Where next for the global PPP market? By Alex Guy, Partner, DLA Phillips Fox

Where next for the global PPP market?

By Alex Guy, Partner DLA Phillips Fox The last two years have seen a signifi cant change in the global

PPP market. The GFC has led to a shortage of long-term, limited recourse debt, requiring governments to take urgent action to engender suffi cient confi dence to enable deals to close. As the global fi nancial markets have started to settle, deals have reached fi nancial close but on signifi cantly more stringent terms, including considerably higher margins. At the same time, governments have been under the competing pressures of reduced tax revenues and the desire to stimulate their economies through public spending. In a number of countries including Australia, spending on infrastructure has become a key focus as part of governments’ individual stimulus packages.

Support for PPP

Support among governments for the use of PPP to deliver public infrastructure has remained strong in most countries already using PPP as a signifi cant part of their infrastructure delivery programs, and interest is spreading across national boundaries to countries such as Thailand, Vietnam and New Zealand. Clear and positive evidence of the benefi ts of PPPs from those countries with experience of employing it across a range of sectors over a number of years abounds. A benchmarking study published by the University of Melbourne in December 2008, for example, which analysed 25 PPP projects and 42 traditional projects in seven Australian jurisdictions found PPPs deliver assets for a price that is far closer to the original expected cost than traditional projects. On average, cost escalation on PPP projects was only 4.3 per cent compared to 18 per cent for traditional projects over the same period. While PPP projects generally took longer in procurement than anticipated, once they reached fi nancial close, the average further delay was only 2.6 per cent (compared to an average delay of 25.9 per cent during the construction phase of traditional contracts).

On average, cost escalation on PPP projects was only 4.3 per cent compared to 18 per cent for traditional projects over the same period. m

Where next for the global PPP market?

A more recent paper produced at the end of last year by the UK National Audit Offi ce (NAO) for the Economic Affairs Committee of the House of Lords paints a similar picture. The paper draws on the NAO’s independent analysis of more than 100 PPP projects over 12 years, including its 72 earlier “value for money” reports. It concluded that most PPPs are built close to the agreed time, price and specifi cation, and that public bodies using a PPP are normally satisfi ed with the services provided by contractors. In the NAO’s sample, 69 per cent of PPP projects between 2003 and 2008 were delivered on time, and of those delivered late, 42 per cent were delivered within 6 months of the agreed time. 65 per cent were delivered at the agreed price. The majority of price increases were due to changes requested by the public sector during construction.

Against this background, many governments continue to wish to employ PPPs as one of a range of procurement methods which enables them to deliver on time and on budget, in a way that promotes an output-based service culture (rather than an undue focus on construction and engineering at the cost of other aspects) and which provides increased innovation, competition and whole of life cost benefi ts. For example, the European Commission’s recent Communication on PPPs encourages their use as an economic tool, making it more likely that European countries will signifi cantly step up PPP programs or commence major PPP programs for the fi rst time. In the Asia Pacifi c region, we can expect to see more PPPs in the coming years, with a number of governments showing real interest for the fi rst time in PPPs, not just for one deal but for a signifi cant pipeline of deals over an extended period.

The current climate

While the opportunities look set to increase, the PPP industry now faces a challenge in overcoming the diffi culties that have arisen in recent years. The problems we now face include: • A continued lack of liquidity amongst commercial banks and the virtual closure of debt capital markets. • A reduction in long-term lending for larger PPP projects and, in some jurisdictions, for any PPP projects at all. • Reliance on government-provided debt or guarantees to engender suffi cient confi dence to enable deals to close. • Increased margins on debt highlighting the cost differential between private sector borrowing and state borrowing, adversely impacting the value for money case for PPP. • Greater risk aversion on all sides of the negotiating table, challenging previously accepted risk allocation models. ...many governments continue to wish to employ PPP as one of a range of procurement methods which enables them to deliver on time and on budget, in a way promotes an output-based service culture ...and which provides increased innovation, competition and whole of life cost benefi ts.

Where next for the global PPP market?Where next for the global PPP market?

Governments can further help both the industry and themselves by encouraging competition, both by making efforts to keep “at risk” bid costs down and removing unnecessary barriers to cross-border participation in their economies.

Moving forward

There is an expectation that these problems will go away on their own as the world economy recovers and that it will be back to business as usual. However, if PPPs are to continue to provide governments with a good value procurement method for major infrastructure projects, the method needs to evolve to meet the challenges it faces head on.

Governments have acted quickly and effectively to boost confi dence in the market, with the UK lending program through the Treasury’s Infrastructure Finance Unit, the French government’s policy for guarantees and the Victorian Government’s debt underwriting support offered for its desalination project being just a few examples. In some cases these government measures have meant that there has been suffi cient confi dence for some of the deals that the measures were intended to assist to be oversubscribed and close without the need for that assistance. Where that assistance has been provided, it has been provided short-term with an expectation that it will be replaced with commercial fi nance as soon as practicable. In this context, it must be recognised that governments are likely to cease offering such support in the near future and the industry needs to be ready to stand on its own two feet without relying on that support. The evidence is that the industry is already starting to do so, with the $759m Peninsula Link deal reaching fi nancial close without any such support in February this year.

Governments can further help both the industry and themselves by encouraging competition, both by making efforts to keep “at risk” bid costs down and removing unnecessary barriers to cross-border participation in their economies. There are many jurisdictions in which the local PPP market is still dominated by local contractors and local funders, despite the best efforts to penetrate those markets with major international players. Such protectionism can lead to lower value for money and reduced innovation (both in terms of design and construction, and the availability of fi nancing products which enable better risk allocation). Ultimately, such protectionism can stifl e economic growth, discouraging foreign investment, increasing risk for government and causing projects to fail. With an open market that encourages competition, local economic objectives can nonetheless be achieved through appropriate project selection and contractual requirements.

While increased competition should lead to better outcomes, if PPPs are to continue to offer good value for money, both public and private sectors also need to be fl exible and adapt tried and tested PPP models to the new economic environment. The Peninsula Link project is a good example of this happening in practice with the state government recognising the need for a shift away from tollbased projects towards availability payments in uncertain times. Another area where a better balance can be struck going forward is refi nancing risk/reward, particularly in those jurisdictions where long-term debt fi nance remains unavailable for PPP projects.

In developing better risk allocation, jurisdictions will need to look to each other to identify the best ways in which risks can be managed. The old adage, “risks should be borne by the party best able to manage them,” is a good one but, in practice, there will always be some risks that neither party is particularly well placed to manage and which nonetheless need to be dealt with. In this context, there may be something to be said for the concession model employed in Spain and Portugal, which allows a rebalancing of the economics of the concession if unforeseen events occur.

Conclusion

The PPP model has proved its adaptability and, whatever the next few years hold, we can be sure that PPPs will be a key part of governments’ infrastructure delivery programs and that we all stand to benefi t from continued fl exibility along with increased competition.

Alex Guy is a partner of DLA Phillips Fox. DLA Phillips Fox is a member of DLA Piper Group, an alliance of independent legal practices. Alex is admitted as a Solicitor in England & Wales and is an Australian Registered Foreign Lawyer. He is restricted in Australia to the practice of foreign law only. He is entitled to undertake work in connection with Australian law only (i) to the extent permitted by s167(3) of the Legal Profession Act 2007 (Qld) where such work is necessary and incidental to the practice of foreign law or (ii) as a lay associate under the supervision and authority of an Australian legal practitioner.