition / optimum term 6-Government of Ribamontán is considering to develop a new road under a government-pays availability based PPP. Technical analysis and common knowledge talks about the need for at least 20 years of term to capture some of the life cycle risk. Government has some concerns regarding affordability so the longer the term the more affordable will be the Project in terms of yearly expenditure (lower availability payment per year). Lenders are able to provide long term finance up to 25 years and a more sophisticated private financing structure (by means of a miniperm followed by a project bond) could potentially allow for 30 years (however this has not been too much tested yet in the market). Which one provides a sensible decision and explanation? A. Contract term should be 30 years as that’s the maximum term for financing considering the different financing options. B. Contract term should be 30 years because that represents 5 years over the maximum term for financing available from the bank community so is giving lenders a material cushion, and going longer may imply higher liabilities in Net Present Value terms. If a project bond solution is possible, there could be still a benefit for the public party by means of longer debt term and higher gearing. C. Contract term should be 50 years, the maximum term available by the national legislation, because that will allow the procuring authority to enjoy the maximum potential increase affordability D. Term should be 25 years because is sufficiently more than the minimum term advised by technical experts and it is the maximum term available from Lenders © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 28 #2 Pure co-financing • Pure co-financing is public financing that is non-revolving - by means of direct payments for a certain proportion of capital expenditure that the private partner is not required to pay back • Pure co-financing is also referred to as grant financing, as these funds are usually granted to the private partner and treated for legal and/or private accounting purposes as grants • Situations in which the government provides pure co-financing generally fall into three categories: 4.2 ̵ Viability gap financing in unfeasible user-pays projects ̵ Increasing commercial feasibility ([including] in viable projects) – especially when there is risk of unavailability of finance ̵ Increasing affordability/lowering the cost of capital • Governments providing pure co-financing should take care to avoid spoiling VfM • The amount of co-financing commonly ranges from 30% to 40% of capital costs (for example, in urban rail) but may be higher © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 29 #2 Pure co-financing – types of grants • Direct grants are the most common form of co-financing, paid either: 4.2 ̵ during construction as a percentage of works in progress or on milestones ̵ or partially or totally at construction completion, or ̵ on a yearly deferred basis as fixed payments – typically when government lacks liquidity, similar to deferred payment DBF contracts • Structuring to achieving Value for Money: ̵ Grants should be conditional on achievement of milestones/completion ̵ More risk implies more incentive to meet milestones but introduces uncertainty for lenders and higher financing costs ̵ Deferring payments implies financial costs • Grants may be provided in kind (e.g. depots in a LRT) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 30 Hypothetical Project – Not Commercially Viable with Conventional Financing © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 31 Hypothetical Project – Commercially Viable with Grants at Milestones © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 32 Hypothetical Project – Borderline Viable with Grant at Commissioning © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 33 Hypothetical Project – Commercially Viable with Deferred Grants during Operations © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 34 #2 Pure co-financing - Contract Development Matters • When and how do payments accrue? ̵ Regardless of when payment will be made, the key issue is when do payments accrue? In particular, if payments will be made prior to completion / final acceptance, when does the private partner earn its right to claim the payments? [examples: CRPAOs in Perú, HSR PPP in Spain] – complementary reading Box 5.7. with 4.2 examples ̵ When payments accrue and when they will be paid has to be clearly reflected in the contract • Grant finance from another administration ̵ Grants may also be made by another government (central or regional or local municipal government) ̵ This is common in transportation and rail ̵ It is good practice for the procuring authority to assume third party government commitments in the contract, so as to avoid duplicating the counterparty risk for the private partner • Who will set grant amount? ̵ In government-pays PPPs, the amount of co-financing is commonly set by the government in the tender documents, and not subject to offer ̵ In user-pays PPPs, the amount of co-financing is usually proposed by the bidder © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 35 National Government Grant Provincial Government PPP Contract SPV © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) SPV has one Counterparty SPV has two Counterparties Grant finance from another administration National Government Grant Provincial Government Grant PPP Contract SPV 36 Quiz - Pure co-financing 7-What is NOT true with respect to pure co-financing? A. Pure co-financing is also referred to as grant financing B. Situations in which the government provides pure co-financing generally includes viability gap financing, increasing commercial feasibility, and decreasing affordability C. Governments providing pure co-financing should take care to avoid spoiling VfM D. Pure co-financing is public financing that the private partner is not required to pay back © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 37 Quiz - Pure co-financing 8-What of the following are true with respect to pure co-financing? 1. 2. 3. A. B. C. D. Direct grants are paid either during construction, or at construction completion or on a yearly deferred basis as fixed payments Grants may also be made by another government (central or regional or local municipal government) In government-pays PPPs, the amount of co-financing is commonly set by the government in the RFP while in user-pays PPPs, the amount of cofinancing is usually proposed by the bidder All of them are true Only 1 and 2 are true Only 1 and 3 are true Only 2 and 3 are true © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 38 #3 Public Loans, hard or soft revolving cofinancing 4.3 • “Co-lending” from a public development bank or public financial agency may be due to ̵ Lack of market capacity to fully underwrite the debt – the public lender accompanies commercial lenders (on hard / market conditions) ̵ A need for a cornerstone financier: to increase bankability / enhance credit standing (on soft conditions [or subordinated in term or guarantees]) • Care is required: ̵ Public loans may produce a ‘crowding out’ effect, reducing private sector lending in the market ̵ Government may indirectly retain project risks • “Soft” loan conditions (more favourable than market) ̵ Do not constitute financial structuring of the contract but indirectly affect the payment profile of the project ̵ Increase affordability [but less than grant financing] • The public financial agency should analyse the project in advance and the requirements for eligibility and conditions of the loan should be clear and accessible to all interested parties © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 39 #3 Public Loans– public subordinated (soft) loans • Soft loans may be provided by the procuring authority • They are an alternative to direct and pure (non-revolving) co-financing if on favourable conditions and subordinated terms 4.3 ̵ Used to reduce the weighted average cost of capital oReduces the long-term burden committed in payment mechanisms (governmentpays PPP) oDecreases the feasibility gap (user-pays PPP) • Public debt records may be unaffected if the loan is not treated as a public investment • Soft loans are commonly in the form of a participative loan (e.g. tolled roads in Spain) ̵ That is, the government receives part of the upside of the project in exchange for the belowmarket conditions • When the loan is provided by the procuring authority, the PPP contract must clearly deal with intercreditor issues and describe remuneration and rights to receive distributions • Examples: BNDES, TIFIA, EIB – complementary reading box 5.8 © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 40 Hypothetical Project – Hard Loan © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 41 Hypothetical Project – Soft Loan © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 42 #4 Filling the viability gap of a user-pays PPP – complementing revenues 4.4 • Viability gap: Some user-pays projects are not fully feasible on the basis of commercial revenues, but the project is economically viable ̵ Quite common in rail ̵ Some roads (particularly if there are significant structures. E.g. Colombia) • The gap may be solved by co-financing (pure and revolving with soft conditions): Lump sum payments/grant