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  • 1. Foreword Jean-Yves PERROT In 1993, France’s Ministry of Public Works and Transportation, under the gui-dance of my predecessor Claude Martinand, published an initial collective work onthe French experience , already at that time deeply-rooted and widely-practiced, inthe area of private-sector financing and management of public infrastructure pro-jects. Six years ago, this first book served to ignite and spur on a debate over themethods needed to associate the private sector in performing public service assign-ments. The French experience, featuring a broad-based approach applicable to across-section of services and infrastructure, proved to be quite original (even unique),against the backdrop of a worldwide economy still heavily and at times dogmati-cally championing total privatization as the sole alternative to public-sector facilitiesmanagement. Since then, the range of public-private partnerships, in terms of both geographiclocation and service sector, has continued to spread throughout the world. A large number of diverse countries, stretching across all continents, have beenholding international calls for tender in order to build facilities and run public servi-ces within a partnership framework, especially in water/sewerage and transportation.Energy production, waste handling/treatment and, to a broader extent, the environ-ment, telecommunications and public housing have all been managed using public-private partnerships, with the legal and financial configurations of such partnershipstaking on a wide variety of forms. Reliance upon a delegated management framework (whether a concession oranother type of public-private partnership), as a means of improving the quality ofpublic services, has thereby come to the fore as one of the basic tools in economicmodernization. Moreover, this brand of partnership has helped refocus the role andresources of the public authority on its regulatory missions. During these past six years, the debate over managing public services throughdelegation (in all its international, economic and legal dimensions) has both maturedand become less vehement. No longer is it concentrated on the legitimacy of jointpublic-private intervention in satisfying public service or facility requirements, butrather on the most efficient manner in which such facilities and services can be set upand operated, via a veritable and well-balanced partnership between public authorityand private operator. In conjunction with these developments, considerable advan-1. DAEI (French Minstry of Public Works, Economic and International Affairs Division), PrivateFinancing of Public Infrastructure, supervised by Claude Martinand, Paris, 1994. 3
  • 2. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSces (e.g. other publications, conferences, seminars, manuals) have allowed gaininggreater insight into the topic. French firms have participated extensively in this opening onto the world bydemonstrating their longstanding tradition of involvement in public services withinmany countries. These firms have made the most of their practical experience ofworking in partnership with France’s public administration, as well as of their tech-nological prowess, in order to develop original formulae adapted to each context andeach project. This book has been intended to draw upon the depth and richness oftheir collective experiences. By its very nature, public-private partnership cannot stem from a single contrac-tual template, but instead must be assembled using lessons gleaned from past expe-rience. As such, it is incumbent upon us to share this experience with other publicand private actors as far and wide as possible, in an effort to incite meaningful andbeneficial exchanges. From a public authority’s standpoint, this book provides:– series of recommendations, reflecting the outcome of such practices and up-to-daterealities;– the various processes during the life of a contract: preparation, award and execu-tion;– detailed descriptions of sector-specific parameters;– examples of successful partnerships conducted in various service sectors across theglobe. The Ministry’s Division of Economic and International Affairs has sought, byvirtue of this latest book (which combines a broad range of contributions from com-pany sources, consultants, public authorities and financial advisers), to extend thegeographic and sectorial scope of strategies related to public-private partnerships.This effort has also been intended to distinguish future trends shaping such par-tnerships, as regards pertinent European and French references (while highlightingsuccessful ventures encountered the world over), in the aim of offering public autho-rities if not an actual delegated-management user’s manual, at least some sound gui-delines for building sector-specific partnerships. 4
  • 3. OutlineForeword ........................................................................................................................................................................................................ 3Outline ............................................................................................................................................................................................................ 5Introduction .............................................................................................................................................................................................. 7Summary ....................................................................................................................................................................................................... 9 I. PUBLIC-PRIVATE PARTNERSHIP IN THE CONSTRUCTION AND MANAGEMENT OF MAJOR INFRASTUCTURE AND PUBLIC SERVICEA. In favor of a pragmatic approach towards public-private partnership ....................... 17B. Ten years of public utility reforms: 7 lessons (from privatization to public-private partnership) ............................................................................ 31 II. CONDITIONS FOR A SUCCESSFUL PUBLIC-PRIVATE PARTNERSHIPA. The concessionary contract: a framework, a process, a contract ...................................... 43B. Risk analysis and sharing: the key to a successful public-private partnership ....................................................................................................................................................................................... 57C. The contract’s life cycle .................................................................................................................................................... 81D. The legal framework ........................................................................................................................................................... 91E. The financial approach .................................................................................................................................................. 103 III. CONCESSIONS IN THE FIELD OF TRANSPORTATIONA. Roads and road-related infrastructure ......................................................................................................... 125B. Public transit systems ...................................................................................................................................................... 169C. Ports .................................................................................................................................................................................................... 201D. Airports .......................................................................................................................................................................................... 219 IV. DELEGATED MANAGEMENT OF MUNICIPAL SERVICESA. Municipal services: the stakes involved in delegation ............................................................... 245B. Water and sanitation services ................................................................................................................................. 277C. Waste management ........................................................................................................................................................... 309 V. CLOSE UP: THEORETICAL FRAMEWORK AND PERSPECTIVE OF MULTILATERAL ORGANIZATIONSA. A draft typology of public-private partnerships ............................................................................... 333B. The European Commission’s point of view: Mobilising partners for networks of tomorrow ................................................................................ 349C. Public-private partnership financing for European infrastructure: The role of the European Investment Bank ......................................................................................... 355D. The World Bank’s point of view ....................................................................................................................... 363LISTE OF CONTRIBUTING AUTHORS ............................................................................................................................... 377TABLE OF CONTENTS ................................................................................................................................................................... 383 5
  • 4. Introduction Objectives of this book As of the 16th century in France, public authorities began envisioning the useof private entities to perform, on behalf of and under the control of the authorityitself, an economic activity aimed at public service provision or a contribution tothe overall economy. The nation’s very first concession was granted to Adam deCraponne in 1554 for the construction of a canal. These partnerships between public sector and private sector began to take onprominence in France towards the beginning of the 19th century, with the appearanceof new public services, especially in the area of water supply. Private companieshave been commissioned to treat and distribute water to the population as aneconomic undertaking on behalf of and under the control of appropriate public-sector authorities. The same would go on to happen in other public service areas,such as public transit. Since the beginning of the 1990’s, the principle of public-private partnershiphas enjoyed, the world over, renewed success. A host of factors explain this regainedinterest, with the most predominant being: the heightened need for public services,in a context of limiting public-sector outlays, and a sharper analysis of the divisionof roles between public entity and private operators. In this vein, a pragmaticapproach has taken shape, enabling greater overlap of both parties’ objectives for themodernization and improvement of public services, while transferring a portion ofthe taxpayer’s financial burden onto users. The advent of public-private partnership can also be legitimized by the respectiveroles played by the public authority and the private operator. The former is responsiblefor ensuring the provision of services essential to the population’s economic and socialwell-being, in accordance with society’s expressed needs; while the latter seeks to carryout assigned missions in optimizing the cost-benefit ratio. The use of public-privatepartnership thus enables reconciling these two positions. Nonetheless, considerableinsight into the process is a basic prerequisite; prior to calling upon a public-privatepartnership, the public authority must have a solid grasp of the potential advantagesand inherent risks, and fully comprehend the process for enhancing a partnership’ssuccess. Public-private partnership has thus become a key issue for the beginning ofthe new millennium in the field of public-sector management worldwide. Itsimplementation necessitates in-depth preparation in order to develop a truly globalapproach. This book aims at underscoring the main characteristics associatedwith delegated management and concessions, as well as displaying their economic 7
  • 5. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSconfigurations, preparation conditions, contract-award procedures and execution.The presentation format includes both the general theoretical standpoint and asector-by-sector analysis; each chapter closes with a series of recommendationsaddressed to public authorities interested in pursuing this mode of contracting. Contents of the book We have produced a book intended for several types of readers. As for content,background material critical to the success of partnerships, in terms of economic,legal and financial principles, has been raised in Part II. Parts III and IV examinethese conditions for success in a pragmatic fashion, by economic sector, for thevarious modes of transportation and types of urban public services. Part V is aimed atsharpening some of the theoretical angles and gleaning the perception of multilateralorganizations involved in such projects. As for presentation, this book has been designed to accommodate a variety ofreading approaches: from a quick skim to a more thorough perusal. Each chapteris led off by a brief abstract which provides an overview of its contents. A sectionhas been included at the end to highlight the set of recommendations addressed topublic authorities seeking to enter into partnerships with private operators. Chaptersare also accompanied, whenever necessary, by tables or summary diagrams of the keypoints discussed. In a number of cases, inserts allow grasping a particular subject ingreater detail; in the sector-specific chapters, descriptions of example set-ups helpillustrate the material presented. 8
  • 6. Summary Gautier CHATELUS Part I – Introduction The first (introductory) part of this book is aimed at discerning the key stakesinvolved in public-private partnerships. The first chapter (I-A) portrays the poten-tial advantages generated by these partnerships, while cautioning against an overly-idealistic vision and stressing that their success depends, above all else, on both thedegree of partner involvement and the project’s intrinsic quality. Chapter I-B presents 7 general conclusions which can be drawn from experiencewith public-private partnerships over the past ten years. These conclusions encom-pass: heightened pressures to justify increased reliance on public-private partnerships;the growing emphasis placed on pragmatic approaches as opposed to public-privatepartnership “models”; the importance of an ad hoc approach to public-private par-tnership able to respond to narrowly-defined problems; the institutional environ-ment’s fundamental role; the life cycle of public-private partnerships projects; thenecessity of a contract regulator; and the need to take contractual procedures throughto the stage of implementation quickly. Part II – Conditions for a successful public-private partnership This part is devoted to a cross-sector analysis of the basic conditions necessaryfor a partnership to succeed. The introductory chapter (II-A) presents the contrac-ting process and the features of the contract itself. The contracting process mustbegin by defining a host framework for the public-private partnerships and thendeveloping the specific contract. It is essential to distinguish between the concessio-nary contract containing a public service-delegation component and a conventionalpublic procurement contract. The contracting process must be laid out clearly, yetincorporate performance objectives. The chapter then turns to the nature of the con-tract, which must be firmly tied to: a detailed description of the works program,the operating conditions stipulated for the public service, and the terms governingcontract termination. The guiding principles always focus on the contractual equili-brium between partners and the guarantee of public service provision. The second chapter (II-B) goes right to the heart of project analysis, which entailsthe evaluation of risks, their limitation and the breakdown of those risks impos-sible to contain. This exercise, valid for all public-private partnership projects andapplicable over the long run, is fundamental to the project’s overall configuration.Many risks can be mitigated thanks to effective measures on the institutional andregulatory environment and a solid project organization. Others need to be split 9
  • 7. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSbetween partners in accordance with the principle of risk assignment to the partymost capable of bearing the risk, depending both on the benefit derived from theproject and on the notion of contractual equilibrium. Chapter II-C focuses on the primary parameter influencing a partnership: thecontract’s life cycle. As opposed to the classical public procurement contract, a par-tnership is entered into for the long haul and engenders relations between publicauthority and private operator that last a good number of years, and in most casesspan decades. Such a contract therefore must be set up to adapt to the inevitablechanges affecting its domain of application. This chapter highlights the characteris-tics of the contract life cycle and their ultimate impact on both the preparation of theeconomic and institutional framework up front and the options available followingthe award procedure. Chapter II-D helps clarify the project’s legal-related concerns and describes theset of legal clauses essential to the preparation of a regulatory and institutional envi-ronment for awarding contracts and ensuring successful partnerships. It also goesinto detail on the basic clauses not to be overlooked during the drafting of a contract.The chapter’s underlying notion is the lack of a single universal public-private par-tnerships model; the ensuing partnership and clauses may be applied within differenttypes of national legal systems, while maintaining the potential to adapt the contractto a particular context. To close this Part, Chapter II-E is aimed at presenting the appropriate financialapproach to public-private partnerships. This approach cannot be merely based onconventional banking tools due to the level of risk involved from the banks’ stand-point and the length of contractual periods. The financial organizations working inthis field have thus devised a new set of sophisticated tools. Yet, even the most favo-rable financing set-up can only function successfully for projects with solid economicjustification. Part III – Concessions in the field of transportation Parts III and IV lay out a sector-by-sector approach organized around two majorthemes: transportation and municipal services. Public-private partnerships do notentail use of a single “recipe”, but rather must be applied on a case-by-case basis.Individual sectors display their own set of specificities, and the experience acquiredin each allows identifying how best to integrate the general principles described inPart I. Part III addresses the broad domain of transportation, which must be conside-red both as an economic activity in and of itself and as a support service for theeconomy. Consequently, owing to the magnitude of capital investments involved aswell as to the fact that users can be required to pay for services, the public-private 10
