The promise of time and cost efficiency through access to specialised skills has had governments increasingly reaching out to the private sector for large infrastructure projects. However, flanking the potential benefits is the rigid design of public-private-partnerships (PPP), inhibiting asset owners from drawing the requisite balance between tightly composed contracts and injecting adequate flexibility to accommodate unforeseen scenarios.
As a result, long term multi-stakeholder projects often encounter financial difficulties and contract disputes, leaving little or no room for structured resolution.
Many PPPs across developing and developed countries have failed primarily due to mismanaged risk and lack of a structured response to unplanned situations. Internationally, for infrastructure concessions in developed countries such as Spain, Italy, Chile as well as developing countries of Latin America renegotiations are common.
A study of the 17 early concessions in Spain revealed that they have been renegotiated a total of 121 times (an average of about seven times). Similarly, a World Bank study has indicated that out of a sample of 1,000 concessions granted in Latin America and Caribbean between 1985 and 2000, 30 per cent underwent negotiations. In the transportation sector, this was as high as about 55 per cent
Theoretically, large infrastructure projects, which have multiple stakeholders collaborating over long periods, require that risk is allocated to parties that are best positioned to manage it. In practice, this results in over-prescriptive, inflexible contracts to address inherent incompleteness of contracts — but is self-defeating as a priori identification of all risks is not feasible. Hence, to address the risks which may be unique to each project/sector, risk management in PPP contracts needs to be made dynamic. These adaptable mechanisms may take several forms:
Contractual structure
Delinking players from unpredictable risks: Transport infrastructure owners may mitigate the impact of crisis on projects by passing on unpredictable risks. For example, instead of the well-established mode of build operate transfer (BOT), concession to the highest bidder, an alternate and, perhaps, more efficient way is through the Least Present Value of Revenue (LPVR) mechanism.
Here, the concession is auctioned to the private partner that offers the best design/construction efficiency and minimum cost of capital. During the project, the concession period is adjusted to account for unexpected events, such as lower-than-anticipated traffic and changes in toll revenue, to ensure that the private partner generates the expected discounted revenues. Chile has used this; many others are following suit.
This mechanism is attractive to all stakeholders. Private sector minimises the risk of a winner’s curse as long-term traffic demand projects do not dictate the bid amount. Public sector gains integrated and optimal design and operations capability over a long term.
Societal benefit is in the form of a significantly reduced risk premium to create a public good. Extensive technology deployment to ensure transparency across stakeholders on quality, progress, traffic would ensure smooth functioning of a variable concession model.
Another variant of the BOT model, currently being used by our road transport ministry is the Hybrid Annuity Model. In this model, the public and private sectors partly fund project construction cost.
Financial returns to the concessionaire are predetermined using semi-annual annuity payments, while toll revenues go to the Government, transferring unpredictable commercial risk to the public-sector partner. The provision of inflation adjusted costs and annuity payments with interests at minimum bank rate hedge inflation and revenue risks.
Contractor selection
Involve private sector early: The principle of early contractor involvement is a collaborative approach to tender a large, complex project. In a two-stage process, based on quality and cost pre-qualification, two-three contractors are shortlisted who compete in developing the best ‘solution’ i.e. detailed project plan, design and price. The asset owner typically provides boundary conditions for these solutions.
Association of the contractor with project development reduces the information asymmetry with the asset owner, infuses ownership and can achieve higher cost effectiveness and expedite delivery. Identification of project scope and risk and value drivers upfront induces collaboration and reduces the risk premium demanded by the private contractor. Governments in the UK, the Netherlands, Australia, New Zealand have utilised this effectively.
Contractual flexibility
Facilitating structured negotiation: Some events lead to substantial permanent changes in operating environments. To account for such possibilities, asset owners should make adequate provision for contract renegotiation, including triggers for exceptional reviews, upfront while defining the contract.
Hence, there must be provision in a PPP contract that clearly articulates dispute-resolution mechanism that provides flexibility to restructure within the commercial and financial boundaries of the project. India is taking steps in this direction.
For instance, last year, finance minister Arun Jaitley announced setting up a Public Utility Bill for resolution of PPP contract disputes based on the Kelkar committee recommendations.
The committee suggested setting up of sector specific monitoring committees to review contracts and prevent distress in partnerships. They also recommended setting up external regulators that would decide the gravity and permissibility of a contract dispute and the Infrastructure Adjudication Tribunal — a multidisciplinary expert committee that would make resolution recommendations.
With the Government’s target of $375 billion in investment in infrastructure by 2019 and a hope of PPPs bridging 50 per cent of this deficit, the need of the hour is to employ institutional mechanisms while designing PPP contracts.
The time is now for asset owners to think through new ways of de-risking key stakeholders, sharing supernormal profits and negotiating unforeseen conditions.
(Subudhi is partner & director and Vasanta is principal at Boston Consulting Group. The article first appeared in The Hindu BusinessLine.)