financing; Deferred grant; Soft loan / Participative public loan • But also by government complementing the private partner’s operating revenues (mixed revenues or hybrid payment mechanism) ̵ It is preferable for government’s contribution to be “service payments” o Based on the performance of the service (availability payments), or o Based on the volume served (shadow tolls) • Read boxes 5.9 and 5.10 for examples © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 43 Hypothetical Project – Complementing User Payments with Government Service Payments © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 44 #5 Equity Participation by the Government • Equity may be provided directly (by the procuring authority) or through a public infrastructure fund • Motivations: 4.5 ̵ Increase day-to-day control and direct access to the accounts and day to day management of the SPV oHowever this creates potential conflicts of interest for government! oThis may discourage bidders → the issue can be mitigated with trust fund structures ̵ Government will share in upside/profits → consider contractual options ̵ Make the project commercially feasible (where the required amount of equity is beyond bidders’ capacity) ̵ Increase affordability (through the public shareholder accepting a lower required return or different financial rights to a private shareholder) • Equity participation by government has significant implications for financial structuring (especially if government’s shares have different economic rights to those held by the private sector) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 45 #5 Equity Participation by the Gov. (Reasons and contract provisions) 4.5 • The contract structure / contract package is impacted by the rights and obligations of the public party as shareholder + special rights of the private shareholders ̵ This should be captured in the Articles of Association of the SPV and a shareholders’ agreement between the private equity investors and public equity partner (a draft is part of the tender pack) ̵ Sometimes these rights are also documented in the contract • Some specific features to be captured: ̵ The public equity partner accepts a lower equity IRR than that of the private equity holder (if this is the case) ̵ The public party as an equity partner may not be obliged to inject additional equity if an unexpected capital increase is required as a result of a risk event ̵ The public party’s shares might not have voting rights, but only economic rights ̵ The documents should set out the parties’ rights to sell to third parties © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 46 #6 Other Ways (“indirect means”) to Increase Financial Feasibility and Affordability Contractual guarantees 4.6 • Inherent to risk allocation • e.g. minimum revenue guarantees in roads / take or pay in plants Foreign exchange risk guarantees • A subtype of the former, when local financial markets are underdeveloped [contractual guarantees/compensation, direct guarantees to lenders] Explicit/financial guarantees or direct guarantees from the treasury • To guarantee project debt; • Sometimes only apply during construction (e.g. UK) Guarantees in respect of government counter-party risk (guarantee funds) • Provides security for government payment obligations [by creating a liquidity fund managed by a (usually) public trustee] Guarantees of a portion of the service payments • Limits on the maximum deduction from availability payments Specific credit enhancement mechanisms • [usually from third party agencies] like International Financial Institutions (IFIs), e.g. Project Bond Credit Enhancement by EIB • Not to incorporate in the financial model unless access is granted and work the access in advance Decomposition of the payment mechanism • Creating an irrevocable and unconditional tranche that may be transferred to third parties [e.g. through securitization] – example “cessions daily” in France © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 47 Quiz - Co-financing and other financial support 9-The government of Ribamontan is analysing a number of options for financial support. Which of the following strategies and assertions look adequate and sensible? NOTE: availability of finance is not a concern in this market 1. 2. 3. A. B. C. D. Co-finance by means of grant financing during the 3 year of construction, with a 20% of the CapEx amount, so as to decrease the volume of availability payments, provided that government can afford those payments during the years of construction period. This will for sure decrease the NPV of all payments and make the project more affordable. Providing public equity is discarded as it will not help affordability (i.e. will not decrease the wacc of the Project) unless equity IRR for public party is lower, but then would be preferable to provide a soft subordinated loan to diminish risk exposure. Also government is concerned about issues of conflict of interest. Providing a soft loan would be the best solution because the increase in affordability is the same than in the case of grant financing with the advantage of recovering the amount invested Only 1 and 2 are correct Only 1 and 3 are correct Only 2 and 3 are correct All are correct © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 48 #7 Revenue regimes • User-pays schemes are typical in economic infrastructure and government pays in social infrastructure • However government payments may also occur in economic infrastructure projects if: 4.7 ̵ The PPP is just one component of a broader network or service (for which there is already an incumbent operator collecting the user fees) ̵ There are user charges but there is a viability gap ̵ Government decides not to charge users ̵ Government retains user payments to retain the risk and reward of toll collection • The decision to have government payments should be made in the Appraisal Phase, based on risk and Value for Money considerations ̵ This should include definition of the payment mechanism (availability vs volume) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 49 #8 User-Pays Financial Structuring Matters 4.8 Tariff levels • In roads: some flexibility with government setting a cap per type of vehicle and cap on the average tariff. More flexibility in dynamic tolling • Passenger / public transport and water supply tariffs are always regulated Indexation Financial structuring matters in user-pays PPPs Risk structuring related to volume risk • Most commonly general CPI (sometimes with a correction factor), but sometimes CPI for a specific industry / sector or a polynomic formula • Gross domestic product (GPD) is also used in some roads • Tariff reviews in some sectors (energy) with pass through of fuel cost Payment / fee to procuring authority Unfeasible projects / Viability gap • Excess revenue may be structured as an up front and/or deferred payment to the procuring authority (rather than decreasing the tariff) • Deferred payments: may be fixed or variable (as a percentage of revenues) • Most typical in brownfield projects • The viability gap can be filled through pure co-financing, soft loans, or complementary payments • Pure co-financing: payments during construction vs deferred • Minimum traffic / minimum revenue guarantees are seen in transport [sometimes government’s contributions are construed as a subordinated loan – M5 Hungary] • Off take agreements in plants and take or pay formulas © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 50 Minimum Revenue Guarantee and Sharing Excess Revenues – Two Sides of One Coin © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 51 Quiz - User-Pays structuring matters 10-Which of the following is NOT true? 1. 2. 3. A. B. C. D. Excess revenue may be structured as an up front and/or deferred payment to the procuring authority and should not be applied to decrease the tariff/charge to users The viability gap can be filled through pure co-financing, soft loans, or complementary payments The most common form of indexation of tariff is CPI for a specific industry / sector or a polynomic formula, rather than general CPI Only 1 is true Only 2 is true Only 3 is true All are true © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 52 #9 Volume-Linked Payment Mechanisms– favourable conditions and back loaded nature 4.9 • Like availability payments, volume-linked payments may be used in user-pays as complementary payments • The decision to use these should be made in appraisal • Shadow payments that are based on volume (demand, number of cubic meters etc.) introduce demand or volume risk (which may be difficult to control / manage) • Conditions that are favourable for volume risk payment structures include: ̵ Clear alignment of interests AND ̵ Traffic or volume risk is considered reasonably assessable and manageable by the private partner (e.g. never when there is an incumbent operator who will continue in that role, with the PPP private partner only responsible for maintenance and ancillary services) • Back loaded nature: (in transport) volume based payments typically increase over time [see next slide] © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 53 #9 Volume-Linked Payment Mechanisms– conditions favourable and back loaded nature (2) • • • • 4.9 Shadow tolls grow as long-term demand grows (generally in line with GDP) This is an advantage