  • 8. Summarypartnership proves a particularly well-adapted formula. Four sectors have been ana-lyzed in-depth: roads, public transit, airports and ports. Chapter III-A discusses roads and road-related infrastructure. This sector pre-sents contrasting aspects: simple in the approach (the primary objective of a public-private partnership in this sector is to finance infrastructure), yet difficult due tovery sizable investment outlays coupled with highly-uncertain and imprecise revenueprojections. Public-sector subsidies are often justified and essential. A key to tollroad, bridge and tunnel projects, especially in urban settings, concerns the socialacceptability of paying tolls. Chapter III-B discusses public transit systems. In this case, the partnership maybe focused not only on the infrastructure component, but on service operations aswell. Such services often exhibit low profitability levels, yet remain essential to urbancohesion (at least as far as urban public transit is concerned). Concessionary con-tracts can thereby incorporate a variety of elements. Rail operating franchises enableoptimizing the use of infrastructure. New high-speed train networks have to be desi-gned from an overall standpoint, so as to enhance compatibility between infrastruc-ture, rolling stock and operations; such projects, however, necessitate considerablesubsidization up front. Tramway or metro systems can be handled using differenttypes of project set-ups, with varying doses of management delegation. Chapter III-C takes a close look at port systems. Their complexity lies in themultiplicity of agreements relative to two functions: port authority (regulatory) andoperator (industrial and commercial). Ports can be divided into three main catego-ries, depending on the level of delegation exercised: operator port, tool port and lan-dlord port. The selected model must be well-adapted to local conditions regardingcompetition, traffic volumes handled, etc. Chapter III-D presents the characteristics of airport systems. This category oftransportation infrastructure has undoubtedly come to represent the most profitableand the most straightforward to implement as concessions. The concessionaire isentrusted with the status of airport authority and must coordinate operations withfour types of entities: airline companies, passengers (and their accompanying par-ties), non-aeronautical commercial activities, and the host of regulatory public ser-vices (airport security, customs, air traffic control, etc.). This assemblage requires atruly multi-faceted partnership established over the long term. Part IV – Delegated management of municipal services Part IV describes public-private partnerships principles pertaining to municipalservices. Though the nature of such public-oriented services remains heavily underthe responsibility of the competent local public authority, the economic activitiesthey engender may be delegated. Quite often, these services associate a local facilitywith a specific service provision, which in general comprises the very core of the acti- 11
  • 9. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSvity. Use of the generic term “delegated management” for these service partnershipsis definitely most appropriate. Chapter IV-A discusses the entire array of municipal services. As a result of thediversity encountered among these services, it would have been difficult to devote aseparate chapter to each. Four major categories have nonetheless been assembled:– environmental protection services (water and waste, which are developed in thisbook in two distinct subsequent chapters);– economic services, both basic (energy, telecommunications) and specific (publicfairs, tourism, slaughterhouses, etc.), and all services related to streets and publicspace (street lighting, public amenities, etc.);– construction and maintenance of public buildings;– recreational services (athletic, cultural, etc.). An insert included in this chapter provides a closer glimpse at electricity supplyand telecommunications services. Chapter IV-B focuses more specifically on municipal water services (production,distribution and sewerage). This sector illustrates to a great extent the multitude ofissues arising in service-oriented public-private partnership projects. Though a pro-duction function is very often present (e.g. water treatment plant), the critical featureherein revolves around the provision of an absolutely vital service (water supply),with its array of issues pertaining to user relations, the social acceptability of waterservice rates, quality of service, etc. On the other hand, this sector includes servicesintended for the locality as a whole, such as sewerage. A wide variety of delegated-management approaches are available, extending from a simple Build, Operate andTransfer “BOT” contract (for a treatment plant) or a service management contract(for overseeing distribution) all the way to the overarching system concession (withvarying levels of investment exposure). This part closes with Chapter IV-C, which examines the environmental services,and more precisely those services related to the entire waste sector. This sector iscurrently undergoing tremendous growth and features an emphasis on innovationand heavy capital investment. Service is provided to the local population, but oftenindirectly through a local authority (as opposed to water, whereby the user is serveddirectly). As is the case with water, a combination of pure service activities (wastecollection) and more industrial activities (treatment) typifies this sector. Moreover,these industrial activities involve a strong degree of product reuse and may combineprovision of services for both public and private clients. Part V – Close-up The final part of the book serves to gain a more in-depth perspective on the sub-ject. To lead off, a more theoretical chapter allows insisting upon the rationale andneed for making use of a panoply of public-private partnership models, adapted tospecific economic and political contexts and stressing certain invariant parameters 12
  • 10. Summaryencountered in all forms of public-private partnership. Accompanying chapters pre-sent the points of view of several eminent international organizations. The opinionsexpressed by the World Bank, the European Investment Bank and the EuropeanCommission have all been assembled here. 13
  • 12. A. IN FAVOR OF A PRAGMATIC APPROACH TOWARDS PUBLIC-PRIVATE PARTNERSHIPCorinne NAMBLARD1. The public-private partnership: seeking an equilibrium forgenerating mutual benefits Partnership, or partner: this term refers first to the person chosen to share adance, then to an ally in a game and finally to a teammate in bringing a project tofruition. The definition provided in one of the most reputed dictionaries is a ratherinteresting one in both its scope and evolution. As the saying goes: “It takes two to tango” In the book produced in 1993 by the International and Economic Affairs Divi-sion of the Ministry of Public Works, Transport and Housing (under the supervisionof Claude Martinand), the comparison was drawn between public-private partner-ship and a marriage. Etymologically speaking, it can also be compared to a dance,like the tango. Such partnerships, of immense utility in modernizing a country’spublic services and offering a whole host of advantages for both public authority andprivate company alike, should however not be presented as a risk-free panacea. The first utopia would be to presume that a public-private partnership features a“perfect equilibrium” in the harmony achieved between two parties. Like in dance,beyond the visual impression of harmony, the two partners are not altogether equal:there is always a leader, the one who “energizes”, sets the tempo, leads. The second utopia lies in believing or inciting the belief that a public-privatepartnership yields a “state of grace” (objective) which all project actors, whetherpublic or private, would have reached through steadfast determination and expe-rience. Such a view is to be completely avoided: the historical assessment provided inthis book is a cruel reminder for all those who champion public-private partnershipsthat this “newfangled” approach is merely a rehash of the same tried and true for-mula. These two preliminary remarks are not intended to rebuke public authorities forutilizing such public-private partnership formulae, but rather to highlight the factthat each application of public-private partnership must be designed and perceivedas one of the most effective solutions to a multi-faceted problem (building a pieceof infrastructure or setting up a public service) involving financial constraints. Its 17
  • 13. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSimplementation however requires the full-fledged support and a sizable and lastinginvestment on the part of both partners. “A new name, but the same old game”: PPP (Public-Private Partnership), a new acronym? Regardless of the titles and formulae chosen, the objectives have never reallychanged. Even the term Public-Private Partnership (or PPP for short) is just anotherrecent buzzword for encompassing a broad array of tools that enable associating pri-vate firms and public authorities in the completion of public service assignments.Included herein would be the various infrastructure concession systems introducedin France during the 16th century or the delegated management of France’s urbanservices, which began to thrive towards the end of the 19th century, along with thepanoply of formulae developed throughout the world over this last part of the 20thcentury in response to changes in local contexts (with, on occasion, preference beinggiven to the extreme option of total privatization). The second section of this article will thus be devoted to the benefits provided bypublic-private partnerships in this quest to satisfy the same basic set of objectives. Yet, as stressed above, all temptation to idealize such approaches must be resisted.As such, an effort to demystify this notion would be most opportune in order tohone a pragmatic approach focused on identifying a tangible basis for advancingand executing these desperately-required projects (regardless of their size and level ofsophistication, in both industrialized and developing countries). The third section ofthis chapter will undertake an assessment along these lines. In sum, it is unavoidable to focus on the existence and evolution of public-privatepartnership models and to examine how the “French model” is positioned (and evol-ves) either in France or internationally, albeit the term “model” has been inappro-priately used here to merely reflect a solid and conclusive experience stemming fromlongstanding tradition. The last section reviews these notions and proposes severalorientations for future initiatives, including potential courses of action.2. The primary advantages from the public authority’s standpointof utilizing public-private partnership formulae2.1 A Partnership that provides services of the highest quality at the lowestcost to the public At the outset, it is fundamental to observe that reliance upon public-private par-tnership for the provision of public services and infrastructure represents a solution 18
  • 14. In favor of a pragmatic approach towards public-private partnershipoffering a considerable number advantages, yet one which remains difficult to imple-ment and fully accompany throughout its duration. Public-private partnership set-ups are, by their very nature, partnerships builtbetween public authorities and private-sector firms/investors in the overall aim ofdesigning, planning, financing, building and operating infrastructure projects, whichare usually developed through more conventional market mechanisms, such as publicprocurement procedures. Public-private partnership does not only signify reliance upon the private sectorfor financing capital investment projects on the basis of revenue streams to be gener-ated by the future facility, but also incorporates the use of private-sector skill andmanagerial expertise in building and operating public service projects more effi-ciently throughout the project life cycle. In this respect, the core of a public-privatepartnership encompasses more the notion of service provision than simply infra-structure financing and construction. This observation leads to describing the basic advantages associated with theintroduction of a public-private partnership approach, along with the implicationsof such an approach in terms of the public authority’s role.2.2. Financial and budgetary benefits for the State2.2.1. Easing budgetary constraints By making it possible to employ private-sector financing, public-private partner-ship enables developing some projects at little or even no expense on the part of thepublic authority (albeit with the need in most instances for a certain level of projectsubsidization). The cost of service provision can often be transferred onto users (e.g.road tolls, water bills) by charging rates close to real costs, provided an adequateuser acceptance campaign has been conducted beforehand – a task expected of thepublic authority. Some financially-profitable projects serve to generate new resourcesby means of sharing profits between operator and public authority (e.g. tolls, taxes,etc.). Projects can thereby be developed without increasing debt exposure or overex-tending the national budget. Public resources are then available for meeting otherpolicy objectives, such as education or health. As a result, a country’s image – oreven its financial rating – gets upgraded, which in turn makes capital markets lessexpensive to access and foreign investment easier to attract.2.2.2. “Value for money” issues In addition to easing budgetary constraints, the use of effective public-privatepartnership set-ups – provided they have been applied to well-suited projects – allowsoptimizing project impacts while raising profitability for a given level of investment, 19
  • 15. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSin comparison with a basic public procurement contract. Such advantages are mani-fested in the following aspects:– better coordination and greater synergy between the phases of design, constructionand operations, under the condition that a sole tender be held for all three phasestogether;– an innovative design, the application of reengineering principles and efficient man-agement techniques;– emphasis placed on the quality of service offered to the user-customer;– an approach aimed at minimizing total project costs throughout the entire projectlife cycle (capital investment + maintenance + operations);– a more effective use of capital, coupled with the generation of complementaryrevenue.2.2.3. Optimal allocation and transfer of part of the risks onto the privatesector Public-private partnershi-type projects almost always comprise a high level ofrisk, due to: the magnitude of the financial stakes involved, uncertainties over con-struction and operating costs, and revenue-related uncertainties. A partnership-basedproject organization relies upon a balanced allocation of these risks (once they havebeen properly identified) and enables transferring a certain portion of them onto theprivate operator when said operator is better able to shoulder them than the publicauthority. In return, the public authority can significantly reduce its risk exposure(even though certain risks must remain on the authority’s side), while overseeingproject optimization efforts. The analysis, mitigation and allocation of a project’srisks will be discussed in Chapter II-B further on.2.2.4. A realistic evaluation and control of costs A public-private partnership set-up enables public authorities to better evaluatea project’s actual cost. A precise and realistic assessment of costs is of fundamentalimportance to project sponsors with respect to attracting financing, both on theequity and borrowing side. Public-private partnership also enables preventing againstmost types of cost overruns encountered all too often in major infrastructure projects.Indeed, by conferring a broad range of responsibilities upon the private public-pri-vate partnership partner, it becomes possible to avoid underestimating actual project-related costs early on in the process and, at the same time, to tighten cost (andschedule) controls by virtue of the bond developed between project builder, financialsponsor and operator. This actual cost then serves as a benchmark for all subsequentimprovements to the quality and efficiency of other public services. 20
  • 16. In favor of a pragmatic approach towards public-private partnership2.3. Economic and social benefits Should the primary concern of actors appear exclusively oriented towards “finan-cial” considerations, the momentum of a public-private partnership project mayeventually stall. Of critical importance herein is for the economic and social benefitsto remain at the core of the project’s rationale, first and foremost because the project(to be financed in large part from operating revenue) must be designed from thestandpoint of obtaining the best service at the most competitive price in meeting theneeds of the largest customer base. A public-private partnership’s underlying principle stems from the fact that thepublic authority remains responsible for service provided to the public, without nec-essarily being responsible for the corresponding investment. By means of the public-private partnership set-up, the public authority is therefore relieved of all investment-related obligations and able to concentrate on service quality control, while the pri-vate operator seeks to optimize its capital outlay in its provision of service at thisspecified level of quality. Furthermore, by extension the user becomes a customer,and the operator is thus in a situation of having to optimize the quality of serviceoffered.2.3.1. A streamlined construction schedule and reliable project implementationable to enhance economic development Whenever a project is deemed beneficial to society, a public-private partnershipset-up allows speeding up both implementation and construction. In this respect,it depends to a much lesser extent on budgetary resources, a condition which oftenleads to project postponement; it then incorporates a more political dimension. Thisaccelerated construction schedule, in turn, makes it possible to realize benefits morequickly for both the private company and the politicians backing such projects. Thisperspective remains valid regardless of the level of development of the countrieswhich implement public-private partnership projects.2.3.2. Modernization of the economy and indirect benefits By accelerating project implementation, these types of project set-ups help stim-ulate economic modernization as well: infrastructure gets built and new technolo-gies introduced more quickly. Given their service quality-oriented implementation,projects (construction + operations) are better able to respond to demand and adaptfast to changes in demand, thereby giving rise to a more dynamic modernization ofthe economy. Sizable indirect benefits for the country’s overall economic develop-ment are engendered as a result. 21
