| Major PPP report sets guidance for private financing |
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| A 600-page report on the process and procedures for PPPs was delivered to the Department of Environment and Local Government in May. This should be the last word in planning a full-scale PPP process in Ireland. PricewaterhouseCoopers were joined by legal alliance of McCann Fitzgerald and L’Estrange & Brett, and engineers MC O’Sullivan and EC Harris. The report is made available on CD-ROM by the Department. The following are the report’s Guidance Notes in relation to private finance in PPPs. |
Private finance should be sought where projects are of adequate scale, where risk transfer is beneficial and where the project is structured in a way that provides a contractual balance that is capable of meeting funders’ key concerns in relation to financial returns, security of cashflows, risk allocation, and any legal concerns.
Contracting authority covenants
The annual nature of the payments to local authorities contrasts with typical payments that arise under PPP contracts that have a much longer time horizon, typically more than 20 years, and can be predictable.
It is not appropriate for the State to give financial guarantees in the context of Public Private Partnership projects. Nevertheless, it is in the interest of Central Authorities to ensure, in so far as is possible, that private funders have confidence in the competence and capacity of sub-sovereign bodies to fully engage in the PPP process.
Approvals for PPP projects
The Department of Finance is responsible for identifying the financial consequences of all proposals put before Government. Every submission to Government and every proposal for legislation must include details of estimated costs and how these should be financed. In addition to current year costs, details of estimated costs should include whole-life costs.
Department of Finance sanction for projects may be specific (in relation to one-off proposals), or delegated (general sanction to deal with clearly defined cases without further recourse to the Department of Finance). For PPP projects, Department of Finance sanction should be delegated to the sponsoring Department or the NRA [National Roads Authority], subject to the agreement of the Department of Finance on periodic review of progress of implementation of projects.
For projects involving private finance which involve long term commitments from the Exchequer, the Central Authority will have responsibility for the final approval, in consultation with the Department of Finance. In such cases, the Central Authority should prepare a briefing paper for the Department of Finance setting out the commercial and long term financing risks associated with the financing of the project. This briefing paper should include:
• An outline of the key contractual terms and the allocation of project risks and summarising the expected value for money implications of pursuing the project as a PPP project. A consideration of key contractual terms, risk allocation and value for money, is to be found in other Guidance Notes [of the within the PPP Guidance Notes series;
• a summary evaluation of the financial viability of the project including, in particular, an assessment of the sensitivity of the project financing to changes in some of the important commercial terms. This sensitivity will be developed from the financial evaluation of tenders;
• a discussion of the proposed accounting treatment of the contract and the impact that it will have on the level of General Government Debt. This discussion should deal with balance sheet treatment for payments which are being made by the Contracting Authority and the private sector; and
• an assessment of the extent and the circumstances in which the financial exposure of the State might be increased.
Taxation
The taxation consequences of PPP transactions are potentially of great significance, and must be considered in the light of the structure of the transaction and the sector to which it is being applied. In macro terms, it is intuitive that the tax treatment of projects should not materially effect the commercial decision on whether or not to procure a project through a PPP process. However, there are anomalies in the tax code as it stands that are being amended and may require further amendment. In order to encourage optimum private sector involvement with PPP transactions, some degree of certainty needs to be established as to the tax treatment of elements of the transaction.
Private finance and procurement
The perceived benefits of private sector finance are largely derived from the discipline that commercial lenders bring to the process. Unless these commercial lenders are allowed to negotiate on some of the key contract terms, then the risk allocation is likely to be sub-optimal, and consequently sub-optimal value for money proposals will be received.
The experience in other territories has been that the financial markets will only commit to the expensive due diligence process once they have been nominated as the preferred bidder. As a result, they are unwilling to make a funding commitment until they have a clear understanding of the project risks arising from the due diligence process. Therefore, where private finance is involved in large-scale projects, the use of the negotiated procedure is likely to be more appropriate, so that optimal value for money proposals are received.
Refinancing
One of the consequences of including private finance in the overall financing structure of a project is that it leads to the possibility of the private sector wishing to restructure their finance as the project develops. Refinancing can be attractive where the risks, which have been accepted by one of the parties, crystallise or lapse due to the passage of time or the occurrence of key events. In these circumstances, the uncertainties (risks) associated with construction and demand have reduced, resulting in the possibility of converting some high-risk finance (equity), into lower risk finance (debt), thereby increasing the returns available on the remaining equity.
The potential benefits from refinancing can potentially be quite large, so it is important that the Contracting Authority should put itself in a position to share in the potential benefits. In preparing the contract documentation, it is recommended that the Contracting Authority should be able to approve any refinancing that the PPP Contractor wishes to make, but that its approval cannot be unreasonably withheld.
Where the PPP Contractor makes an equitable proposal to share the benefits of the refinancing with the Contracting Authority, it is recommended that the Contracting Authority’s approval of the refinancing is not withheld.
A related issue arises (in terms of sharing of benefits) in relation to caps on unforeseen profits. Where the PPP Contractor takes all of the demand risk for a project, there will be an expectation that they will reap all the rewards if the project is successful. The Contracting Authority should seek to avoid a situation where the PPP Contractor is earning excessive returns through contractual mechanisms such as royalties on revenues above a defined level, or adjustment/regulation of the unitary/user charge. |
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| Article appeared in the June 2000 issue.
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