for the public party (higher average life of payments) especially in the early years of the contract But it increases the overall burden* (higher average life of payments!) and diminishes fiscal space for future governments And… the DSCR required by lenders and equity IRR requested by the investor will be correspondingly higher © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 54 #9 Volume-Linked structuring elements (1) – Volume risk structuring 4.9 • The final structuring usually focuses on delineating and limiting the volume risk • It is common to establish a system of bands to temper risk / share part of the risk and reward ̵ At lower traffic volumes, the shadow fare increases to compensate for part of the loss of revenue ̵ The tariff decreases if the traffic volume is above a defined band ̵ The procuring authority should avoid entirely protecting the private partner from the risk ̵ There should be a maximum traffic level above which government makes no payment (to avoid open-ended fiscal exposure) oExcept for compensating the private partner for extraordinary levels of traffic to cover higher O&M costs and increased or accelerated renewals –This can be achieved through a small shadow toll approximately equal to the marginal O&M cost, or through a right to negotiate compensation © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 55 Volume Risk Structuring Example – Roads From (Million Vehicle Kilometres) To (Million Vehicle Kilometres) Payment (cents per Vehicle Kilometre) Band 1 0 70 9 Band 2 70 100 6 Band 3 100 130 3 Band 4 130 Band Source: National Audit Office (UK), The Private Finance Initiative: The First Four Design, Build, Finance and Operate Roads Contracts 0 © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 56 #9 Volume-Linked structuring elements (2) – Indexation of Shadow Tariffs 4.9 • The most common approach is to link the payment to the Consumer Price Index, CPI or another price/cost inflation indicator ̵ Rationale: To link the inflation of the price of the service to that of the general economy or relevant sector ̵ This increases the payments over time, increasing the affordability of payments in early years ̵ CPI is usually a national measure, but sometimes regional (this is sensible only when/if the project cost inflation is clearly better correlated with the regional economy) • Some projects use a fixed indexation factor ̵ The private partner will charge a risk premium for this, or hedge its inflation exposure • Other projects use a polynomic indexation formula based on different price indexes for different cost factors ̵ This may only be appropriate for very specific projects © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 57 Indexation – Why Use Actual CPI rather than a Fixed Percentage? © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 58 #9 Volume-Linked structuring elements (3) – Performance Correction 4.9 • Volume linked payments are not inherently linked to performance requirements • But the contract may provide that a breach of established performance levels results in a penalty or liquidated damages • As in some Availability Payments, some systems include a “quality component”: deductions / penalties may arise as a function of the number of performance points accrued © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 59 Quiz - Volume-linked structuring 11-Which of the following is NOT true? A. Volume risk payment structures make sense when traffic or volume risk is considered reasonably assessable and manageable by the private partner and is in the interest of the procuring authority to promote higher volume of use B. Shadow payments that are based on volume (demand, number of cubic meters etc.) introduce demand or volume risk, which is beneficiary as it generates VfM C. The back load nature of shadow tolls means that payments grow as longterm demand grows so there is higher average life of payments. But this will increase the overall financial burden to the government D. It is common to establish a system of bands to temper risk / share part of the risk and reward © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 60 #10 Availability Payments • Should be used when the level of use of the infrastructure is not a public objective [or when volume risk is not bearable by the private party] 4.10 ̵ This is the most common payment regime in social infrastructure ̵ It is increasingly used in transportation (roads, rail) and water (transport, treatment) ̵ Used in energy generation (in Power Purchase Agreements) and transmission • Government only pays for the asset or services when they are available (“no payments” until completion) and to the extent they are available • Two general criteria: ̵ Physical availability (the infrastructure is available to use) ̵ Deemed availability (determined by reference to condition criteria) • The payment mechanism should be unitary (prorated by time units) ̵ with a caveat for EMDEs → see next slide ̵ With potential nuances → see slide 51 Payment due Maximum payment Availability deductions • Higher Bankability than in volume payments ̵ Availability risks are ultimately operational risks (intrinsically manageable - subject to reasonable criteria: realistic, objective and measurable) ̵ The payment is usually segmented into sections (roads) or areas (social) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 61 #10 Availability Payments– immature PPP markets • The PPP availability payment mechanism is unitary in nature – no service, no payment • Some EMDEs opt for non-standard de-risking approaches: 4.10 Box 5.12 ̵ Tranching the payment, dividing the payment amount into three components: o Repayment of the principal, and interest on the senior debt, which may be exempted from any deduction once the asset is built and commissioned o Equity repayment and reward [which could be merged with the former] o O&M costs ̵ Limiting the deduction to be applied in payment calculations but also then carrying forward the deduction not applied, and applying it against future payments. ̵ Alternatively, if, without applying the limit, the deductions exceed a specified amount then the contract will be terminated • Breaking the unitary concept to protect lenders, or to increase commercial acceptance of the PPP, may remove the incentive for high standards in performance and therefore reduce VfM © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 62 #10 Availability Payments – nuances and calibration • Performance requirements and availability criteria ̵ must be objective, measurable and realistic ̵ must be challenging but achievable ̵ should be driven by the value of the availability and urgency for remedy ̵ high standards are compatible with acceptable risk (higher standards may have longer rectification periods or modest deductions, while lower standards may have shorter rectification periods or higher deductions) 4.10 Box 5.13 • Non critical requirements (e.g. cleanliness of the waiting room in a hospital) may be dealt with in a specific payment stream – this gives flexibility for changes in “soft services” • The performance requirements and availability criteria should be tailormade, but precedents and generic standards are a useful input • The procuring authority should conduct ‘dry runs’ and calibration oRefining and assigning final numbers to the various parts of the mechanism oRunning simulations of performance scenarios in a model to assess the financial impact of different grades of performance oDoes an acceptable performance produce an undesired outcome (e.g. bankruptcy)? © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 63 Quiz - Availability Payments 12-Which of the following is NOT true? A. Calibrating the payment mechanism implies assigning final numbers to the various parts of the mechanism so as to run simulations of performance scenarios to assess the financial impact of different levels of performance B. One reason for higher bankability in volume payments than in availability payments is that volume payments increases over time C. Is not uncommon for EMDE markets to apply non-pure standard approaches in designing availability payment schemes like “tranching the payment” (dividing the payment amount into components) or limiting the deduction to be applied in payment calculations D. Performance requirements and availability criteria must be objective, measurable and realistic, as well as challenging but achievable © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 64 #10 Availability Payments– elements and structuring matters 4.10 Availability / unavailability definition. Categories and faults Composition of a unitary payment Adjustment factors or deductions Time weighting factors* Rectification periods Ratchet mechanisms* Maintenance works and other exceptions Indexing First payment and early completion Other payments and adjustments Frequency and calculation process (*) Represent matters / headings of #4.10 that are not part of Preparation syllabus © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 65 #i Availability / unavailability definition. Categories and faults 4.10.1 • Two general sets of criteria ̵ Those related to physical availability for use ̵ Those related to “condition criteria”: ‘deemed unavailability’ – the asset or service is regarded unavailable even though it is being used • Deemed unavailability ̵ When performance thresholds (“condition criteria”) for an acceptable level of service are not met (e.g. index of roughness or lighting levels in a road) ̵ Especially those related to safety and security [in transport context] • A performance monitoring regime must be in place to assess availability. The procuring authority must define [described in section 9, not included in syllabus] ̵ Who performs the monitoring ̵ Who pays for the monitoring ̵ This is linked to the reporting obligations of the private partner © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 66 #ii Composition of a unitary payment • The unitary payment covers all of the private partner’s costs • It is divided into segments when practicable 4.10.2 ̵ The segments correspond to parts of the infrastructure (that are self-contained, with their own economic sense) o Areas of a hospital or other social infrastructure facility o Sections of a road ̵ Payments/deductions are calculated by area or section ̵ Each area / section will have its own weighting o Critical areas have the most severe deductions o Sections of a road are usually weighted in terms of use/traffic ̵ Functional unit weightings determine the size of the deduction • The payment is earned for each section or area by ̵ Units of time - availability may be measured in units of days, hours or [not often used in practice] minutes ̵ Trips – on rail systems © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 67 #iii Adjustment factors or deductions • Adjustments depend on the seriousness of the unavailability – i.e. seriousness of the condition criteria being breached • Other factors 4.10.3 ̵ The area (or section in a road) that is unavailable, as some areas or sections will have higher weightings than others ̵ The length of time for which the area or section is unavailable ̵ Potentially, the specific time of the day and year (month or day of the week), especially in transport projects [i.e. time weighting factors] ̵ Potentially, the persistence or repetition of the breach – ratchet mechanisms ̵ Whether the asset (or the area affected) is effectively being used despite the unavailability – especially in road projects • Payments are usually calculated from bottom to top (summing up payments earned per unit of time, duly adjusted by the adjusting factor) • Deductions / adjustments may be larger than the value of the payment in a specific time period, but the actual overall deduction is limited to 100% for payment calculations [e.g. when calculating the monthly payment] © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 68 #v Rectification periods • A rectification period is a period of time to remedy a breach so that it is not 4.10.5 taken into account for the purpose of deductions • The rectification period starts from the moment the breach is detected • If the breach is rectified within the specified period, there is no deduction for unavailability • If the breach is not rectified within the specified period, the deduction is calculated from the moment breach detected • Not every breach should have a rectification period • Critical criteria should not have rectification periods • Unavailability starts when the event is detected (through monitoring and scheduled inspections) or reported (by the procuring authority [through direct inspections] or an interested party – e.g. a teacher in a school) • Temporary fixes: some unavailability events require an immediate response regardless of the rectification period (e.g. glass broken in a school requires placing boards immediately before replacing) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 69 Example: Rectification Period Commencement Calculation of the Available Prisoner Place Failure Abatement 1. If the Unavailability… is not Rectified.. within the Unavailability Rectification Period, an… Abatement will apply… 2. The Unavailability Rectification Period will commence at the moment that the Unavailability: a) first comes to the attention of any member of Staff; b) is detected by the BMS or any other automatic monitoring or alarm system; or c) should have come to the attention of any member of Staff or should have been detected by the BMS or any other automatic monitoring or alarm system, if Project Co was complying with its obligations under this Agreement, “BMS” = Business Monitoring System whichever is the earlier. © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 70 #vii Maintenance Work and other Exceptions to Unavailability 4.10.7 • Maintenance does not constitute an unavailability event provided it is in accordance with agreed maintenance plans – this can be implemented by: ̵ Allocating a zero time weighting factor to specific periods of the day ̵ Granting a “bag of maintenance hours” to be used at less disruptive times • Other exceptions – an area or section is not regarded as unavailable if the cause is: ̵ A police order or other lawful requirement ̵ An accident in a road projects ̵ An excused event described and regulated in the contract © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 71 #viii Indexing • The price of the service should be the same during the whole life of 4.10.8 the contract, with the exception of changes in capital works or services (the procuring authority should avoid tailor making the slope of payments to artificially back-load the payments) • The cost of the service is not entirely linked to inflation (usually less than 50%): ̵ equity is exposed to inflation risk, ̵ O&M cost will change roughly in accordance with CPI, but ̵ debt service is mostly a fixed cost – the private partner hedges the interest rate risk, converting interest payable to a fixed rate for the life of the loan • Availability-based projects opt for a compounded indexation formula – only a proportion of the unitary charge is adjusted for inflation • This allows the project company to accelerate the debt repayment compared to full CPI indexation [and this diminishes the overall financial burden to the procuring authority] © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 72 Indexing a Unitary Payment – A Prison Example Healthcare Cost Component Indexed using the Health Price Index Staff Cost Component Indexed using the Wage Price Index Maintenance Cost Component Capital Cost Component Indexed using the Consumer Price Index (general inflation) Not Indexed Availability Payment © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) Source: Simplified adaptation from State Government of Victoria (Australia), Ravenhall Prison Project Agreement 73 #ix First payment and early completion • Availability is about paying for the ability to use the asset • Payments during construction should be avoided • Exceptions: 4.10.9 ̵ Parts or areas of the infrastructure that can be effectively used (certain stretches in a road, multifacility projects) ̵ O&M costs of existing infrastructure • Early completion ̵ The contract should regulate this situation ̵ The procuring authority should have no obligation to pay for the asset if availability starts before the target date ̵ Early availability is usually in the interest of the procuring authority, but it may not be ready to make payments – the solution may be to establish an early completion floor ̵ If construction is completed ahead of schedule it is customary to establish at least a ‘cut’ payment to cover O&M costs © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 74 #x Other Payments and Adjustments • Inverse volume risk adjustments in transport projects: 4.10. 10 ̵ Availability of transport infrastructure is unrelated to the actual traffic or volume ̵ But maintenance costs and life-cycle costs will vary with intensity of use ̵ To avoid misalignment of interests between parties, the procuring authority may oDefine a shadow payment linked to volume intended to cover the “marginal O&M cost”, or oRevisit the unitary charge value if traffic consistently exceeds a threshold © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 75 #x Other Payments and Adjustments (2) • Service payments for some soft services in social infrastructure and benchmarking of costs: 4.10. 10 ̵ Availability based payments are appropriate for most accommodation facilities, e.g. hospitals or schools ̵ Availability parameters are designed for an occupation level ̵ More demand implies higher variable costs for the private partner ̵ Above thresholds of occupancy, O&M costs will rise ̵ Therefore oThe contract should provide an adjustment to unitary payment when occupation is above threshold, or oConsider a separate ad hoc payment component for certain services that are very sensitive to demand ̵ Benchmarking [value testing] oCPI does not capture all changes in the cost of certain services [e.g. cleaning] oAim to adjust the unitary charge in line with changing market conditions through benchmarking of costs [or alternatively use market testing] © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 76 #x Other Payments and Adjustments (3) • Subjective adjustments and user satisfaction components of a payment mechanism: 4.10. 