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Thursday, 18th April 2024 |
| PPPs offer untapped potential if problems resolved |
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| The Public Private Partnership model has not caught on to the extent initially envisaged in Ireland. Michael Flynn writes that there is untapped potential in this investment vehicle but a number of problems need to be resolved. |
<The use of Public Private Partnerships (PPP) for public infrastructure projects is a growing phenomenon across the world. Having originally been introduced in the UK, a number of pilot projects were initiated in Ireland. It had been anticipated that PPP would play a significant role in the provision of infrastructure in Ireland across all sectors with significant budget allocations to PPPs as part of the National Development Plan and Government five year capital projects. Unfortunately, reality has not quite matched these plans and the expected roll out of PPPs has never quite happened. The question is whether PPP is the solution for Ireland’s infrastructure deficit and what, given recent history, level of interest remains within the private sector for the Irish PPP market.
A PPP represents a partnership between public sector and the private sector for the provision of a service. In its fullest form, this will involve the private sector designing, building, financing and operating a service over a long term contract. What is often forgotten is that PPP merely represents a different method of procurement. The key to generating the optimum value for money is ensuring that the various risks associated with the project are allocated to the party (public, private or shared) which is best able to manage the particular risk.
Some of the difficulties in Ireland to date have been due to the fact that the Irish public sector has sought to transfer more than the optimum level of risk. This has been particularly prevalent in the self financing projects where the State has sought to have the project entirely funded from revenues generated from third parties (tolls, property sales etc). In addition, the public sector has found it difficult to understand how a PPP project can ever prove to be value for money when it is financed by private debt which costs more than public sector funds. This ignores the benefits to the public sector of transferring risk under PPP projects which would ordinarily remain its responsibility under traditional procurements.
What investors look for
The success of any PPP project requires the private sector to take on various project risks for which it will be provided with the opportunity of generating a financial reward. This, however, assumes that the private sector properly manages the risks such as completion on time and on budget, and ongoing lifecycle costs relating to the asset and operations. While most transactions will be highly leveraged, the levels of risk involved will drive the gearing ratio allowed by the project’s bankers. Given the transaction size, in most cases, promoters will have significant capital at risk irrespective of the gearing. As a long term investment, the returns can be quite respectable with overall project returns (IRR) in the region of eight per cent to 13 per cent over the life of the project.
There is concern that some of the PPP projects brought to the market in Ireland are too small. Due to the complexity of the project structures (irrespective of the deal size), the high associated bid costs and the returns required to justify involvement, it is important that PPP projects have significant scale. A minimum capital cost of €50 million is considered a suitable benchmark. Scale also increases the interest of large international construction companies and banks which should increase competition for projects further and improve value for money in the PPP tendering process.
Level of interest
The Irish Government has indicated that PPP will continue as a method of procuring infrastructure projects in the future. As the requirements for capital investments increase, meeting these needs could place the public finances under some strain. Given the needs, and stated interest, PPP is an attractive financing alternative, providing it can be shown to provide value for money. However, the private sector is increasingly questioning the real level of interest within the public sector with PPP deal flow continuing to be slow. Arguments regarding value for money and the cost of finance continue to be repeatedly made which further erode the private sector’s confidence in the future opportunity in Ireland.
Another consideration is that the Irish PPP market now has increased competition from other countries. Many of these markets (particularly central Europe) are being more receptive to bidder issues, risk transfer is not always as aggressive and deal flow is strong. Markets with significant deal flow, less onerous risk transfer requirements and speedy procurement timelines are proving increasingly attractive, hence Ireland will have to compete for bidders’ interest in future projects.
Future projects
To date, the PPP deals in Ireland have been relatively straightforward from a technical perspective, with the real complexities and delays being caused by planning requirements, objections and risk transfer requirements. A better understanding of the real potential of PPP and the basis for including private finance in projects is required within the public sector to allow development. Opportunities exist across all sectors where capital projects are required, including transport (road, rail, airports), health, waste, housing (social and affordable), justice and education.
In the UK, the PPP process is beginning to move away from the purchase of specific project related solutions (for example, hospital beds and classrooms) to an approach where the public/private relationship is created for the long term delivery of public services, for example, NHS LIFT and Building Schools for the Future. Given the requirements in both the health and education sectors in Ireland, this structure could be employed to bring efficiencies into the procurement system.
Recommendations
So how can the PPP market be improved such that all parties benefit?
Increase deal flow: Major infrastructural projects required should be prioritized and fast tracked. This allows the appropriate time and resources to be focused on the projects of most need. Many of these projects would be suitable for PPP. It is important that an appropriate risk transfer basis is applied with the requirements of both public and private sectors in mind.
An increase in PPP deal flow will create a momentum in the market place, increasing interest and competition for projects. In addition, the Eurostat ruling which allows PPP projects with certain risk profile to be treated as ‘off balance sheet’ should be utilized to allow a greater level of investment to occur in Ireland.
Streamlining of the procurement and approval process: This will allow for a more efficient process. It is important that the basis of approving projects and determining value for money is finalised and published by the public sector so that bidders are clear on the ground rules. This should then be applied consistently on all procurements (PPP and traditional).
Planning issues and delays must be tackled: Virtually every large project in Ireland in recent years has been delayed due to planning issues. While the process is important, the impact on project timelines and the overall economic needs should be considered to reduce the time impact of the process.
Summary
A significant opportunity exists to meet Ireland’s capital investment requirements by involving the private sector. Interest among bidders remains relatively strong, however, this should not be abused with over aggressive risk transfer policies by the public sector. An increase in the level of deal flow and a clear demonstration of the Government commitment to PPP is needed to bring a new impetus to the market which will be positive for all sides. With an invigorated marketplace, PPP projects represent a good long term investment for promoters and how the potential to deliver badly needed infrastructure in a short timeframe and in a manner which provides value for money for the tax payer. |
Michael Flynn leads the Deloitte Specialised Finance division.
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| Article appeared in the March 2005 issue.
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