  • 17. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTS2.3.3. Access to financial markets, combined with the development of localfinancial markets Reliance upon private-sector financing also displays a decisively beneficial impactfrom a macroeconomic standpoint for developing countries. Such initiatives allowimproving access to international financial markets, by means of: attracting interna-tional capital; strengthening the country’s image in the capital markets, and utilizingwell-renowned operators enjoying special access to these markets. In the long run, this reliance also enables developing a local financial market.Complex project configurations imply a number of financing sources and often actto catalyze the local market, which is then led to modernize (or evolve) and adapt.2.3.4. Social benefits: improvements in services to local residents By refocusing the role of the public authority, in enabling it to better identifyits expenses and in scaling back budget allocations, major public-private partnershipprojects allow better earmarking resources for financing the unprofitable portion ofa project’s public service provision. Yet, for the most part, financial resources arefreed up for other public services not compatible with the public-private partnershipframework (health, education, social welfare, etc.). As such, local public agencies areable to channel resources and energy into their social service missions. Furthermore, some of the case studies developed in Parts III and IV of this bookreveal that public-private partnership set-ups can provide highly-innovative solutionsfor accommodating the less well-off population segments (e.g. water supply in LaPaz or Manila, waste services in Caracas).2.3.5. Sights set on sustainable and environmentally-compatible development As opposed to a commonly-held misconception, involvement of the private sector(within the scope of a public-private partnership) may actually enhance the environ-mental aspects associated with a development project, from two vantage points. Firstof all, the creation and expansion of environmental services (primarily sewerage andwaste removal/treatment) has become a fundamental component of any sustainabledevelopment program. The infrastructure needed to operate such services requiressizable capital investment, and collection functions (as regards waste) must be rununder flexible conditions. In this vein, a public-private partnershipapproach allowscreating these services more quickly and efficiently at a considerably lower cost forpublic-sector budgets. The second positive environmental impact of public-private partnershippertainsto the involvement, across the entire range of public services, of major internationalcorporations with access to the most up-to-date and “environment-friendly” tech-nologies. These corporate groups are increasingly cognizant of environment-relatedneeds (noise control, air pollution mitigation) and have considerable experiencing 22
  • 18. In favor of a pragmatic approach towards public-private partnershipadapting to the strictest of regulatory systems found throughout the world. Moreo-ver, they are capable of innovating and tailoring their service provision to changesin environmental demands. Building a partnership between public authority andprivate operators enables designing solutions better adapted to reconciling servicequality demands, the economic profiles of both users and the public authority, andenvironmental imperatives.2.3.6. Refocusing the role of the State on its regulatory functions By relieving the public authority of its role of service operator, the public-pri-vate partnershipgives the authority the opportunity to pursue its regulatory missionexclusively, which may consist of more accurately identifying public service demandsand their corresponding costs. In this manner, the authority is in a position to effec-tively assess the optimal level of service provision desired by the society, along withthe associated cost, in order to reach an appropriate tradeoff between economic andsocial efficiency. Public-private partnershipset-ups also make it possible to determineusers’ «ability to pay» threshold as well as the amount of subsidies necessary to main-tain unprofitable services deemed of public interest: the aim herein is to optimizefinancing of such services or at least to initiate a critical examination of this topic.2.3.7. Technological benefits Public-private project partnerships serve to attract high-level experts who havealready acquired broad international experience: builders, operators, along with spe-cialists and consultants in the engineering, finance and legal fields. While this high-level expertise is naturally exhibited by the private partner, it must also be accessiblefor the public authority, either in-house or through retained advisers. The resultanttransfer in technology or know-how turns out to be significant from several pointsof view:– construction and operating systems (the most modern techniques can be proposedin a way that has been adapted to meet local conditions);– project and operations management;– financial engineering;– institutional engineering;– etc. This transfer in technology and know-how exerts an impact not only on localfirms, whether directly involved in the project or not (by means of benchmarkingfor industry-wide standards), but also on the administrative agencies responsible formonitoring the project, local financial institutions and other context-specific actors.Another important factor pertains to the training of local personnel. Within a part-nership involving an international consortium, foreign firms will first seek to relyupon local personnel which it can train at the outset of the project, therefore leaving 23
  • 19. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSon site just a minimum number of foreign office executive staff beyond the transitionphase.2.4. The political benefits2.4.1. A new role for the public authority The political benefits also prove to be significant. By refocusing public authorityaction on its regulatory missions, a public-private partnership strategy transformsthe authority’s role from a service owner/operator into a regulator and controller.This newfound role then provides the opportunity for promoting efficient demand-oriented services of social benefit. The public authority comes out a winner by virtueof providing a better quality of service, while concentrating its resources on socialwelfare issues. In addition, the introduction of a public-private partnershipallowsrethinking the breakdown of public vs. private roles outside the confines of a purelydualistic mindset. This political advantage, however, may backfire if the public-private partnershipis not applied under adequate conditions and if the State has not procured the meansfor: establishing its objectives realistically, preparing its agencies and institutions forthe successful implementation of public-private partnership formulae, and in par-ticular conducting effective regulatory action.2.4.2. Allocation and not “abdication” Although the term privatization sometimes gets abusively used in public-privatepartnership cases, keep in mind that a public-private partnership is not a privatiza-tion program. Rather, it serves to attract private investors without abdicating publicservice missions to the benefit of private concerns. In sum, the public-private par-tnership can be defined as the delegation of a public service provision to a privateoperator for a given period of time. In no way does it alter the public sector’s owner-ship rights to the service infrastructure (as those facilities existing prior to the conces-sionary contract as well as those built during the concession return under publicauthority possession upon contract expiration). The authority maintains both itsrole of shaping public service missions and its regulatory oversight. Moreover, thisprocess is indeed reversible, either at the end of the stipulated contract period or(in exceptional cases of serious conflict) during the contract’s execution. The public-private partnership approach thereby allows retaining the “public” essence of theseservices while steadfastly refuting all accusations of “selling off ” national public assets(or service activities) to foreign interests or third parties.2.4.3. Project stability The social and economic advantages described above exert obvious impacts ona country’s economic, hence political, stability. For one thing, contracts are signed 24
  • 20. In favor of a pragmatic approach towards public-private partnershipfor periods exceeding the terms of elected officials. As a result, the public servicesconsidered tend to be less sensitive to both direct and indirect “electoral” effects. Theparameters of maintenance and quality of service are less likely to be subjected touncertainty, and projects will be required to display a tangible socioeconomic valuein order to be selected. Secondly, by enhancing the quality of public services without drastically increas-ing fiscal pressures, public-private partnership projects are able to instill economicwell-being in addition to social stability. Here again, any hasty introduction of apublic-private partnership-type partnership must be avoided: taking the time neces-sary to prepare both the population and local administration and to plan out thetransition periods is crucial to ensure not only acceptance of the notion that oneshould pay for service (at least in part), but also an appropriate regulatory frameworkto prevent against abusive practices.3. A therapeutic infusion of reality3.1. No miracle solution exists. It should start to become clear by now: public-private partnership can providea number of benefits in the domain of public interest projects. This type of set-upoften represents a more efficient alternative to the conventional public procurementcontract formulae for projects featuring a sizable “service” component. But be advisedof the dangers in simply jumping on the bandwagon or blindly believing in the exist-ence of a new miracle solution which – on its own – enables localities or the State torealize all their projects without investing any effort, time or money. The public-private partnership tool remains complex to implement and by itselfcannot take any project and turn it profitable. The bottom line is to recognize that apublic service or infrastructure project devoid of any real socioeconomic value cannotbe taken to fruition by virtue of merely introducing a public-private partnershipstructure. In order to be deemed viable, a public-private partnership project mustabove all fulfill the prerequisite (yet not entirely sufficient) condition of presentingan adequate level of socioeconomic profitability, i.e. combining utility for societywith economic feasibility.3.2. A contract between a public administrative entity and a private operator3.2.1. Instituting a basic contractual relationship between public authority andprivate firm Once these preliminary remarks have been fully incorporated, the public-privatepartnership constitutes in the end the formalization of a relationship, via a con-tract, between a public authority and a private builder/operator. As highlighted by 25
  • 21. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSRémy Prud’homme in Chapter V-A of this book, all public action implies privately-generated material supplies in one way or another (with the minimum consisting ofoutright public-sector procurement). As with any contract between a public entity and a private firm, both partnersare seeking to gain from the relationship. The public authority is looking to maxi-mize the socioeconomic profitability of public-sector investment (i.e. optimizing thecost-to-benefit ratio from society’s standpoint). The private operator, on the otherhand, is looking to maximize its financial profit (i.e. increasing the return on capitaloutlay). These objectives overlap to some degree (seeing the project succeed) while divergeotherwise (how to share project-induced benefits): a discussion is thereby held bothto determine how best to achieve overlapping objectives and to strike a balance(through vying for leverage) in dividing project benefits. In conventional public pro-curement contracts, this bipolar confrontation is simplified within the scope of thetender procedure and competitive bidding process: the public authority establishesboth the project’s objectives and set of specifications, while the bids received fromcandidate firms serve to determine the price level, hence the breakdown, of benefits.3.2.2. Who actually leads this public-private dance? The public-private partnership approach is a complex one, by virtue of sharedrisks and benefits against the backdrop of an evolving long-term relationship. None-theless, this “tango” gets choreographed as a real tug of war as regards the divergingobjectives. Two overlapping and interrelated factors (yet subject to widely-varyinginterpretations) set this dance’s tempo: time and money. For the public authority, the chosen form of public-private partnership must allowdeveloping and implementing the necessary infrastructure without excess budgetpressures and in a timely manner. For the private operator/builder, the key is to beable to perform its activity at an acceptable level of remuneration. If the user is solventand if his propensity to pay for service enables covering production costs, it may beenvisaged to pass on the entire cost to users. This situation reflects a profitable publicservice and the critical issue then turns to ascertaining whether a potential revenuestream should be tapped and split between operator and delegating authority. Suchis typically the case with airports and certain kinds of water distribution services.This dance-tug of war thereby focuses both partners on the amount to be paid forsupplying and operating the service. On the other hand, both parties share the sameimpetus to accelerate the start-up of service operations as much as possible. In other cases, the service proves to be of intrinsic value for society (socioeco-nomically, but not financially, profitable), i.e. users alone are not able (or willing)to cover production costs. Such is the case with a number of toll roads (not all),urban transit systems and rail services. In these instances, it becomes necessary forthe public authority to award a subsidy, either at the beginning of the construction 26
  • 22. In favor of a pragmatic approach towards public-private partnershipphase or on a proportional basis following start-up of operations. When a subsidyis involved, the financial discussion is centered on the amount to be offered (and,in direct correlation, on the partners’ respective risk-bearing thresholds). However, asecond element then comes into play: time. In most cases, the private sector infusescapital investment at the outset and thus prefers operations to start up as quickly aspossible once construction has gotten underway. In particular, the private partnerwill be incited to complete project construction ahead of schedule whenever feasible.Similarly, once the tender procedure has been held, the private builder/operator hasevery interest in seeing the process advance without delay. In contrast, this issue is much less straightforward from the standpoint of thepublic authority. For a combination of socioeconomic and political reasons, theauthority would prefer the project to be built quickly, or at least to be able toannounce a timely construction schedule. This impetus often gives rise to projectsbeing announced and tender procedures held before the “maturation period” hasbeen completed. Consequently, the tender process runs the risk of getting boggeddown due to the project’s poor technical preparation and the public authority’s inca-pacity to set the course right. Moreover, from a budgetary standpoint, the authoritywould be better served by putting off the tender to enable spreading public spendingover a longer period and, to a certain extent, reducing the subsidy amount (since, inmost cases, demand increases over time with respect to both service volumes and usersolvency). The authority is thereby tempted to procrastinate either during the tenderprocess (which sometimes gets launched prematurely, again for political reasons) orthrough obstructing a speedy project implementation (e.g. by holding up certainvital administrative procedures). This conflict over timing and schedules can adversely impact the project in thatit engenders heavy surcharges which get passed on not only to the operator, but alsoto the users and the authority either directly or indirectly. Such surcharges are to beavoided by effectively preparing the project and its financing plan ahead of time.3.3. The sharing of risks: reality or illusion? Time and money therefore serve to drive the decisions and negotiations involvedin building Partnerships. The discussions held at this stage get reflected in theproject’s organization, which is based on the notion of “risk sharing”. Chapter II-Bprovides an in-depth examination of this notion’s application. At this point, only the importance of this principle really needs to be stressed,along with its limitations. The breakdown of risks is after all what distinguishes apublic-private partnership from a conventional public procurement contract: theserisks may take on a wide variety of forms, anywhere from the basic construction risk 27