10 ̵ Quality of service cannot easily be reduced to a practical set of availability and performance criteria ̵ Satisfaction surveys can be used as a small part of the overall payment regime ̵ The financial impact should be small ̵ The private partner may be obliged to conduct a survey or performance audit at its own expense ̵ Poor scoring requires a remedial plan and may result in a direct deduction in the yearly payment (or accrue performance points) ̵ High scoring may result in a bonus ̵ Subjective quality factors should only affect the equity return, and only to a modest extent © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 77 #xi Frequency and payment calculation process • The contract must clearly state when payments will be made 4.10. 11 and the process to calculate the payment earned • Monitoring and calculations are complex – usually payments are made no more frequently than quarterly • Avoid requiring the private partner to finance significant working capital: calculate deductions each month and make payments monthly in arrears or • Middle path solution – determine deductions on a quarterly basis but with monthly “advanced payments” based on a notional deduction • Delays in payment should be subject to interest rates consistent with that of the private partner under its financial agreements © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 78 Quiz - Availability Payments structuring matters 13-Pick the incorrect statement A. The adjustment on the payment due to a breach of a condition should depend on how relevant is the a condition criteria or specification being breach. B. Deductions / adjustments may be larger than the value of the payment in a specific time period, however the total deduction during one month may be usually limited to 100% of the maximum monthly payment. C. The unitary payment covers all of the private partner’s costs. However it is customary to divide it into segments. An example would be dividing a road by fixed stretches of 1 km or segmenting the payment in a hospital by weighting its areas considering the surface of each of them D. A rectification period is a period of time to remedy a breach so that it is not taken into account for the purpose of deductions, but not every breach should have a rectification period © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 79 Quiz - Availability Payments structuring matters 14-Pick the incorrect statement A. Unavailability will only start when the unavailability event is detected through scheduled inspections B. A closure of a carriageway in a highway due to maintenance should not constitute an unavailability event provided it is in accordance with agreed maintenance plans C. In terms of indexation, availability-based projects opt for a compounded indexation formula – only a proportion of the unitary charge is adjusted for inflation. This is because cost of service is not entirely linked to inflation and this provides financial efficiency as debt repayment is more accelerated D. Early completion situation: early availability is usually in the interest of the procuring authority, but it may not be ready to make payments – the solution may be to establish an early completion floor © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 80 Quiz - Availability Payments structuring matters 15-Pick the incorrect statement A. Inverse volume risk adjustments in transport projects happens because availability of transport infrastructure is unrelated to the actual traffic or volume but maintenance costs and life-cycle costs will vary with intensity of use B. In the former case (A), to avoid misalignment of interests between parties, the procuring authority may define a small shadow payment linked to volume or revise the value of the payment if traffic consistently exceeds a defined threshold C. In a social infrastructure PPP based on availability payment, if demand/occupancy is higher than expected and considered in the design of the facility, private partner should be compensated for increased in O&M costs D. Yearly payments may be an appropriate frequency of payments considering how complex are monitoring and calculations in these projects © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #2 Financial structuring 81 3 Risk Allocation and Structuring Guide Section #5 82 Contents Objectives and overview of the Phase • Objectives & where we are in the Process Cycle • Overview of the Structuring Phase • Summary Description of Main Tasks to be Carried Out in thus Phase Financial Structuring (from the Public Perspective) • Elements of FS and competing objectives • Term Definition • Pure Co-financing • Public Loans: Hard or Soft Public Agency Loans • Filling the Viability Gap of a User-Pays Project • Equity Participation by the Government • Other Ways to Increase Financial Feasibility and Affordability • Categories of Revenue Regimes in PPP Projects • Financial Structuring Matters in User-Pays Projects • Volume-Linked Payment Mechanisms • Availability Payments Risk Allocation and Structuring [Other matters] • Defining Risk: The Risk Management Cycle • Risk Identification • Risk Assessment • Mitigation Measures (early mitigation by the authority) • Deciding on Risk Allocation • Contractual Categories of Risks: Compensation, Relief, and Force Majeure Events • Introducing the Main Project Risks and their Potential Allocation • Early termination © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 83 #1 General concepts of risk allocation 5.1 Definition and rationale 55.1 • Risk allocation: define which party will assume each risk (and to what extent) to achieve VfM • Risk transfer to private partner relates to search for efficiency ̵ The key motivation for undertaking a project as a PPP • Transfer of financial consequences creates incentive to supply timely services (as scheduled) and in the required condition • Theory: allocate to the party best placed to reduce likelihood and control consequences but government should recognise that it remains exposed to reputational risk and is ultimately responsible for service outcomes • The private partner will charge a risk premium for accepting transferred risks o If the premium is higher than the expected loss for the public sector if the risk is retained, taking back the risk increases VfM o Some risks may be not acceptable to private partner at any price/premium o Or some risks may be tolerable for the private partner but the public sector is better placed to manage them • Some risks are shared instead of transferred © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 84 #1 General concepts of risk allocation 5.1 Definition and rationale ii 55.1 • Interaction with Appraisal phase in terms of risks ̵ Appraisal Phase Box 5.15 oGovernment will have identified and assessed risks, and oDefined the preliminary risk allocation structure –Necessary for VfM calculations, commercial feasibility and affordability assessments ̵ Structuring Phase oRisk allocation is reviewed and refined to incorporate into contract oRisk structure (pre-structure) should be shared in advance with the market oMaterial changes should be avoided/carefully communicated oSignificant changes will affect the results of the appraisal © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 85 #1 General concepts of risk allocation 5.1 Optimum allocation (VfM vs judgement) • Theoretical / numerical VfM: when the marginal VfM of changing the risk allocation is negative • Noting that results of quantitative risk analysis are uncertain by themselves or some risks are by definition unquantifiable • Judgement: “Is the private partner better placed or able to manage this risk more efficiently than the public partner?” 55.1 • Best able to manage ̵ Greatest ability to prevent ̵ Capable to best deal with consequences ̵ Ability to price risk “Best able to carry the risk at the least cost” (OECD) • Exception to VfM rule: ensure bankability / commercial feasibility in EMDEs by de-risking projects © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 86 #1 General concepts of risk allocation 5.1 Endogenous versus Exogenous Risks, structuring & allocating Endogenous v exogenous • Endogenous risks – the private partner can do something to ensure that the actual outcome approximates to the expected outcome • Exogenous risks – risks that the private partner, and in many cases either party, cannot control 55.1 Allocation v structuring • Risk structuring implements and develops risk allocation further into the contract: ̵ Specifying and nuancing the definition of the risk events ̵ Specifying the extent to, and the form in which, each party assumes each of the risks ̵ And how the party that has not been allocated the risks will be compensated if the risk occurs • [contract development: risk can be allocated through specific provisions or by nuancing and qualifying other provisions] © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 87 #2 Defining Risk & risk management cycle Definitions 5.2 • OECD “the probability that the actual outcome will deviate from the expected outcome” • Australia “the chance of an event occurring which would cause actual project circumstances to differ from those assumed when forecasting project benefit and costs” • UK (orange book) “uncertainty of outcome, whether positive opportunity or negative threat, of actions and events” • Essence of risk characterize by two factors ̵ The likelihood: probability of the risk event occurring within the project X ̵ The impact: financial value of the risk event’s effects • Prioritization: focus should be on risks that have a high degree of expected loss • Uncertainty (unmeasurable risk) vs