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Saturday, 19th September 2020
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Public Private Partnerships - 4 Billion the initial target Back  
Peter Brennan on the background to the PPPs initiative
Public Private Partnerships (PPPs) are a vehicle whereby private investment and expertise are used in the design, build, operation and financing of public goods and services. PPPs in some shape or form are used extensively in most developed economies. The rationale for the introduction of such an approach in Ireland is to bring about accelerated and additional build.

Infrastructure Bottlenecks

What is driving IBEC’s intensive lobby on PPPs is the harsh reality that Ireland's infrastructure bottlenecks must not only be eliminated, but much sooner than is currently envisaged. Major bottlenecks in the economy will result if PPPs are not embraced by the entire public sector as one of the solutions to improving the country's competitive position.

Private investment has the potential to leverage up large-scale projects, especially in the areas of transport and environmental services where the investment requirement is a staggering £7 billion. The EU co-financing element will be a mere 6% of this total. Thus the European Commission is very supportive of the introduction of PPPs in Ireland.

In its joint submission on PPPs of 27 April, IBEC/CIF identified nearly 30 projects crucial to Ireland's competitiveness which may be amenable to a PPP approach. These included the construction of motorways between Dublin and large urban centres, rail links, incinerators, landfill sites, water supply and waste water treatment facilities, education facilities, health and community-based projects, telecommunications infrastructure, sports and recreational facilities and the refurbishment of the country's courthouses. IBEC considers that the PPP component of the National Development Plan (2000-2006) could be in the region of £4 billion.

Government commitment

A significant Government decision on the implementation of the PPP process and the selection of potential projects to the value of £600m was made on 1 June last. In addition to four pilot transport projects, Minister McCreevy also announced the Government's intention to 'actively' explore the potential for the development of the Kilcock-Kinnegad section of the N4 along PPP lines. Projects in education, solid waste management area and water supply are also included in the pilot programme, with specific projects due to be identified within a few weeks.

This announcement demonstrates the commitment of the Government to rapidly advancing the development of a Public Private Partnership process in Ireland.

Barriers to PPPs

The undertaking made by Minister McCreevy to identify, in partnership with the private sector, ways of fast tracking the introduction of the PPP process and tackling the obstacles to PPPs is very encouraging. The need to tackle the barriers to PPPs formed a central plank of the IBEC/CIF submission. The two working groups which are currently in the process of being established (with public sector and private sector participation) will contribute further to providing solutions to overcoming the legal and financial/taxation obstacles to the successful introduction of PPPs in Ireland.

The IBEC/CIF submission identified a number of obstacles which will have to be addressed before a successful private investment programme could proceed with any degree of confidence. For example, primary legislation may be needed to create an adequate legal environment for potential investors and their public sector clients. Tendering procedures will have to take account of the EU's complex rules on public procurement and concessions. The costs of preparing PPP tenders will have to be kept under control and contractors will expect to be involved as early as possible in a potential project; that is at the design stage.

If the PPP barriers which we have identified are examined systematically - and this should take no more than four months - then the scene will be set for a major step change in terms of the delivery and operation of key infrastructure and service projects across the economy.

Planning

The Government’s upcoming legislation to overhaul the planning laws and process is a sine qua non if PPPs are to become part of the public policy mix. While some contractors may be prepared to assume the planning risk for large-scale projects, the vast majority of projects will be subject to the vagaries of the planing legislation in force. Thus the new Bill will need to convince potential project promoters that the planning problem in Ireland is being tackled in a comprehensive and fundamental manner.

Risk/Rate of return

Financial institutions in Ireland backing PPP projects will need to be satisfied that the risk allocation process is appropriate, i.e. that the party best able to manage/control the risk is the party to which such risk is allocated.

It would appear, however, that there is some uncertainty at official level concerning the cost of financing PPP projects in the private sector versus the public sector. In particular, it is often quoted that the Government’s cost of capital is its cost of debt (say 4%) versus the private sector’s cost of capital being its cost of equity (say 15%).