  • 23. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTS(a water treatment or waste plant BOT) to the full-fledged construction/commercialoperations risk (State Highway 91 in California). In basic terms, the project itself must dictate how risks are to be divided to bestensure maintaining overall equilibrium. It must be kept in mind that any assump-tion of risk necessitates some type of payment. The sharing of risks is not to beconsidered like a transfer of risk free of charge from the authority to the privatepartner, but rather a more optimal allocation of risks among partners based on theirrespective risk-bearing capacities. This feature also signifies that the cost associatedwith a given level of risk assumption is sometimes the factor being minimized in apublic-private partnership set-up. As an example, the construction/operations riskmay be controlled to a large extent by the private partner, hence the private partner’sperceived low cost for providing protection against this risk (implicitly included inthe construction price). On the other hand, the commercial risk is often quite sig-nificant and the cost of its assumption by the private partner may prove to be ratherhigh (which would engender a high contract price and an even higher subsidy shouldthe project happen to be unprofitable). If the authority were to absorb this risk, itmight wind up having to pay out compensation in the event of inaccurate traffic oruse forecasts. Yet, justification could be found for a project carrying with it strongsocioeconomic advantages. In the end, the sharing of risks is not a miracle solution, but instead a meansfor optimizing a project with respect not only to the technical and service qualityoptions, but to the cost of protecting against inherent risks as well. In this vein, theapproach recommended via the English PFI (Private Finance Initiative) framework,despite other rather severe limitations, seems most worthwhile. Furthermore, it is quite comforting to recognize that the most dynamic privatefirms on the international scene are now capable of citing the various public-privatepartnership “approaches” as references of their past successes. This continual enrich-ment and overlapping of experience are of great benefit by providing real-life casestudies for assessing the breakdown of risks/costs, the cornerstone of all public-pri-vate partnershipprojects.4. Public-private partnership projects cannot be integrated intoa strictly-deterministic model, but instead must be adaptedto the local context and allowed to evolve over time. As indicated above, France’s experience with various forms of public-private part-nership is indeed longstanding. As recalled in the Ministry of Public Works, Trans-port and Housing’s publication produced under the guidance of Claude Martinand,this manifold experience has often been channeled into the notion of a “Frenchmodel”. The term model is most certainly a misnomer since the very nature of 28
  • 24. In favor of a pragmatic approach towards public-private partnershippublic-private partnership does not in any way suggest the application of a model.A public-private partnership’s emphasis lies in an experience requiring adaptation tothe individual project and its unique context: as opposed to a basic public procure-ment contract, the public-private partnership cannot be easily standardized accord-ing to a strict set of criteria. This statement should not be construed as license to do anything and everything.This book has been intended to demonstrate that it is possible and even necessary todevelop strict approaches, yet adapted to each individual case, on the basis of a set ofeconomic, legal, ethical, administrative and financial principles. In France, the strong tradition of relying upon concessions has led to setting upan efficient overall system, some elements of which however have been progressivelycriticized within the scope of European integration. Nonetheless, the pertinence ofneither concessions nor the concept of delegated management has been challenged;rather, implementation practices were deemed not entirely adapted to the evolutionin the economic and institutional context. It has thus been necessary to modernizethe system in the aim of ensuring consistency: the corresponding steps are currentlyunderway in France. This process has been facilitated by the fact that the most active French compa-nies in the domain of concessions have built up their operations abroad and, as such,have been able to tailor public-private partnership implementation practices to sat-isfy a wide array of institutional frameworks. Regular and ongoing adaptation of experience gained in the area of public-pri-vate partnerships is thereby necessary, while not overlooking the founding principleswhich remain unchanged from one project to the next.5. A few recommendations for ensuring effective partnerships In the book’s following chapters, the various aspects of public-private partner-ships will be discussed and a series of pertinent recommendations will be derived. Wewill focus herein on the general approach to be employed for ensuring a successfulpublic-private partnership. First of all, it is essential to reinstate the good name of the term partner. Eachmember of a partnership is obviously promoting an agenda which cannot (and mustnot) totally overlap. Nonetheless, the common objective of all partners is to con-struct in the most efficient manner and at the lowest cost a piece of public infra-structure, and then to provide service operations under the most optimal conditions.Common interest therefore dictates that all public service projects be completed andoperate in accordance with contractual specifications. As such, an approach must be adopted which accommodates the interests of eachparty to the greatest extent possible by means of drawing commonalities from thesediverse interests. At the same time, each actor must be able to defend a clear and 29
  • 25. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSwell-founded position regarding the various points of divergence, so as to stream-line negotiations in the aim of reaching the fairest and most judicious compromisesbetween potential economic gain, incumbent costs and assigned risks. To be avoided therefore are: the fruitless meetings where one partner is playedagainst the other; overly drawn-out negotiations in which the objectives and goals ofboth parties are not clearly expressed; position changes during the course of bilateraldiscussions, etc. The financial stakes involved, coupled with the efficient allocationof time, money and resources, incites a more streamlined process. One of the recent advances within the scope of economic internationalization is without a doubt the growing necessity of tightening the respective obligationscontained in written contracts. The commitments undertaken by project actorscan no longer simply be based on moral grounds, but instead must be expressedin written, tangible terms. The outcome of negotiations leading to the final mode ofcontractual relationship must be recorded in the contract. Furthermore, all contractsmust stipulate arbitration or discussion clauses to handle situations in which thepublic-private partnership’s initial hypotheses prove invalid. Every potential scenariocannot be anticipated ahead of time (as the Anglo-Saxon legal tradition calls for);however, it can very well be anticipated that changes to the project’s context willrequire adaptations, hence the need to outline discussion conditions (so-called land-scaping amenity clauses). The body of jurisprudence is continually evolving and con-tracts should reflect this evolution. It is still necessary for each partner to uphold its commitments as well. The riskexists for partners with greater leverage in the contractual relationship to elect towaive their commitments and change the terms of the contract unilaterally. Suchmight be the case for the operator if it happens to possess considerably greater exper-tise than the public authority. Then again, such could also pertain to the authority,which alters its commitments either directly by invoking the «Imperial fiat» or moreindirectly by failing to execute the planned complementary projects or modifyingthe legal and regulatory framework. Recording the application of public-private partnership formulae in a “formalregister of concessions/public-private partnership”, along the lines of State-backedfinancial guarantees (which are entered into Central Bank accounts), could be rec-ommended as a measure to avoid such temptations and to firmly cement each party’scommitments, especially political commitments. 30
  • 26. B. TEN YEARS OF PUBLIC UTILITY REFORMS: 7 LESSONS (FROM PRIVATIZATION TO PUBLIC-PRIVATE PARTNERSHIP)Dominique LORRAIN Against a backdrop of public monopolies, both national and sector-specific, theprivatization movement of the 1980’s was interpreted as a strong statement. It rep-resented the tearing down of conceptions built between the Great Depression andthe post-War era which were inspired by planned-economy and Keynesian notions,whereby public intervention provides the efficient means for correcting market fail-ures. Moreover, during this period, natural monopolies were considered as signs ofmarket dysfunction. Spurred by the winds of political change sweeping in from the United States,Great Britain, Australia and New Zealand, the telecommunications sector was dereg-ulated, followed by the electricity sector and ultimately urban utilities (mainly water).These reforms took place at just the right time to bolster a French tradition, stem-ming from a longstanding (not well known) history of conferring public servicemanagement upon private firms. For many, the French “experience” in this fieldremained the domain of major nationalized companies, which was not at all thecase. This initial period of reform was characterized by strong political input andenthusiasm, along with the excesses such input engenders. The ideas championedby these reformers often got mistaken for reality. As is the case with any new phe-nomenon on the verge of taking off, backers were pressed to justify, defend and winacceptance of their actions. This period brought with it a flurry of intellectual activ-ity, thanks to the attention given by the disciplines of economics, political scienceand law (Law and social sciences) (Demsetz, 1968; Stigler, 1971; Kay et al., 1986;Littlechild, 1986; Vickers and Yarrow, 1989). Ten years later, at the end of the 1990’s, the change is striking. What had to bejustified and defended ten years ago today is simply taken for granted; the age ofheated debate has been left behind. All of the major industrialized countries haveadopted a stance in favor of such policies, and but a few of the developing coun-tries have yet to join the movement. For these reasons, the overall issue regardingdelegated management has shifted considerably. Emphasis is no longer on decidingwhether to delegate, nor on discussing the virtues of large private firms versus publicagencies: focus has moved from the “why” to the “how”. How should a durable coop-eration be organized between public authority and private firm? How can services bedeveloped to ensure accessibility to the greatest number of users while fulfilling all 31
  • 27. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSpertinent public service obligations? How can contracts be made robust enough towithstand crises? On the basis of a broad array of experience, encompassing a handful of sectors onall continents, an objective assessment can now be drawn. At this juncture, such anassessment is aimed at deriving general lessons reflective of the overall situation. Thehistory of delegated management is still obviously very present; for this reason, theexercise conducted below is to be considered as a sort of intermediate benchmark.The perception, in embarking upon this assessment, depends heavily upon the par-ticular frame of reference, the angle used to approach such operations. In spite ofthese safeguards, a close examination of key issues via a survey of past and presentcases (Lorrain, 1995 and 1999) has yielded a series of germane and pivotal results,leading to a group of seven lessons:1. From political doctrine to a needs-based response The strong debates over the choice of management structure during the initialyears have given way to a stance of pragmatism. The past was characterized byreforms relying upon a critique of existing bureaucracies: too costly, lack of respon-siveness to users; today, on the other hand, the pressures generated by service needsare such that a private sector presence is now mandatory. The reason behind thistransition is quite simple: infrastructure-related needs have become tremendous,whether in the area of large-scale technical systems (telecommunications, electricity,highways or the railroad) or municipal utilities (water, sewerage, waste, public tran-sit). Changing urban demographics in the world’s major conurbations, the industri-alization of developing countries and environmental protection impetus constitutethree forces all favoring the creation of a single gigantic market: a sort of urban infra-structure industry. These heightened needs explain the diversity found in the basic terms for namingthe new formulae between public authority and private firm: Public Private Partner-ship (PPP), Private Finance Initiative (PFI), privatization, delegated management,etc., all added to the lexicon with the traditional French term “concession”. Public-sector budgets have not been designed to accommodate this new level of expendi-ture. The net result is the arrival of major firms in the field of urban services manage-ment, for many of them, a phenomenon which should endure over the long run.This represents a turning point in the evolution of city management, with impactsspanning the spheres of local government and urban planning. Until now in most countries (France not included), urban issues had been han-dled by either a city’s public works department, one of local government’s branchagencies or large public corporations. The arrival of multinational and multi-sectorialfirms raises a whole new set of issues, with respect to both utility network regula- 32
  • 28. Ten years of public utility reforms: 7 lessonstion and metropolitan area governance. The scope of privatization operations hassurpassed the sector specificity intended at the outset. A decade ago, the experiences conducted throughout the world were still ratherlimited; at present, the number of requests received by firms to undertake projects issoaring. The choices offered are indeed quite broad: the tendency is to opt for majormetropolitan areas, able to propose large-scale projects and whose populations areoften more affluent than the rest of the country (with the prospect of high enoughvolumes to allow benefiting from economy-of-scale effects). A “map” of the world’smajor «privatization» operations closely resembles that of the largest conurbations.It remains to be seen whether a country’s dissemination of such experiences and aharmonious spatial balance can occur.2. From competition among models to a problem-resolutionapproach At the time of the first privatization decisions, defending the use of such prac-tices tended to polarize the contrast between the two most prevalent models: Anglo-American and French. Differences admittedly exist: each country has over the courseof history developed its own conceptions of how to go about structuring its munici-pal utility networks. These differences are not at all trivial or superficial; they per-tain to design, project selection, control measures, contractual relationships, conflict-settlement procedures, etc. The types of institutional architecture are also not thesame (Martinand, 1993). Moreover, these differences have on occasion been insti-gated by the competition held among firms since competitive bids were typicallyinvolving France’s three major service-provision firms, the main English utilities anda few of the top American players from the fields of energy services, waste and sys-tems engineering. Yet these stable «formulae» (referred to as models), thanks to theirdurability, reflect above all a level of constancy in the solutions to problems previ-ously encountered, without adding any presumption regarding solutions to new-found problems. One of this past decade’s key lessons has been to downplay the theoreticalantagonism between models. Actors in this domain wind up adopting pragmaticapproaches, depending upon the nature of the problems at hand, such that:• Actors set out to devise well-adapted technical solutions with a balanced cost struc-ture based on a service fee affordable to all users. This approach has allowed involv-ing private firms in those countries and cities with sizable shares of low-incomepopulation. If for cost-related reasons it proved impossible to provide the same qual-ity of service as in industrialized countries, operators would seek out and implementnew solutions. 33
  • 29. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTS • Actors innovate with financing set-ups, combining equity contributions with bor- rowing from international financial markets. Here once again, each contract is to be handled case-by-case. • The contractual structures themselves are getting fine-tuned. Regardless of their national origin, contracts are designed to offer a steady stream of solutions, giving rise to a wide range of potential learning situations and public-private partnerships. This line of discussion strengthens the argument against the presence of irreconcila- bly-opposed “models”. Through the use of different terms, each country has created distinct types of contracts which correspond with varying degrees of private-sector involvement and contract durations. From a low involvement profile to complete privatization, the gradation of potential solutions spans the entire gamut. In each case, the pertinent public authority chooses from among the range of available con- tract types, which all stem from either American, English or French legal doctrine. The firms, for their part, simply adapt. The various type of contract. High Privatization Concession BOOT BOTLevel of authority conferred Leasing “Affermage” to the firm Contracting out Incentive contracts, management contracts “Marché d’exploitation” Delegated management Low Operating & maintenance Short-term Medium-term Long-term Length of commitment The “invention” of new urban service provision models, assemblages of bits and pieces from existing models coupled with lessons drawn from past experience, is certainly ongoing. The number of multinational, multi-sectorial firms created over these last ten years attests to this trend: they are able to develop and implement solu- tions across sectors and across countries. 34
  • 30. Ten years of public utility reforms: 7 lessons3. Public-private partnership as a customized solution Out of this discussion comes the simple idea that no one best way, no singlepreferred model, exists which could be reproduced from one sector to the next orfrom one urban setting to the next. In order to last, contracts must be adjusted tomeet specific problems, contexts and actors. They must also be designed to accommodate both the type of service networkand the responsibilities being assigned to the firm:• Type of service network: Each category of network is naturally a unique technicalcomposition and features distinct constraints in terms of coordination. The first fewyears of the privatization process tend to focus on economic and bid-related consid-erations. It sometimes seems that the same tender procedures (competition for themarket) and the same competitive framework (competition on the market) couldbe applied to all sectors – from electricity to transportation, from cable networks towater supply systems. The inclusion of real factors, such as sunk costs1, and the issueof asset “indivisibility” have instigated the search for customized solutions in eachtype of network.• Along the same lines, the public procurement framework has exerted the mostdominant influence (Laffont and Tirole, 1993); efforts were undertaken to apply thisframework to relationships between private firm and public authority in the area ofpublic service delegation as well. Diversification in the form of privatization thenmade it possible to discern that service operations under private-sector managementresponsibility clearly belonged to a separate category. Two factors certainly accountfor this difference: i) the transaction per se does not pertain to a precisely-definedgood, but rather to the provision of a more nebulously-defined service; and ii) suchcontracts often extend over long periods of time. In order to incorporate these spe-cificities, project actors focus on building institutional configurations adapted tothe risks borne by each project partner. Some of these newly-devised contracts havebecome complex and sophisticated instruments.4. The importance of the institutional environment At the end of the 1980’s, international institutions and a good number of cor-porations embarked on «the good cause» by presuming that private-sector manage-ment of public services simply entailed buying and selling the assets of public-sectormonopolies and conferring operations. Such a vision however did not stand up verylong. The list of failures and incomplete projects have served as ample reminderof the truth that collective action can only succeed when propped up by a set of1. A notion signifying that in this type of sector, a minimum threshold of investment must be met priorto conducting any activity; such investment would be unusable elsewhere should the firm withdrawfrom the project. 35