measurable risk – the former reflected in ordinal / non-numerical probabilities © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 88 #2 Defining Risk & risk management cycle Risk Management Cycle – Public Perspective 5.2 Structuring and drafting contract. Risk allocation is refined and incorporated into the contract (mostly based on qualitative assessment). Risk identification Risk assessment Preliminary allocation (early) Risk mitigation Risk allocation For risks transferred Appraisal Phase. Risk assessment and pre-allocation incorporated in VfM analysis and financial analysis (commercial feasibility and affordability). More exhaustive: uses a risk register (but for preliminary allocation may use a risk allocation matrix) Quantitative assessment is mostly used for VfM and financial analysis and qualitative assessment for pre-allocation. Risk monitoring Ex-post management Contract management. © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring Risk structuring For risks retained Risk treatment Risk monitoring Ex-post management 89 #2 Defining Risk & risk management cycle 5.1 Efective management strategy – public perspective • For retained risks, the public partner will develop specific management strategies for each risk: 5.2 ̵ Self-insuring and building up contingency funds in the budget ̵ Contracting out insurance policies for some risks ̵ Entering into hedging mechanisms for some financial or economic risks (e.g. inflation) ̵ Relying on reactive management when a particular risk occurs ̵ Uninsurable risks • Design and operate a monitoring system for all risks ̵ Review the identified risks ̵ Detect new risks as they arise ̵ Establish how to deal with the risks when they occur, including risks that have been transferred © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 90 #2 Defining Risk & risk management cycle Instruments and risk strategies - Private Perspective • For transferred risks, the private partner has a range of tools and possible strategies available: 5.2 Box 5.17 ̵ Absorb the risk and price it into the financial offer ̵ Pass on the risk to contractors through the project contracts – there emerges a counterparty risk ̵ Contract out a coverage or an insurance • Develop and implement a risk plan for all risks ̵ Preventative and reactive measures ̵ Risk monitoring system • Decision to retain or transfer will depend on third parties’ ability to manage the risk (by absorbing or even passing it through to subsequent third parties in a cascade). © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 91 #3 Risk Identification – what is involved 5.1 • Define a comprehensive list of risk events • Usually grouped into categories • Describe them to clearly understand how they will impact the project outcome if they materialize 5.3 ̵ More exhaustive during Appraisal (using a risk register), for VfM and commercial feasibility ̵ Less exhaustive during Structuring, for risk allocation • Some risks are only assessed by private party (e.g. credit counterparty risk) and some only assessed at country/program level (e.g. convertibility) • Multiple classifications – but all potential events should be identified and treated in terms of qualification, quantification and allocation • Eliminate the risk of ‘blind spots’ and avoid double counting of natural overlaps → risk register © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 92 #3 Risk Identification – purpose of a risk register 5.1 • Conduct an orderly quantitative risk assessment during Appraisal, and • Define the financial base case in order to conduct the commercial feasibility analysis and conduct the VfM exercise • Identify and avoid ‘blind spots’ • Handle overlaps • However allocation is more frequently handled through a “risk allocation matrix” 5.3 Note: The example of risk register is an extra, included to help participants understand the potential contents of such a tool. It is not included in the Guide and not subject to examination. © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 93 #3 Risk identification – risk matrix (purpose and composition) 5.1 • Identifies and systematically describes all [relevant] risks properly, ̵ how they affect the project (and in what form) ̵ potential mitigation measures (a risk may potentially have a severe impact, but be easy to mitigate) ̵ Some matrixes includes the qualitative assessment → see tolerability matrix #4 5.3 Box 5.18 • Developed for every project, containing at least: ̵ Risk name and category ̵ Risk description ̵ Risk effects/consequences ̵ Measures to mitigate the risk, where available ̵ Risk allocation – the party who bears the risk (and extent of risk when it is shared) • Helps government organize the risk analysis and record the risk allocation decision to be incorporated into the contract © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 94 #3 Risk Identification – the Guide´s risk categories5.1 • Site risks: Availability of the site, design risks, environmental, permits, and ground conditions • Design risks • Construction risks • Commissioning risks • Revenue risks: Demand/usage (in user-pays and volume payment mechanisms), price or tariff risk (in user-pays), availability and quality risks, third party revenue risks, and so on • Maintenance risks • Other operating risks • Financial risks • Changes in law • Force majeure risks • Early termination risks © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 5.3 95 #4 Risk assessment – quantitative assessment 5.1 • Estimating or defining values of the possible outcomes or “expected values” - also referred to as “adjusting values for risk” • Usually applied during Appraisal for financial analysis, VfM and CBA • Values may be presented in two different ways: 5.4. 1 ̵ a) The most likely of possible outcomes ̵ b) The full range of possible outcomes, including their probabilities • Most common approach is to define the base case of the project’s main cash flows on the basis of the most likely outcome • Sensitivity analysis allows government to test the robustness and resilience of the project’s financial architecture and estimate the contingencies built in by the private partner © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 96 #4 Risk assessment – qualitative assessment & risk allocation 5.1 5.4. 2 • Uses nominal (1,2,3 …) or descriptive (high, medium…) scales for the two dimensions (likelihood and impact) • Known as semi-quantitative • Translated in a “risk tolerability matrix”, used to prioritize • Allocation exercise concentrates in the yellow and red zones © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 97 #5 Mitigation Measures (early mitigation by the authority) 5.1 5.5 • Optimizing scope of the project and the planning process, e.g. ̵ Avoid innovation and complexity if the benefit does not outweigh the cost ̵ Choose a realistic delivery date ̵ Plan crucial building activities during the summer so there is less risk of weather related delays • Robust investigations , e.g. ̵ Studies that enable the parties to better assess risks: archaeological maps, geo-technical studies, traffic and revenue studies, utility location, environmental and social impact assessment, etc. ̵ Incorporate into contract to create a baseline by which some risks will be allocated as they occur versus provided “for information purposes” • The tender/selection process itself ̵ By ensuring the capacity of the awardee to develop and handle properly the project and its risks © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 98 #6 Deciding on Risk Allocation - Default situation 5.1 • Risk transfer is defined by the contract scope and the PPP contract structure • Default position on risk allocation is defined by two interrelated factors: 5.6 ̵ Scope of obligations and service: which performance requirements must be met to entitle the private partner to payments (or the ability to charge the user) and to what extent the private partner has to finance the project ̵ How and when will the private partner be paid and under which regime (including the payment mechanism in government-pays contracts) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 99 #6 Deciding on Risk Allocation - General rules 5.1 1. Design, construction, commissioning, operations, maintenance, revenues, and financial risks should be generally transferred to private partner, unless risk assessment clearly recommends the opposite 2. Risks related to responsibilities not naturally embedded in the scope or revenue regime should be retained, as well as direct actions by public partner affecting/changing obligations (contract changes and discriminatory changes in law) 3. Risks beyond the respective responsibilities and capability of either party should be generally shared Note that it may be appropriate that contract transfer some portion of the risk (even if is completely out of private partner´s control) to incentivize the private partner to mitigate © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 5.6 100 #6 Deciding on Risk Allocation - Exceptions to general rules 5.6 • For risks connatural with scope – It is appropiate to take back risks when there is evidence that the private partner will not add value • For risks not related to scope (e.g. vandalism affecting assests not constructed by private partner but related to its assets and close to them) → see “dealing with