This can to be addressed on two counts:

Firstly, the Government’s cost of capital is higher than its cost of debt because when the Government finances projects it assumes project specific risks such as cost overruns and delays (vividly described in the recent report by the Comptroller and Auditor General). These are real risks with real costs and should be factored into the Government’s cost of capital when it looks at each new project.

Secondly, the private sector’s cost of capital is not its cost of equity, but rather the weighted average of its cost of debt and equity. A typical PPP type project might be financed with a debt/equity ratio of 90%. The resulting cost of capital calculation is presented below:

Equity Target Return 15%
Cost of Debt 5.5%
Cost of Capital 6.5%

Thus the comparison is between the Government’s cost of capital of 4% (to which a risk premium must be added) with the private sector’s 6.5%. The argument is that the private sector is better equipped than Government to manage many project risks such as cost overruns and delays. If the private sector is better at managing these risks then it should also be better at pricing these risks. Thus by financing projects in the private sector and transferring risk the public sector achieves significant value for money.

Capital Markets and Availability of Equity

The advent of the Euro should open up the Euro capital markets for Irish projects with discrete, future income streams (e.g. shadow toll projects). Equity finance should be readily available for Irish PPPs, certainly from institutional funds/investors but possibly from private investors, particularly if there were associated tax incentives. While some institutions provide mezzanine finance, subordinated debt/quasi equity is more likely to be provided by project sponsors than financial institutions for Irish PPPs. The NTMA may also have a role to play in raising finance for PPP projects.

Tolling/Charges

It has been strongly recommended that the Government clarify its policy on the issue of tolling, shadow tolling and the use of user fees and charges. This issue is top of the agenda of the working group set up to consider the financial and taxation obstacles to PPPs.

Taxation barriers

Ideally, PPPs should be governed by separate, clear, tax legislation to provide the maximum incentive for the private sector to become involved in such ventures.

Whatever vehicle is chosen for the PPP, that structure should be transparent for tax purposes so that profit and losses accrue directly to each partner. In that situation, profits are extracted from the structure without additional tax costs and losses are availed of as they occur. Group relief and consortium relief should be extended, if necessary, to cover all possible structures envisaged in the PPP system.

Legislation may be needed to clarify tax relief for start-up costs of the PPP, whether they are incurred by the PPP vehicle or by the partners themselves. Bid costs for both successful and unsuccessful bidders should be tax deductible in all situations to encourage as active a participation in the tendering process as possible.

Specific legislation should be introduced to minimise transactions costs associated with the PPP structure. It is usual for a public body to transfer land to the PPP vehicle and subsequently repurchase/repossess the completed project some years later. Ideally, both transactions (i.e. the sale and repurchase) should be exempted from stamp duty to avoid unnecessary layers of cost in the PPP vehicle.

Equally, in situations where certain public or semi-state bodies, who would otherwise be exempt from VAT, become involved in a PPP, the VAT regime should ensure that no unnecessary irrecoverable VAT costs arise at the beginning or end of the PPP structure.

Where land is transferred to the PPP vehicle, an exemption from capital gains tax on the public or semi-state body should apply in all cases.

By adopting these measures, most unnecessary tax costs would be eliminated from the PPP structure, which should allow it to operate as efficiently as possible.

In order to kick-start to the PPP process, IBEC/CIF recommended that accelerated capital allowances be made available on PPP projects. These allowances should be available to either the vehicle or alternatively, to lessors of PPP projects. Such allowances should be capable of generating project equity and reduced funding costs to the PPP.

Conclusions

Following the Government decision of 1 June, it is now clear that the concept of PPPs has very strong political support. On the other hand, until there is clear evidence that private finance will be used, project promoters and their financiers will be cautious about the depth of the commitment to PPPs. Build and operate contracts should not be dressed up and presented as PPP projects.

In approving the National Development Plan, perhaps as soon as the end of July, the Government will not only indicate the level of investment it expects from the private sector over the next seven years, but specific categories of potential PPP projects.

There are grounds for optimism that IBEC’s pioneering work on PPPs will result in the delivery of an ambitious but pragmatic PPP programme over the coming years.

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