  • 31. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSstable, public-oriented rules shared by all the actors. In the area of urban services,the involvement of private firms presupposes the existence of a certain kind of insti-tutional environment. Put otherwise, the presence of action implies having metthe prerequisites for action, a stance which pays tribute to the neo-institutionalismeconomists (Coase, 1937; North, 1990; Williamson, 1994). Once this aspect has been fully recognized, the solution is taken to the halfwaypoint. It is still possible to resurrect a few laws prior to adopting privatization poli-cies, yet their inadequacy would quickly become apparent: passing laws is one thing,but instilling a new mindset is altogether different. The institutional framework inplace cannot be dissociated from the culture and values ingrained in the actors apply-ing the laws. The cultural side of action programs cannot be reformed overnight. This last aspect has incited an evolution in favor of new approaches for designingreforms. In the past, simply privatizing public monopolies and signing contracts wasconsidered sufficient. Now, credence has been placed in the notion of dual-facetedaction featuring the contract as well as the overall project environment. Howeverthe global environment can only be partially altered before privatization by outsidereform. In most instances, the actors themselves build the institutional framework asthe action unfolds on the basis of the problems/solutions encountered. This orientation leads from an instantaneous conception of reform – possiblyincorporated within the scope of a political program – to a process-based concep-tion. It takes time to build effective rules; in order to ensure their acceptance andcomprehension by all actors (elected officials, service users, firms), a participatoryprocess is required. In response to this perception, international institutions invokethe term “capacity-building”.5. The “proper” sequencing and corresponding exceptions In many countries, sizable efforts have been expended by international financialinstitutions to set up initial experiences. As such, reformers and their consultants hadconsidered that by following the “proper” sequence (i.e. preparing the bid, award-ing the contract and then regulating operations), it would be possible to execute thecontract under harmonious conditions. In other words, according to the initial idea,a strong launch phase would be enough to ensure a successful project. Over time however, repeated events have revealed that the launch phase in and ofitself is not sufficient: it proves most difficult to develop forecasts and plan out thedetails of long-term service provision contracts (Annales des Mines, 1999; Defeuilley,1999). Admittedly, greater attention focused on preliminary design studies (hencea more costly preparation phase) has been a step in the right direction. While suchstudies yield a new source of knowledge which can be shared by all actors (public 36
  • 32. Ten years of public utility reforms: 7 lessonsauthorities, international institutions and firms alike), they are unable to provide theprecision of real-life contract experience or to predict major environmental transfor-mations. The basics tend to get covered, yet implementation often requires adapta-tion to new givens: updated environmental standards, revised investment priorities,a currency devaluation, or even social upheaval. With respect to contracts, it had often been deemed preferable and feasibleduring the first years of privatization to draft complete contracts2 (Henry, 1997).The past decade of experience tends to refute this position and suggests starting outwith incomplete contracts. This approach promotes a new balance in the contractualeffort over time. It turns out to be advantageous not to seek precision at all costsfrom the outset, so as to preserve resources and flexibility over the life of the project.This notion gets reflected in concrete terms during two specific time periods:• Incomplete contracts have practical impacts on the preparatory phase. It is notadvised to advance the design studies too far before selecting the operator since thepreliminary design may be quickly superseded and will, in any event, overlap withthe chosen operator’s input.• While it is acknowledged that long-term contracts cannot forecast all projectparameters with accuracy, contract revisions should not be viewed as project crises.This point is a critical one inasmuch as contractual adaptation has much too oftenbeen perceived as a failure, as an attempt by the firm to realign the contract toits advantage. Contractual adaptation is nothing more than a normal adjustmentmechanism for coping with changes in the initial conditions.6. The need for a regulator Throughout the rivalry between firms and between models, the French havelong challenged the idea of a heavy-handed regulator. National experience leads tothe spontaneous reaction that the same results can be achieved using less expensivemechanisms and that the relationship with the public authority can be set up toavoid confrontation. To a certain extent, experience has affirmed the validity of thisattitude. Regulation carries with it a cost, which may turn out to be quite high andnot necessarily in proportion with the results obtained. On the other hand, it has also been demonstrated that the notion of self-regula-tion, as practiced in a country like France (for urban utilities), proves difficult toapply in developing countries. In France, contractual relationships between localpublic authority and private operator are placed into a long-term setting of laws,rules and standards structured by the State and administrative agencies. When sucha setting is lacking (the case in several developing countries), the absence of an inter-2. A notion developed by economists to designate contracts with outline all possible scenarios andspecify all obligations. 37
  • 33. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSmediary – the regulator – can leave the public authority and private firm in a paralyz-ing standoff. The contract should not be viewed as a cure-all: it cannot address allproject parameters, especially exogenous parameters. One key lesson from these various experiences is the vital need for a regulator indeveloping countries. The history of the industrialized world shows that building aninstitutional framework within each sector has taken a sizable amount of time: sev-eral decades in order to derive a set of rules covering the majority of situations. It isnot imaginable that developing countries could do likewise in less time: institutionalsystems cannot be exported like any ordinary industrial good. Granted the obligation of a regulator, but how should this regulator be consti-tuted? for which set of missions? In light of the above discussion, it would clearlybe preferable to position the regulator more towards the realm of overseeing theproper implementation of public service-related rules (in accompaniment of Stateand local authority efforts) than with a strict mandate for inspecting/validating con-tract execution. In extending this concept further, a two-tier type of regulation canbe foreseen, featuring:– ongoing technical monitoring on the part of the municipality: this componentwould allow settling the day-to-day, micro-level problems which cannot be anticipa-ted and incorporated into the contract; such problems are specific to the operationsof each utility network and do not merit being routed up to the level of the regula-tory authority;– sector-by-sector regulation performed by a specialized agency, assigned a triplemission: i) overseeing the fulfillment of the major contractual commitments andconducting statistical comparisons; ii) assisting the local public authority; and iii)providing backup for the State level in adapting rules and building the institutionalframework.7. Progress through accepting risk In the absence of appropriate rules however, what course of action should betaken, given the reliance of utilities on a heavy dose of industry-wide rules? Would itbe necessary to wait for a body of rules to be produced? Yet, how are such rules to beproduced and where does the production process begin? Action cannot be initiatedwithout some sort of prop: nothing can be built out of thin air. As opposed to the rationality which guided reforms over the first few years, theinexistence of rules obviously leads to accepting incomplete contracts and toleratingbehavior which does not necessarily comply with the principles of rational action –consistent, communicative – along the lines of the Weberian ideal. One could wagerthat experience generated from these imperfect set-ups is still more valuable thaninaction and that, thanks to the inherent lessons drawn, project actors will be in aposition to draft new, more effective rules. 38
  • 34. Ten years of public utility reforms: 7 lessons This means of conceiving action occurring within imperfect institutional set-tings leads to the notion of “building” markets (the construction of urban servicemodels), i.e. the rules, standards and institutions necessary to incite action do notrepresent a fixed, available, exogenous stock for actors to choose from. In emergingfields – nowadays, information technologies; at the beginning of the 20th century, itwas water and electricity – or in developing countries, these elements get generatedby actors during the action process. This dynamic, which happens to be especiallypronounced in the utilities sector, engenders several consequences:• Contract-based consequences: If all contract parameters cannot be fully antici-pated, if actors are developing some of the rules during the action process itself, theuse of incomplete contracts (designed as a learning process and not as an ultimatedocument) is to be favored.• Regulation-based consequences: Current conceptions (the principal-agent theory)are based on the notion of a separation between regulator and firm. In manyinstances, the absence of rules is due to the public authority’s incapacity to draft themon its own; if the authority delegates there would be no reason to rapidly expandits know-how in this area. What stance should be adopted then? Acknowledge theasymmetry existing between private firm and public authority; recognize that theproduction of new rules is the fruit of a joint effort on the part of these entities; asa consequence, the strict breakdown in those roles which theoretically underpin theregulatory activity is not, in reality, so absolute. One major lesson from this past decade of reforms is the urgency of institutingnew regulatory modes which incorporate: the breadth of skills possessed by largefirms, the principle of jointly-produced rules, and the need to enforce public serviceobligations. What lessons are to be learned from the experiences of the 1990’s?u As a result of sizable and ever-increasing needs, major industrial rms haveentered the domain of public service management in an enduring fashion, in par-ticular in the world’s largest metropolitan areas.u An increasingly-pragmatic approach has been favoring ad hoc project organi-zations adapted to each legal and economic context as well as to each type ofnetwork, as opposed to the application of strict models.u The development of an appropriate institutional framework in accompanimentof the contracts themselves is vital, within the scope of a necessarily-lengthyinstitutional learning (“capacity-building”) process.u The public-private partnership constitutes a long-term association, which isnecessarily based on incomplete contracts. Unforeseen events must be antici-pated, and the regulatory system must often rely on the involvement of an inde-pendent body. 39
  • 35. FINANCING OF MAJOR INFRSTRUCTURE AND PUBLIC SERVICE PROJECTSu A public-private partnership is meant to be long-lasting and entails a certaindegree of risk to be shared between partners: risk tolerance proves essential toa project’s evolution.References“L’Europe des grands réseaux”, Annales des Mines, Réalités industrielles, april 1991.“Les réseaux de services publics”, Annales des Mines, Réalités industrielles, october 1994.“Exporter les services publics”, Annales des Mines, Réalités industrielles, october 1999.COASE R.H. – “The Nature of the Firm” in The Nature of the Firm, 1937; Williamson O.E., Winter S.G., London, Oxford University Press, 1991.DEFEUILLEY C. – Services urbains et développement durable. Paris, Ministère de l’Équipement-Isted, Institut de la gestion déléguée, 1999, 20 p.DEMSETZ H. – “Why Regulate Utilities?”, Journal of Law and Economics 11, 1968, p. 55-65.HENRY C. – Concurrence et services publics dans l’Union européenne. Paris, PUF, 1997, 225 p.HIGH J. (ed.) – Regulation, Economic Theory and History. Ann Arbor, The University of Michigan Press, 1991, 191 p.KAY J.A., MAYER C., THOMPSON D. (eds) – Privatisation and Regulation: The U.K. Experience. Oxford, Oxford University Press, 1986.LAFFONT J.-J., TIROLE J. – A Theory of Incentives in Procurement and Regulation. Cambridge, The MIT Press, 1993.LITTLECHILD S. – Economic Regulation of Privatised Water Authorities. London, HMSO, 1986.LONG M. et al. – Les grands arrêts de la jurisprudence administrative. Paris, Sirey, 1993, 820 p.LORRAIN D. (ss la dir. de) – Gestions urbaines de l’eau. Paris, Economica, 1995.LORRAIN D. – Urban water management. Levallois-Perret, Ed. Hydrocom, 1997.LORRAIN D. (ss la dir. de). Retour d’expériences (six cas de gestion déléguée à l’étranger). Paris, Minis- tère de l’Équipement-Isted, 1999, 94 p.LORRAIN D. – “The construction of urban service models”, in Bagnasco & Le Galès (Eds), Cities in contemporary Europe, Cambridge University Press, 2000, p. 153-174.MARTINAND C. (ss la dir. de) – L’expérience française du financement privé des équipements publics. Paris, Economica, 1993.NORTH D.C. – Institutions, Institutional Change and Economic Performance. New York, Cam- bridge University Press, 1990.STIGLER G. – The Theory of Economic Regulation. Bell Journal of Economics 2, 1971, p. 3-21.VICKERS J., YARROW G. – Privatization, (An Economic Analysis). Cambridge, London, The MIT Press, 1989, 433 p.WILLIAMSON O.E. – Les institutions de l’économie. Paris, InterÉditions, 1994. 40
  • 37. A. THE CONCESSIONARY CONTRACT: A FRAMEWORK, A PROCESS,A CONTRACTXavier BEZANÇON The decision on the part of a public authority to “contract out” in a concessionor «delegate» responsibility for an infrastructure project or a public service to theprivate sector requires, regardless of the country involved, fulfilling three essentialconditions.• First of all, an appropriate political, legal, fiscal and administrative framework mustbe set up to accommodate this type of contract, which is considered as distinct from anordinary public procurement contract. The concession is a long-term partnership-building process established between a public authority and a private entity aimed atenabling the latter to invest profitably in a public service – or public works – relatedproject. In contrast, public procurement merely consists of an acquisition procedurewithout any consideration paid to either contract period, service operations or levelof capital investment.• Secondly, this authority will be required to follow a specified contract-award pro-cess, which requires several stages which encompass facility or service design, con-struction and operations.• Lastly, a contract will be introduced to bind both parties over the long run. Sucha contract must contain minimum threshold conditions in order to: ensure the suc-cessful execution of the entire project, assign each party’s corresponding set of risks,and protect their vested interests. French tradition, for example, distinguishes fourmajor types of contracts. In sum, a public-private partnership will be completely built around these threebasic stages. The present introductory chapter provides a thorough review of thesestages, with special focus on contract content and the contract-award process. Subse-quent chapters will detail a public-private partnership’s core elements. Chapter II-Blooks at the economic side, which covers analysis and the breakdown of risks. Chap-ter II-C highlights a single vital parameter in a concessionary contract: the long-term nature and need to incorporate a contractual period spanning into the tens ofyears. Chapter II-D then parlays these contractual notions into legal prescriptionsby outlining the necessary legal context and clauses. Lastly, Chapter II-E provides adiscussion on the financial approach. 43
  • 38. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS1. A concession-compatible framework The concession is a process which allows associating a private partner, due to itsparticular competence and financing power, in the provision of a public service orin the construction and operations of public infrastructure projects over a long timeperiod. This contract, as well as the so-called “public-private partnership” contracts,is not at all identical to a public procurement inasmuch as their complex naturenecessitates a different, customized legal framework. However, the legal framework alone is not sufficient in launching a concession:it is also necessary for the authority or the country backing the project to exhibita strong pro-partnership stance and fulfill a series of preliminary technical condi-tions. Without such conditions, long-term capital investment programs could not beimplemented. This notion will receive considerable attention in both Chapters II-C and II-D.In what follows, we will examine more specifically two key elements to this contrac-tual set-up: the definition of a concession (Section 1.1), and the need to lay out aclear contracting process for concessions (Section 1.2).1.1. The definition of a concessionary contract1.1.1. A concessionary contract is not a basic public procurement contract. A concessionary contract is profoundly different from a classical contract for thepurchase of facilities or services, which is simply awarded to the low bidder on thebasis of a set of predefined specifications. The public-private partnership is in essence the outcome of a search for the mostappropriate long-term partner able to provide the necessary expertise and manage-ment capacity to effectively run a public service or facility. This type of contract canbe distinguished in broad terms from a public procurement contract by the follow-ing characteristics:– the total or partial assumption of the project’s capital investment program bythe concessionaire within the scope of a long-term contract, which affords the timespan necessary to both fully depreciate this investment and carry out the contractu-ally-stipulated service obligations;– the transfer of public service obligations from the concession-granting entityto the concessionaire with respect to public liability and the ensuing breakdown ofrisks between the two parties;– the unique, all-encompassing and complex nature of the contract, includingdesign, financing, construction, maintenance, facility operations, service provision,etc., the magnitude of which necessitates in-depth negotiations between the twoparties prior to drawing up the contract; 44