exceptions” © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 101 #6 Deciding on Risk Allocation - Risks that Should Never be Transferred 5.6 • Force majeure events (including acts of god) • Changes in service requirements or scope of works needed to adapt the project to new circumstances • Discriminatory changes in law or policy, and other actions by the government that negatively affect the project economics © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 102 #6 Deciding on Risk Allocation- Dealing with exceptions – which risks should be taken back? 5.6 • Judgement is of essence • Take back the risk if none of these factors are present: ̵ The private partner has a greater ability to assess the risk due to experience and technical capability ̵ The private partner has a greater ability to negotiate with third parties so as to pass through the risk to them at a reasonable or efficient price ̵ The private partner has a higher capacity to reduce the probability of the occurrence of a risk ̵ The private partner has a higher capacity to mitigate the consequences of the risk occurring and repairing the damage more efficiently “When none of these factors are present, and the risk event has a significant potential impact, that risk should be retained or taken back from the natural risk position” “Exceptions may be identified on the basis of: (i) real precedents, (ii) knowledge and experience of advisers or government’s own experience, and (iii) market tests/discussion with interested parties” Read examples of allocation in Table 5.3. © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 103 #7 Contractual Categories of Risks • From the standpoint of contract • All need to be clearly defined including procedures for assessing and conditions for accessing Compensation events Relief events Force majeure 5.7 • Private partner entitled to receive financial compensation [and excused for breaching – time & money] • Restore the financial equation • Full, partial / shared • Excused for breaching (time) • Compensation and relief • Sometimes a legal term or defined as standard • Relevance of legal traditions (see next slide) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 104 #7 Contractual Categories of Risks (2) - Force majeure 5.7 • Legally defined concept in civil code countries ̵ Should not prevent the definition of a wider term or including specific risks similar to force majeure when appropriate • Parties agree on contract terms in common law jurisdictions, including an exhaustive list of events in the contract • Common ground - risk events that are, by their nature, impossible to assess in terms of impact estimates, and very difficult to estimate in terms of likelihood. They also always relate to exogenous factors, are unrelated to the performance of the private partner, and are caused by external agents (wars, riots, natural disasters, and so on) • Complementary reading - examples of definitions in table 5.4. © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 105 Quiz - Risk 16-Pick the incorrect statement A. There are risks that should be taken back / not transferred as the transfer will not generate VfM, i.e. the price for the risk to be charged by the private can be higher than the value of the risk for the public if retained B. “Best able to manage the risk” means greater ability to prevent, and/or deal with consequences and/or better ability to price the risk accurately C. Sometimes (in some countries depending on their level of development) may be necessary to sacrifice VfM in favour of a reasonable level of bankability D. Options / strategies available to the private partner to deal with transferred risk includes absorb the risk and rely on future negotiations if risk eventuates, pass through the risk to contractors or pay for an insurance © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 106 Quiz - Risks identification / risk register 17-Which is NOT correct with respect to a risk register? A. It is needed to conduct an organized qualitative assessment of risks B. It helps to identify and avoid blind spots, i.e. to be sure that all potential risks are regarded C. It is aimed to define and register the risk allocation D. Allows for or help to handle potential overlaps © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 107 Quiz - Risk assessment - qualitative 18-Which approach is the correct approach or the most accurate statement, considering a risk tolerability matrix of 3x3? A. A risk with high potential impact but low likelihood could be ignored as long as it is rare / unlikely that eventuates and the expected value will be always low B. A risk with medium potential impact and medium likelihood should be prioritize C. A risk with high likelihood but low potential impact will not be a priority D. Small / low impact means always no priority risk © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 108 Quiz - Risk assessment - quantitative 19-What is NOT true with respect to quantitative assessment? A. As part of the exercise it is necessary to conduct a sensitivity analysis to test the robustness of the Project B. Is about estimating values of the possible outcomes or “expected values” of risks C. Values may be presented in the form of the most likely of outcomes, or as a the full range of possible outcomes D. It is commonly based in a base case constructed on the basis of the most pessimistic or conservative project’s main cash flows © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 109 Quiz - Deciding on risk allocation 20-Which are NOT true with respect to risk allocation? A. The default position on risk allocation is defined by the scope of obligations and services considered and how and when will the private partner be paid B. Design, construction, commissioning, operations, maintenance, revenues, and financial risks should be generally transferred to private partner while risks related to responsibilities not naturally embedded in the scope or revenue regime should be retained C. Risks that are beyond the control and capability of the private partner should be fully retained D. Risks related to direct actions by the authority or government should be always retained © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 110 Quiz - Contractual Categories of Risks 22-What best described the meaning of a compensation event? A. A Force Majeure event B. An event that if eventuates, the private partner will be excused for any contract breach as he is consider to be impede to fulfil its obligations for a reason out of his control C. An event that if eventuates, private partner will have both the right to receive a financial compensation to restore the originally expected financial equation of the Project as well as being excused for any contract breach D. An event that if eventuates, private partner will have only the right to receive a financial compensation to restore the originally expected financial equation of the Project, but will not be excused for entering into contract breaches because that is Relief Events © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 112 #8 Main project risks and their potential allocation (i) Related to design and construction phase – including site conditions Risk Description /impact Public Private Commnents / nuances / good practice Land availability and acquisition Cause delays and indirect cost overruns, direct cost implication when expropriations directly managed by private Environmental assessment An adverse assessment may imply project changes and therefore capex overrun X Other permits Mostly delay X Design risk May cause delay/cost overrun (capex and opex) X Construction risk Risk of cost overrun and/or delay in construction (missing part of scheduled revenues) Completion and commissioning Failing to meet the construction outcome as prescribed – main impact is in terms of time delay [certain events related to unanticipated ground conditions] Like adverse geotechnical conditions, archaeological findings, utility relocation, latent defects, squatters Site (buildings) should be available at tender launch. Linear, a significant part. If expropriations managed by private, risk of cost overrun should be retained (or shared with a cap) X (X) 5.8 Pre-existing contamination is a usual exception and retained risk Grantor should assume risk related to the requirements May also affect O&M phase X With certain exceptions described as specific compensation and relief events (e.g. Force Majeure) X Potential exceptions in terms of “interruptive” unforeseen events (see below)– [which may cause also direct cost overrun] X © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) Depend on likelihood and potential impact and reliability of information. Need to work/research during appraisal. Treated as relief events and some times as partial compensation / shared events (avoid full financial relief) #3 Risk structuring 113 Risk of Environmental Impacts [Additional content – not examinable] • The PPP Certification Guide says that environmental assessment risk is a private sector risk. It goes on to say that: ̵ Environmental impacts have to be anticipated to the largest possible extent by the authority in order to limit or mitigate this risk for the benefit of both parties. The authority should remain responsible for adverse assessments related to the specifications settled in the contract. • What does this really mean? Environmental Impact Assessment • Should be completed by government and approved prior to the RFP being finalised Specifications • Should include requirements based on the environmental approvals • Government takes the risk that the specifications do not comply with the approvals (particularly if the approvals are not finalised at the time of tendering) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) Construction Phase • The Private Partner takes the risk of noncompliance with the environmental approvals as reflected in the specification 114 #8 Main project risks and their potential allocation (ii) During operating phase Risk Description /impact Revenue risk in user-pays Revenue not being correctly assessed /projected. Mainly volume risk (also applies to volume based payment mech) Subset: network risk and competing facilities [also fraud/non-payment] Revenue riskinflation and indexation Revenue riskavailability and quality Risk of cost inflation exceeding the price revision/indexation Not meeting performance requirements / condition criteria that produce abatements or LDs Other revenue risk events Such as credit/counterparty risk, ancillary revenues, forex, fraud Maintenance and operating costs Correlated with design especially as per renewals Potential exceptions for some items Residual value and hand-back conditions Public (X) Private X Comments / nuances / good practice 5.8 Is at the heart of user-pay structures. Potential exception with sharing mechanisms through minimum traffic / minimum revenue guarantees. [appendix A: also excepting related to competing facilities] X X [with limited exceptions related to certain events including mainly force majeure] X Potential qualifications/nuances regarding fraud / nonpayments by users (see appendix A) X Potential exceptions - in ordinary O&M related to utilities/energy, some soft services, insurance premia or inverse risk of usage - technological enhancements (see changes in law) X © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 115 #8 Main project risks and their potential allocation (iii) Financial risks Risk Description /impact Availability of finance Financing not being available at commercial close or before construction starts or at prohibitive conditions Public Private Comments / nuances / good practice X With some EMDE sharing by means of committing public institutional finance X [typically insured by swaps or fixed rates] Exception, in some countries, is interest base rate volatility (from bid submission through financial close) Financial costs/interest rate Risk of fluctuations in interest rate Refinancing Financial conditions at refinancing being different than expected X X Shared to the extent that public party shares benefits Rarely sharing downside Forex In cross border financing (X) X [In EMDEs that need access to cross border finance, forex risk is sometimes assumed or shared by the public – see chapter 1] © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #3 Risk structuring 5.8 116 #8 Main project risks and their potential allocation (iv) Other risks both phases Risk Changes in law – specific and discriminatory Description /impact May impose additional investment or affect ordinary O&M Changes in services and scope of works Public X Private X X Force majeure (acts of god) Natural disasters or other natural events such as hurricanes, earthquakes, storms, and so on – producing loss or revenue/extra costs/investments Force majeure (political risks) Certain events of a political nature with low likelihood but unmeasurable effects such as wars, terrorism, nuclear contamination, and so on X Uninsurable risks Potentially embedded in the force majeure definition, and risks which are required to be insured but become uninsurable during the course of the contract. X Early termination The risk of the compensation sum being insufficient to meet financial obligations or being less than expected X Comments / nuances / good practice 5.8 Any change in law that generally affects any business should be borne by the private partner. Good practice to establish risk sharing and limiting potential impact for discriminatory changes in law (intended to affecting the specific project – usually full compensation), and specific changes in law (affecting only the specific sector). Contract should include clear rules to fully compensate X [Private to the extent of the insurance pack as required in contract] X [Private to the extent of the insurance pack as required in contract] Some countries / some contracts include malicious damage (and more exceptionally riots) under the force majeure concept In such circumstances, the contract should provide relief from the obligation of being insured X © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) It is important for the authority since a compensation method perceived as unfair or unbalanced, or ambiguous, may involve losing bids or even no-bids situation. #3 Risk structuring 117 4 Other matters Guide Sections #9.9 118 Contents Objectives and overview of the Phase • Objectives & where we are in the Process Cycle • Overview of the Structuring Phase • Summary Description of Main Tasks to be Carried Out in thus Phase Financial Structuring (from the Public Perspective) • Elements of FS and competing objectives • Term Definition • Pure Co-financing • Public Loans: Hard or Soft Public Agency Loans • Filling the Viability Gap of a User-Pays Project • Equity Participation by the Government • Other Ways to Increase Financial Feasibility and Affordability • Categories of Revenue Regimes in PPP Projects • Financial Structuring Matters in User-Pays Projects • Volume-Linked Payment Mechanisms • Availability Payments Risk Allocation and Structuring [Other matters] • Defining Risk: The Risk Management Cycle • Risk Identification • Risk Assessment • Mitigation Measures (early mitigation by the authority) • Deciding on Risk Allocation • Contractual Categories of Risks: Compensation, Relief, and Force Majeure Events • Introducing the Main Project Risks and their Potential Allocation • Incorporating Risk Allocation into the Contract: General Comments • Early termination © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #4 Other matters 119 #9.9. Early termination contract provisions Reasons for termination 9.9 Termination for convenience or “unilateral termination” and termination for fault by the public partner Termination for force majeure Termination for default of the private partner © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #4 Other matters 120 #9.9. Early termination contract provisions Consequences / calculating the compensation Termination for convenience Termination due to force majeure or similar situations Termination by default of the private partner 9.9 • Grants the private partner rights to full compensation • Recover all funds invested • Costs of breaking its contracts with third parties • Opportunity costs of the equity investment • Grants the private partner rights to recover all investments in full • Some countries/contracts also recognize the right to a positive equity IRR at a pre-agreed rate, usually to obtain a close to 0% equity IRR in real terms • Grants the private partner (or lenders) rights to receive a compensation sum • Different approaches: Book value; Debt-based compensation; Market value/market sale • Procuring authority agrees a replacement partner with lenders (prohibited in some jurisdictions) © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #4 Other matters 121 Example: Termination Payment Calculations Source: Department of Treasury and Finance (Victoria, Australia), Partnerships Victoria Template - Termination Payments Schedule © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) 122 Quiz - Early Termination 23-Which one is correct with respect to early termination scenarios? A. B. C. D. When a contract is early terminated because a Force Majeure event, the private partner should be entitled to receive a compensation sum that allows the partner to repay all debts and costs of breaking contracts, recoup all the equity investment and enjoy an equity IRR similar to the one originally expected, because the event was beyond his control so thee partner should not suffer any harm When a contract is early terminated unilaterally by the grantor, the private partner should be entitled to receive a compensation sum that allows him to repay all debts and costs of breaking contracts, recoup all the equity investment and enjoy an equity IRR similar to the one originally expected, because the procuring authority should assume the consequences of its decisions When a contract is terminated by the default of the private partner there is never a compensation for the private partner as a consequence for defaulting materially its obligations in a default termination The usual approaches to calculate the compensation sum are: book value, debtbased compensation, market value/market sale and an expert opinion © K-Infra & Foster Infrastructure 2020 | Structuring & Drafting (Preparation) #4 Other matters 123 Contact Andres Rebollo arebollo@k-infrastructure.com Richard Foster richard@fosterinfrastructure.com This material is intellectual property of Knowledge Infrastructure and Foster Infrastructure. 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