  • 39. The concessionary contract: a framework, a process, a contract– the link established between concessionaire remuneration and service operat-ting performance, notwithstanding the type of fee collection (e.g. tolls paid bythe public authority), and even if the right to financial equilibrium is supportedby a considerable body of national jurisprudence, and as the concession-grantingauthority’s participation in project financing or facility operations does not impactcontract characteristics, as long as some risk (even operation-only) is borne by theconcessionaire. In cases where the concession involves both the construction and operations ofa facility (as opposed to merely the delegated management of an existing servicenetwork), it is commonplace for the project to encompass a long works period priorto service start-up, hence before revenue-generation. This financial situation resultsfrom the sizable investment required up front, thereby producing a project financialcurve unique to this type of concessionary activity. On the other hand, a purely-service concession typically entails a correlated remuneration as of the contract’seffective date. The concession is defined therefore by a multiplicity of criteria. National lawmust provide for a legal framework dedicated to concessions, as distinct from that setup to accommodate public procurement contracts featuring specific rules for theiraward and execution. Table I below presents the essential differences between thesetwo contract types.1.1.2. A long-term process The concession is part and parcel of a long-term process, as discussed throughoutthe remainder of this book. The fundamental feature of any concessionary approachis reliance on a longstanding political commitment, not only for the project in ques-tion but also for concessionary formulae applied to other projects within the samecountry. Failure on the part of the public authority to fulfill its commitments mayhave negative repercussions on the country’s international relations and on otherpublic-private partnership projects as well. To prevent this from occurring, it is nec-essary to establish a distinct legal framework for this type of contract.1.1.3. A specialized working group within high-level government bodies Many countries with rather limited experience in the use of public-private part-nership, including those in Western Europe, have set up specialized working groupsfor concessionary contracts either within the Finance Ministry or at a high levelof government. Such steps have allowed deriving a standardized methodology forawarding concessionary contracts by capitalizing on cumulative experience at thenational level. Such working groups are composed of specialists and external consult-ants, combining a wide variety of skills and providing guidance to public authoritieson how to draw up concessionary contracts. 45
  • 40. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS Table I – Comparison between a public procurement contract and a concession. Public Procurement Concessionary Contract Provision of supplies, component (s) of a works Création of a public facility and management ofDéfinition program, or a service determined by the public a public service by a private entity via an authority agreement negociated with the public authorityPrimary – Single objective – Multiple objectivesCharacteristics – Short-term – Long-termThe contract – Lack of association with service management – Definite association with service managementThe contract – Not granted a public service delegation – Has been granted a public service delegationawardee mission mission – Supervision of execution of works by the – Supervision of service operations by the public authority concessionaire – Absence of pre-financing, co-financingt or – Pre-financing, co-financing and financing of financing of the works on the part of the the facility on the part of the concessionaire contracted builder – Zero capital investment from the contracted – Capital investment contributed by the firm concesionaire – No freedom in service or facility design – Freedom accorded in service/facility design accordedBasic – Contract devoid of any service creation or – Contract instituting and organizing the servicecharacteristics organization function (“secondary” contract) specified by the public authority (“primary” contract) – The contracted firm is not the project – The concessionaire is the project developer developer – Lack of contract management leeway granted – Contract management leeway granted to the to the firm concessionaire – No long-term hold of public domain – Generally associated with a long-term hold of public domain – Absence of joint Construction – Management – Long-term joint responsability assigned to the - Maintenance responsability concessionaire N.B.: Please note that the source of firm remuneration has not been highlighted in this table, since this parameter in no way serves (not even marginally) to differentiate these two contract types. 1.2. A clear concession-granting process 1.2.1. An approach based on project performance Whenever the concession-granting authority requests bids from the private sector, it is highly advised that authority demands be expressed in terms of expected service performance and that these demands incorporate at an early stage project externali- ties and administrative constraints. Unfortunately, it is not extremely rare to encoun- ter near-insurmountable obstacles further on in the development process, seriously jeopardizing the project’s feasibility. The private sector is indeed better able to define a performance-based response to both the problem and its associated constraints, provided they have been accurately defined at the outset, than when the public authority has opted to handle the implementation. The private sector’s propensity to innovate must be harnessed to generate customized solutions as of the project 46
  • 41. The concessionary contract: a framework, a process, a contractconsultation phase. The notion of performance indicators is examined in the insertat the end of this chapter. An increasing number of countries have been opening up to privately-developedprojects (and not just those inspired by infrastructure concessions) after having setup an appropriate legal framework. This trend should be looked upon favorably andcan be attributed to a longstanding tradition of “private-public” relationships. The proprietary status of the original concepts and innovative technological con-tributions submitted by the various candidate firms in a concessionary bid must beprotected by an ad hoc legal mechanism, so as to incite an innovation-driven proc-ess. Bid candidates would not be forwarding the same bold proposals if doubts wereto linger over the confidentiality of their ideas. Having all candidate firms compete on the basis of an idea submitted by onefirm and the subsequent application of innovations or original solutions collected bythe concession-granting authority during the bidding procedure without obtainingconsent or compensating the innovative firm(s) represent poor practices and serve todiscourage potential concessionaires.1.2.2. A fair treatment of all concessionary candidates The coordinated development of concessions requires that all firms submittingbids be treated equally. Candidate firms must be capable of assembling all of theskills necessary to fulfill the concession’s objective without the preliminary specifica-tion of the legal status for the candidate firms or consortium. Since the feasibility studies associated with a concession prove long and costly, itmay be useful to anticipate compensating candidate firms for a significant share ofthe bid-preparation costs incurred in the event of non-selection.1.2.3. The negotiated aspect of the concessionaire-selection procedure With the concessionaire of a public facilities project being obliged to undertakea long-term commitment and assume a multiplicity of risks (technical design, con-struction, financing, commercial, operations), it is essential for:– the public authority to clearly state the selection criteria used;– an initial stage of the tender procedure to draw up a short-list of candidates whichhave submitted attractive proposals for basing a round of public authority-candidatenegotiations, to be conducted in preserving the confidentiality of all ideas contrib-uted by each candidate;– the concession’s negotiation to be held with the various selected candidates with-out dismissing the possibility to propose variant solutions;– the principle of an intuitu personae assignment of concessions to be recognized,according to which the concession-granting party’s assessment of the concession-aire’s inherent qualities (on the basis of previous project references) is a key to thecontract-award decision. 47
  • 42. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS1.2.4 Contract stability and fairness The concessionaire and its financial backers must be ensured that the contract willextend until expiration without any potentially-destabilizing modifications being intro-duced. Both imperial fiat and Acts of God clauses must be included from the outsetwhen drafting the contract. In more general terms, the right to immediate compen-sation for the concessionaire must be anticipated in the event of a contract modifica-tion introduced by the public authority, while not altering the contract’s initial con-ditions.1.2.5. A concession built upon the notion of economic equilibrium The concessionary contract is to be built upon the notion of economic equilib-rium, which in part gets manifested by a well-balanced breakdown of risks betweenconcessionaire and concession-granting authority. Furthermore, the contract mustinclude appropriate clauses to allow for its evolution and eventual adaptation tochanges in the contract environment, while maintaining the potential for publicauthority control. These economic aspects of concessionary contracts will be dis-cussed in greater detail in the following chapters.2. The concessionary contract The contract serves to institute the rights and obligations of each of the two par-ties. It must contain certain clauses relative to the construction works and serviceoperations, as well as other clauses which establish the project’s financial equilibrium.Moreover, the contract stipulates the respective responsibilities of each party over thevarious phases of its execution. The contract must be written in a way that introduces no ambiguity in the mean-ings ascribed to each term or clause so as to avoid any potential misunderstandingduring execution. The concessionaire agrees to perform construction work and operate a service.Four obligations are incumbent upon the concessionaire: building the infrastructure,maintaining it in a good state of repair, providing service, and transferring control ofproject facilities to the public authority upon expiration of the contract period.2.1. Construction phase Most concessionary contracts entail the infrastructure to be built up front, andin some instances, some of the construction work is spread over the contract period.The initial capital works and all subsequent upkeep, repair work and heavy mainte-nance are typically absorbed by the concessionaire, and the contract must be expliciton this point. The concessionaire is bound to building the infrastructure under theconditions laid out in the set of specifications. The public administration has the 48
  • 43. The concessionary contract: a framework, a process, a contractright to oversee this phase. The concessionaire cannot assign its role of prime con-tractor to a third party for any facilities development, in accordance with the preceptof intuitu personae, which implicates the concessionaire “personally” in the contract’sexecution. According to French legal theory, the concessionaire holds no actual rightto the facilities, but has to deliver the infrastructure specified in the contract. Furthermore, the concessionaire is required to announce a detailed constructionprogram, along with a calendar of completion dates for each project component.A smooth technical transition from the initial works phase to the subsequent main-tenance mode requires emphasis on preliminary coordination efforts. Maintenancecosts for facilities contracted out as a concession may prove, over the long run, tobe significant, yet the absence of an ongoing maintenance program can jeopardizestructural integrity and result in handing over a facility in a poor state of repair uponcontract expiration. This transference at the end of the concessionary period presup-poses a state of repair and service operations in accordance with the contract’s initialterms. As such, all of the concessionaire’s construction-related responsibilities must bedefined and then overseen by the public authority until the contract’s completion.The definitions employed may indeed make reference to international or Europeanstandards. An appendix to the contract contains a detailed diagram of the worksprogram, some selected drawings and a calendar with the sequencing of operations. The concessionaire, by acting in the stead of the public authority as regards theconstruction and operations of public works, is granted the actual rights of a publicbody with respect to third parties. In this manner, the concessionaire holds the legalpower to expropriate in the name of public utility. The completion of certain sequences of the works program is decided throughjoint agreement by both parties; such components need to be identified and theirexecution determined at the outset of the contract1. Concessionary theory is based on the concept that a concession does not implythe transfer of ownership rights, whether temporary or permanent, but rather theright to provide a public service. While the concessionaire enjoys no actual propertyrights to the facilities it builds, it is still empowered to collect either payment fromusers, usually in the form of tolls, or remuneration for service provided. The author-ity agrees to grant a use right (sometimes an exclusive right) of public domain inorder to build the facility.2. The conditions stemming from European Community directives relative to public procurementcontracts (i.e. Directives 93/97 and 93/38) are in application throughout Europe. 49
  • 44. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS Table II. Primary stages during a concessionary contract. Stage Stage-completion criteria Political approvals of the PPP by both elected officials and the administration Social and economic acceptance of the future facilityThe first stage consists of creating theproject, obtaining all necessary political Project feasibility studyand social approvals and beginning Site expropriation and procurement of rights-of-wayto assimilate all project-development Initial technical development studyconditions Project profitability analysis Definition of expected performance levels Identification of environmental problems Commercial law and public-private partnership-based jurisprudenceThe second stage consists of creating Foreign investment lawthe projects legal framework favorable tothe use of a concessionary format Public-private partnership tax law Public domain Creation of a project team at the national government level Verification of the countrys financial ratingThe third stage consists of preparing Specification of the expected performance levelsthe tender procedure Selection of potential variants Pre-qualification of concessionaire characteristics Dissemination of a call for candidate bids Followed by the international call for tenderThe fourth stage encompasses both Step-by-step concessionaire-selection procedurethe tender procedure and all risk-related First round of negotiations with short-listed firmsnegotiations Identification, quantification and attribution of risks between the two parties through negotiation First draft of contract Determination of the definitive set of financial conditions offered byThe fifth stage, once the best bid has the parties involved (banks, the State, financial institutions)been chosen, consists of establishingand signing the contract Drafting of the definitive contract and (in some instances) a vote of approval by the National Parliament Transference of project site to concessionary control Issuance of pertinent administrative authorizations and buildingThe sixth stage corresponds to project permitsstart-up Execution of construction works Service start-up of the facility Start of operation supervision by the Public Authority Supervision of the concessionaire: – for execution of the construction works – for facilities management Precise assessment of complementary investment requirementsThe seventh stage covers the contracts Regular contract meetings to discuss and (if need be) adjustentire execution phase execution conditions Payment of subsidies or loans, in accordance with contract stipulations, and fees for use of public domain Upon contract expiration: handover of facility and equipment to the public authority 50
  • 45. The concessionary contract: a framework, a process, a contract2.2. Service or facility operations The public service outlined in the contract must be provided continuously underconditions stipulated with utter clarity. The assigned rate schedule must be respectedand the public authority is responsible for carrying out controls lying within its scopeor jurisdiction. The concessionaire’s obligations must also be precise concerning facility opera-tions: the contract establishes both the characteristics and quality of the service pro-vided to users. The public authority defines the nature of the concessionaire’s obliga-tions, which may be subject to subsequent modification, upon mutual agreement. The public authority at all times remains liable for the actual provision of thedelegated public service, regardless of the delegation status adopted. The contract’s conditions are to structure the relationships between the conces-sion’s customers and the concessionaire by virtue of a set of technical and administra-tive specifications of user access and corresponding rate schedules. In general, service operating conditions comply with the principles introducedover time into public service jurisprudence:– the service continuity principle : service to users must be ensured on a continuousbasis, without any interruption whatsoever on the part of the concessionaire; thisprinciple is then balanced by the following one;– the principle of concessionary financial equilibrium: although service operating con-ditions are liable to change upon public authority request, the concessionaire’s rightto ensure the financial equilibrium of its contractual commitments is fully recog-nized;– the principle of equality implies application of the same rate schedule and serviceaccess conditions to the entire public;– the principle of adaptation or evolution stems from changes in user needs and con-tinual advances in leading-edge technologies: the concessionaire must be able toadapt its service to accommodate these modifications, and it is advisable for thecontract to address such eventualities;– the principle of neutrality: this principle stipulates that no category of user shall besubjected to discrimination not grounded on economic differences. The concessionaire is granted a true level of management autonomy in carryingout the missions assigned in the contract. The public authority agrees not to meddlein management practices implemented by the concessionaire during the fulfillmentof its obligations. On the other hand, the public authority must perform controls inaccordance with contract provisions; this function corresponds to one of its obliga-tions in the concessionary process. Since the concessionaire (chosen to a great extent on the strength of referencesfurnished) is being held “personally” to its commitment of fulfilling service obliga- 51
  • 46. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTStions, a contract transfer to a third party can only take place with full public autho-rity consent.2.3. A well-balanced contract The concessionary contract draws its equilibrium over the long run and in accord-ance with initial expenditure projections. The extent of this contract period dependsupon the capital investments and services assigned to the concessionaire. The longerthe contract period, the greater the likelihood that the concessionaire will be able todepreciate construction costs and provide service under profitable conditions. The concessionaire’s remuneration incorporates the risks being absorbed (design,construction, financing and operations, in addition to all exogenous risks); it mustbe fair and allow the concessionaire to earn a reasonable profit. With respect to infrastructure concessions, technical risks are often very sizable.The commercial (or traffic-generation) risk may also prove to be considerable when-ever a change in consumption patterns or product/service prices occurs during thelife of the contract. Concessionary contracts contain a clause relative to the principle of «unforesee-able events», as discussed above. Such a clause stipulates that the concessionaire isentitled to compensation for an imbalanced operating situation should the contractbe modified significantly by events or circumstances exogenous to both parties andbeyond their control2. The contract must also contain specific mechanisms to enable modificationsshould the need arise or should a change be sought by both parties. The contract must address the issue of liability in the event of damage caused tocustomers or third parties. Generally speaking, operations liability is assumed by theconcessionaire in its capacity as service manager. In the case of concessionaire default,public sector liability may be implicated. Such is also true if the public authority hasnot adequately exercised its power of control over the concessionaire. Since the concessionaire has been granted the right to operate the facility, itenjoys complete independence, free of all public authority dictates3. The operator’sprincipal rights pertain to policing the facility and collecting user fees; the policingfunction stems from the contract itself, which assigns the concessionaire the respon-sibility of ensuring the service runs properly pursuant to the delegation of power. The right to collect tolls and user fees is also laid out in the contract. Fee sched-ules are often established by administrative agencies in conjunction with the con-cessionaire, which retains full rate-setting freedom within the scope of fully-privateconcessions subject to a ceiling set forth by the public authority.2. A simple modification to the contract execution conditiond does not cause this principle to beinvoked; rather, a sizable and durable contract desequilibrium is necessary.3. The contract may forbid the concession-granting party from awarding a second concession in com-petition with the first. 52
  • 47. The concessionary contract: a framework, a process, a contract Table III – Public service delegation: Each party’s role during contract execution. The public authority Both public authority The concessionaire and concessionaire Organization of the public service Delegation Provision of the Transfer deleguated public service Service contracting Overall delegation design Detailed delegation design Design and technical/financial options1. The public entity assumes control Remark: Two objectives areof the public service, examines the possible:issue of potential delegation – Complete public service – Partial public service, especially2. Overall design responsibility for public works (infrastructure)the delegation process (degree of concessionsdelegation or association, feasibility 1. A long-term contract:considerations, financial impacts, – Agreementetc.) – Set of specifications3. Establishment of the Rights and – Remuneration basesObligations assigned to the – Risk-taking 1. Technical solution proposalsconcessionaire and users, along with – Breakdown of risks submitted by the concessionaireprimary service characteristics: – Phasing of project operations regarding service management,– Third-party considerations – Public authority prerogatives capital investment program,– Equality-continuity- – Service regulation remuneration framework, etc. transferability of service – Service continuity organization4. Decision on the public sectors 2. Negotiations held between thepower to delegate made by two partiescouncil/assembly deliberation 3. Joint statement of purpose5. Selection of the concessionaire issued by the two partiesand contract award6. Setting up the concessionarycompany (approvals / permits /public domain rights-of-way)7. Delegation control 4. Acceptance of completed Depending on the level of– Control of construction work facilities autonomy built into the contract:– Control of service provision 5. Relations between the two 2. Investment - Financing - parties with respect to service Subcontracting provision: 3. Public service operations and Adjustments, amendments, etc. provision - relations with: – Users (rates/level of service/responsibilities, etc.) – Third parties – Personnel8. Handover or buyout 6. Transfer of the service in 4. Eventual buyout exchange Termination of contract Handover of equipmentThe first column corresponds to the level of “political determination”: the contract’s founding legalpremise.The second column serves to shape the two parties’ joint statement of purpose, covering both the con-tractual organization and service regulation.The third column specifies the concessionaire’s responsibilities throughout the contract’s execution. 53
  • 48. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS2.4. Termination of the concession The concession comes to an end either upon expiration of the contractually-stip-ulated concessionary period, contract cancellation, concessionaire default, or buyoutby the public authority. At the contract’s expiration, the public party begins acting in the stead of theconcessionaire, which is thereby obliged to hand over all facilities in a good state ofrepair to the public authority. Contract cancellation announced by the concessionaire occurs infrequently: con-tracts are typically cancelled by mutual consent. Contractual default on the part of the concessionaire is pronounced by the publicauthority, which then decides unilaterally to cancel the contract (often in associationwith penalties depending on the severity and duration of the default). Lastly, contract buyout is a right held by the administration to replace the conces-sionaire before expiration of the normal concessionary period, in exchange for com-pensation. Such an eventuality however must be stipulated in a separate contractualclause.BibliographyBEZANÇON X. – Essai sur les contrats de travaux et services publics. Contribution à l’histoire adminis- trative de la délégation de mission publique. Paris, Librairie générale de droit et de jurisprudence (LGDJ), 1999.BEZANÇON X. – Les services publics en France du Moyen Age à la Révolution. Paris, Presses des Ponts et Chaussées, 1994.BEZANÇON X. – Les services publics en France de la Révolution à la Première Guerre mondiale . Paris, Presses des Ponts et Chaussées, 1999. 54
  • 49. The concessionary contract: a framework, a process, a contract Quality considerations: The introduction of performance indicators André BINDERThe objective of any public-private partnership is to expand the possibilities for providing high-quality public service by means of combining the resources and expertise of each partnerand then channeling them into achieving a common set of goals. Keep in mind that the fun-damental goals of both public authority and private rm tend to be in mutual opposition.The public authority primarily focuses upon:– the long term, materialized by the major structural effects generated by physical infrastruc-ture;– minimization of the reliance upon public-sector funding.The private operator, on the other hand, places emphasis on:– the short and medium term, materialized by the rm’s project-generated workload;– maximization of nancial returns.Within this context, the objective of pursuing a set of overlapping project goals can be met onlythrough the application of detailed, clearly-understood and relevant ground rules throughoutthe life of the partnership; these rules serve to limit any divergence in incentives caused bydifferences in the two parties’ specic intentions.1. The central thrust in the qualitative evaluation of public service provisionThe partnership engaged in order to develop a project can be characterized by a series ofcommitments from both parties, comprising qualitative as well as quantitative criteria.As regards the quantitative side, the ground rules used to assess project compliance withcommitments are straightforward to identify and implement.On the qualitative side however, such is not the case: satisfying the public authority’s long-term objectives basically involves upholding qualitative commitments across all stages of thepartnership’s life cycle: selection of partner(s), project design and construction, and then facil-ity operations.The public authority must therefore make use of methods and tools that allow determining,dening and ranking these qualitative aspects, so as to be able afterwards to evaluate thelevel of compliance with contractual commitments.2. Keys for incorporating qualitative evaluation into public service provisiona) During the private partner-selection processThe qualitative aspects being sought by the public authority must be identied and estab-lished within the tender’s set of contract specications.This step entails signicant efforts in order to:– determine the qualitative factors deemed important by the facility’s future customers(users);– rank these qualitative factors on the basis of future customers’ expectations;– dene each factor using terms which are not just comprehensible, but also capable of beingemployed within the performance-compliance evaluation system.The last point needs to be formalized to a great extent, inasmuch as qualitative factors revolvearound general concepts such as: personal safety, user information, comfort, hygiene, recep-tion amenities and human presence.Moreover, the manner in which proposals are incorporated into the overall bid evaluationmust be indicated in the tender rules. This feature would enable each candidate to devise, ina situation of perfect information, its bidding strategy. 55
  • 50. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSThe means implemented to monitor performance regarding qualitative attributes, in particularthe compliance of results with respect to contractual commitments, must be mutually agreedupon so as to ensure that each party fully recognizes the inherent representativeness andfairness of the approach.Candidate rms may nd it worthwhile to propose performance-evaluation techniques as ofthe time of bid submission. Such a move would then allow establishing and approving per-formance measurement conditions during the negotiations held prior to signing the nal part-nership contract.In conclusion, an approach along these lines provides enhanced visibility to both partieswhen formalizing contract specications and selecting a partner (from the vantage point of thepublic entity), and when formulating a bid (as seen from the private side).b) During the life of the partnershipIn order to satisfy its long-term objectives, the public authority must be in a position to ensure,throughout the life of the partnership, the compliance of service provision or construction workwith contractual commitments.Both the pertinence and mutual acceptance of the means employed to evaluate such compli-ance are thus critical. The evaluation process must be agreed upon from the outset of thepartnership and acknowledged as being representative; in this manner, the groundwork maybe laid for subsequent cooperation which will allow assigning responsibilities through applica-tion of each party’s rights and obligations.Furthermore, in such a nebulous realm as a project’s qualitative aspects, it is most essentialto remain exible while regularly calling into question, as the partnership progresses, thecontinued relevance of the initial contractual framework.This issue gets raised to the extent that customer expectations are inuenced not only by theexperience acquired from use of the service, but also by exogenous factors, such as competi-tion from other services, technological evolution and the regulatory environment.The periodic reevaluation of qualitative specications is thus imperative to achieving long-term public authority objectives.Any such reevaluation, as well as that of the monitoring methods, must be conducted with theapproval of both parties in a truly cooperative spirit, thereby enabling each party to act withinthe scope of its specic agenda while remaining a positive actor to a well-balanced partner-ship.3. A well-balanced partnership based on both qualitative and quantitative evaluationsAs highlighted by a plethora of examples, incorporating quantitative factors alone raises aserious risk of failing to meet the public authority’s long-term objectives.An efcient public-private partnership therefore also necessitates taking account of qualita-tive factors. This requirement has already made it possible to extend the search for pertinentsolutions, based on exacting approaches.Only once quantitative and qualitative factors have both been included into the equation cana true public-private partnership, well-balanced and in the vital interests of the community,actually be instituted. 56
  • 51. B. RISK ANALYSIS AND SHARING: THE KEY TO A SUCCESSFUL PUBLIC- PRIVATE PARTNERSHIPJean-Marie AOUST, T. Craig BENNETT, Roger FISZELSON The preferred economic approach for analyzing Public-Private Partnerships is centered on the equi- table sharing of risks. This notion serves as the basis for building a well-balanced partnership between private operators and public authorities. The goal herein consists of each partner stamping its mark on the project blueprint in a way that allows both parties to come away winners. While the fundamental interests of each party are quite distinct, both stand to gain from a successful public- private partnershipproject. Project risk management involves a four-stage process: risk identication, assessment of the poten- tial impact in the event of risk occurrence, risk-by-risk limitation, and allocation of residual risks. The primary categories of risk are as follows: technical risks (design-construction), nancial risks, demand-based risks (service operations), revenue-based risks, risks of “force majeure” (Acts of God), macroeconomic risks, and legal risks. Some of these risks happen to be specic to the private sector (e.g. insufcient return on investment), while others only pertain to the public authority (non- performance of a public service). A number of measures can be taken in a coordinated manner by private operator and public authority in order to limit overall project risks, namely by means of establishing a sound project basis, deter- mining the most appropriate choice of nancing, and adopting a well-targeted marketing approach with respect to the end user. Nonetheless, once these more general “project” risks have been con- tained, the inherent residual risks must still be allocated. From this standpoint, the two partners’ set of interests do not overlap; hence, an effective public-private partnership represents the successful completion of a well-balanced negotiation process conducted with a long-term perspective. Two basic principles serve to guide this division of risks. The rst stipulates that risk must be remuner- ated, with the quantity of risk borne by a partner being made proportional to the level of prot earned (nancial, socioeconomic, etc.) from the project. The second principle states that each risk is to be assigned to the actor most capable of managing it, given the nature of the risk; such an approach must be applied with the rst principle keenly in mind. The heart of a public-private partnership project lies in the analysis of the inher-ent risks. Such an analysis serves to shape the project, determine its feasibility, devisethe measures necessary to limit risks, and enhance viability of the overall projectenvironment. Moreover, risk analysis allows structuring the Partnership: each par-ty’s role, level of involvement, contractual commitments and financing premises. Inshort, this analysis gives rise to the entire set of conditions governing the success ofa public-private partnership. 57
  • 52. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS1. Reminder: The primary risks borne by the public authority andthe private operator In a concessionary (or delegated management) framework, the public authorityand private operator enter into a partnership with an overlapping objectives, yethighly-distinct motivations: the former is seeking to improve the quality of serviceprovided to the public, whereas the latter is seeking a reasonable return on capitalinvestment, sharing of expertise and assumption of risk. However, this deviation inobjectives does not exclude a certain degree of commonality in the purposes behindpursuing the partnership, first among them being customer satisfaction. Reliance upon a public-private partnership can be of benefit to both partnersprovided that the risks inherent to this type of project set-up have been sufficientlywell analyzed beforehand and fairly apportioned, i.e. individual risks being assumedby the most appropriate partner. It is also necessary to have won acceptance for thepartnership politically, socially and even culturally. Once these conditions have been fulfilled, each partner is in a position to contrib-ute in a meaningful way to building the partnership. The private party contributes itsskills, innovation capacity, management expertise, productivity, and both direct andindirect financial sources (equity and debt). On the other hand, the public partner(within the scope of its public service mission) is able to cut its financial expenses,thereby freeing up newly-available resources for other public service obligations (, health and safety) in areas with no direct revenue-generation potential. In an optimal scenario, the result is a “win-win” situation where both partiesalong with the ultimate beneficiary – the service user – gain from the partnership. In order to make the most of such a project set-up, it is essential to accuratelydetermine the most suitable contractual period: keep in mind that ventures of thistype typically last a minimum of 20 years and, just like during a human’s life, are veryprone to risk (risks at “infancy”, “adolescence” and “adulthood”). It is quite obvious that a drop in performance, let alone a breakup of the partner-ship, would most certainly engender:– for the public authority, a degradation in the quality of service provided, coupledwith the risk of budgetary surcharges if it must eventually step in to assume respon-sibility for running the service, in the absence of private-sector interest;– for the private operator, a lower remuneration, or even a loss of a portion of capitalinvested. As such, a risk affecting one of the partners has repercussions not only on theproject, but on the other partner as well. It is in the common interest of both part-ners therefore to work together to limit all risks with a bearing on project success. These risks are not generated from a single cause, but rather may stem from anumber of both direct and indirect causes arising throughout the life of a project, 58
  • 53. Risk analysis and sharing: The key to a successful public-private partnershipfrom its origin all the way to maturity, which at any point in time may undermineor kill the project. In order to minimize the occurrence of such risks and to prepare, in the event ofrisk occurrence, the appropriate remedial measures, it is essential to identify as farahead of time as possible the various types of risks capable of upsetting the projectbalance, distorting it, or even leading to its demise. These considerations have incited us to conduct a typology of risks (broken downinto general risks and risks specific to either private operators or the public authority)and to analyze the means by which their mitigation and elimination is possible. Risklimitation normally involves four successive stages as follows:– risk identification and inventory;– quantitative and qualitative evaluation of potential project impacts due to riskoccurrence;– risk mitigation;– allocation of each residual risk to the most relevant partner.2. Typology of common risks All projects entail risks: the key to setting up a Public-Private Partnership lies inevaluating the inherent risks and in determining how best to manage them. This process involves distinguishing risks intrinsic to the project from exogenousenvironmental risks and then categorizing them on the basis of both their periodof occurrence over the project’s duration and their direct or indirect influence onoperating material and financial flows. From this vantage point, it is necessary to differentiate between risks capable ofoccurring during the design-construction phase, those capable of affecting the opera-tions phase, and those related to the project environment.2.1. Risks arising during the design-construction phase This category encompasses risks on both the “technical” side and the “economic/financial” side.2.1.1. Technical risks The technical risks (or construction risks) encountered during the design-con-struction phase result from technological choices and the sequencing of the con-struction program: they consist of cost overrun risks and schedule overrun risks. • Cost and schedule overrun risks These risks can stem from several sources: delay in administrative approvalsand/or land acquisition, geological conditions, poor appreciation of the local con-text, default on the part of a supplier or subcontractor, etc. 59
  • 54. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS The risk of cost overruns can also arise from an underestimation of the costof works and facilities or from a change in project specifications (in particular byvirtue of public authority request). This risk does not necessarily engender a scheduleoverrun as well; however, the reverse is highly unlikely due either to the extra costsrequired in accelerating construction in order to reduce delays (at least partially) orto the application of intervening financial charges. The consequences of risk occurrence can be measured in financial terms: increasein the amount of capitalized interest, hence higher financing needs or deferment ofthe initially-projected operating revenue. • Risk factors introduced during design Restraint must be exercised within the scope of a public-private partnership whenresorting to untested technological innovation, given that financing outlays are tobe reimbursed and remunerated for the most part by future revenue streams. Theuse of untested technological developments implies risks of implementation, capac-ity shortfall and operating difficulties. Even the combination of several tried andtested techniques or a simple “scale jump” can raise detrimental compatibility- orperformance-related problems. The level of caution necessary in the use of new techniques however should notdissuade from pursuing technological innovation, which remains an integral part ofthe makeup of a concession whenever innovative techniques represent the sole meansfor completing the facility (e.g. the “Rion Antirion” Bridge in Greece, the upcomingviaduct project in Millau, France) or enable reducing construction costs, hence tolls,significantly. In such cases, the financing plan must integrate risk by means of settingaside an adequate reserve. A number of risks, especially geological ones, can even beborne by the concession-granting authority when its assessment proves overly uncer-tain (see Colombia’s highway-building program: El Vino / Puerto Salgar). • The project completion risk factor This risk pertains to the technological risk as well as to the construction firm’scapacity to build the facility; it may lead to the risk of both schedule overrun and costoverrun. Moreover, it may be tied to the builder’s incapacity to execute the projectsatisfactorily (project completion risk), in addition to other factors governing theinteractions between project actors. It is not uncommon for several construction firms to be involved, with each beingassigned responsibility for a specific component of the project (e.g. water treatmentplants, which incorporate both a civil engineering firm and a process company).This scenario presents an interfacing risk, or a coordination risk between the actorsinvolved, which could engender a risk of both schedule and cost overruns. For reasons, either imposed (mandatory recourse) or inspired by competitivepressures, reliance upon subcontractors (particularly local ones) may engender risks 60
  • 55. Risk analysis and sharing: The key to a successful public-private partnershipof insufficient technical capacity and incomplete control over individually-assignedproject components, which imply risks of both schedule and cost overruns (the sub-contracting risk). Lastly, for many large-scale projects, unforeseeable risks related to conditionsexogenous to the work site must not be overlooked either. These pertain, in particu-lar, to climatic and subsoil conditions (which prove considerable in projects involv-ing undergrounded structures or especially deep foundations).2.1.2. “Economic/financial” risks “Economic/financial” risks are related to parameters inherent in the project’sfinancial set-up. The impact of their occurrence is felt as cost and/or schedule over-runs, hence an overall inflation of project costs and a loss of overall economic profit-ability. This category of risks lies, first and foremost, within the set of parametersexogenous to the contract which serve to establish its financing conditions; it alsoencompasses the respective capacity of the contractual parties to uphold their finan-cial commitments. • Risks related to the contract’s reference financial parameters The indexation risk can arise, notably in the case of a long-term constructioncontract whereby the price is not firm but rather indexed to certain economic param-eters (such as the construction cost index). Should the rate of inflation prove higherthan anticipated and reserves insufficient to cover this excess, the amount of financ-ing allocated will fall short of needs. The interest rate risk arises when variable-rate financing has been allocated forthe construction period (e.g. Euribor, Libor programs). Since the project is not gen-erating any revenue during this period, any increase in the variable rate will give riseto an increase in capitalized interest and thus to additional financing needs. The exchange rate risk may arise whenever expenditures and revenues are basedin different currencies. • Upholding commitments and refinancing The refinancing risk may arise whenever financing has only been settled for theconstruction period. This risk weighs on the project if, upon completion of construc-tion, no long-term financing can be procured to take up the slack in expired finan-cing. The counterparty risk may stem not only from a misevaluation of the projectbuilder’s financial capacity (up-front equity contribution, financing of cost overrunsor shortfalls in revenue generated from the service’s partial start-up, etc.), but alsofrom misevaluation regarding subcontractors (weak financial status, inadequate levelof guarantees, etc.). Such a risk may engender the inability of the builder to fulfill itscontractual obligations, thereby incurring at least a risk of schedule overrun. These 61
  • 56. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS“private” risks are then complemented by the “public” risk resulting from failure ofthe public authority to meet its specific set of commitments (provision of subsidy,customs fee waiver, V.A.T. waiver, etc.).2.2. Risks arising during the operations phase Once the construction phase has been completed, risk then gets transferred ontoboth project-generated cash flow volumes and operating costs. This risk intensifiesas the period of operations, over which the accuracy of forecasts cannot be ensured,grows longer.2.2.1. The income risk This risk can be divided into a pure patronage (or “volume”) risk and a price riskleading to an insufficient volume of income. The pure patronage (or “volume”) risk is characteristic of infrastructure projects,and in particular for newly-constructed transportation facilities. It tends to be deci-sively higher than in cases of merely improving existing infrastructure (e.g. upgrad-ing a thoroughfare to meet highway standards), especially if the new facility (tollroads, toll bridges/tunnels, public transit, etc.) is subject to competition from eitherfree modes of transportation or from modes considered to be less expensive. User demand is very difficult to assess at the project’s outset: estimation errorsmay lead to project failure regardless of the toll or service price set. The price elasti-city of demand is critical, yet remains a parameter quite complex to evaluate. Theseestimation errors may pertain to the initial level of demand, the ramp-up period orthe medium- and long-term traffic growth rate. In this respect, any dysfunction takeson major proportions, leads to added costs and could render the service inoperable.Such errors can also stem from the presence of a competitive alternative which couldnot have effectively been prohibited in the initial concession contract. Generally speaking, demand must be projected using very conservative bases; atthe present time, demand forecasting is not an exact science. Other types of projects, notably in the water services sector, are not expected toencounter any problems in selling off their production, yet may show extreme sensi-tivity to both the price charged the consumer and social acceptability. In this instance,the volume risk turns out to be low, while the revenue risk is high, inasmuch asimposing the price required to ensure project profitability may meet resis-tance. Some projects, such as power plants, can display both volume- and price-relatedrisks by virtue of their acute sensitivity to the elasticity of the service rate/volumecouple. Other direct risks of revenue shortfalls exist, which are indirectly tied to boththe level of demand and price elasticity. Revenues, on their own (without any increasein operating costs), may thereby be insufficient. 62
  • 57. Risk analysis and sharing: The key to a successful public-private partnership Such a situation can be caused by several factors, a sample of which are listedbelow:– performance on the part of the operator or certain suppliers;– service interruption;– personnel strike;– technical failures;– total or partial default on subsidy payment;– absence of supplies for the newly-contracted concessionaire (e.g. reserve of fuel oilfor a power plant, procurement of water use rights for a dam project);– nonpayment of the customer or user (of critical importance in water supply andenergy projects).2.2.2. Risk of operating cost increases If design has been well-controlled, construction adequately performed andstart-up testing carried out satisfactorily, it can reasonably be expected that operatingcosts will be held in check. However, a number of factors may enter into play to induce an increase in operat-ing costs. The following list provides an illustration:– poorer management results than projected;– omission or underestimation of a cost category;– rise in the price of raw materials or certain purchases;– exceptional climatic conditions;– underestimation of maintenance costs, major repairs and facility renewal;– increase in the level of fee paid to the public authority without any accommoda-tion in exchange, or more stringent demands made by the public authority (, quality of service);– subcontracting of a portion of service operations, capable of creating an interfac-ing risk.2.2.3. Financial risks The same types of financial risks encountered during the design-constructionphase are also found during operations, yet at times with a slightly different orienta-tion. Those risks related to the financial parameters guiding the contract, in particularthe exchange rate risk and the interest rate risk, tend to rise as the concession con-tract and reimbursement period grow longer. Moreover, foreign shareholders in theconcession expect their dividends to be paid in strong currencies, which further addsto the impact of exchange rate risks. As regards the indexation risk, procurement,operations and sales contracts are normally set in constant money terms at the outsetand then reevaluated on an annual basis. Nonetheless, the risk remains of encounter- 63
  • 58. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSing indexation formulae which lead to stronger rates of increase on the expenses sidethan on the revenue side (the so-called “scissors effect”). Since the number of project participants is higher during the design-constructionphase, the sources of counterparty risks prove to be greater as well; the operator, theshareholders, the suppliers or even the buyers may be the cause of such risks.2.3. Permanent «indirect» risks related to the project environment This category of risks does not pertain to either of the two parties to the contract,yet may spur financial and commercial repercussions on the private partners, whileaffecting service provision and overall project costs for the public authority.2.3.1. The risks of Force Majeure (Acts of God) These may involve events and incidents associated with not only classical cases ofForce Majeure, such as natural disasters, but also political causes, such as an embargoon the delivery of raw materials, refusal to deliver a work permit for expatriates, etc.2.3.2. Macroeconomic risks The recent financial crises experienced in South America and Asia have demon-strated, if it were really necessary, the consequences of a sudden drop in currencyvalue and the ensuing repercussion on project profitability (e.g. Mexico’s highway-building program). Other major macroeconomic changes can also affect projects,e.g. an energy crisis or an economic crisis reflected in a lower standard of living. Macroeconomic risks may also arise due to the failure of certain hypotheses tocome to fruition (e.g. lack of market success) or to the presence of new constraints.2.3.3. Legal risks This category pertains both to a failure to comply with pertinent legislation andregulations and to the risk of an adverse change in existing regulatory legislation. Thelegal environment must be examined from a broad perspective, including:– corporate law;– banking law;– tax law;– environmental legislation;– sector-specific legislation;– avenues of legal recourse, especially arbitration-related clauses (possibility or notof resorting to international arbitration). 64
  • 59. Risk analysis and sharing: The key to a successful public-private partnership3. Private partner-specific risks Within the scope of the partnership, the private operator bears those risks inherentin any partnership concluded with a public entity, which are usually grouped underthe heading “political risk” and which encompass:– expropriation, nationalization, confiscation, embargo;– shift in governmental priorities, retroactive legislation, change in institutionalcontext;– inability to transfer or convert project-generated revenues. This classical political risk is to be coupled with a new political risk (calledthe “extended political risk”), which spans the public authority’s failure to complywith “specific commitments” undertaken in order to support the partnership (e.g.contractual obligations with respect to the concessionaire to enhance the feasibilityof construction and operations, financing, underwriting on the part of projectinsurers, etc.). Project investors, lenders and insurers pay close attention to the strictfulfillment of contractual obligations of the public partner; failure to meet thesecommitments invokes the political risk. Such commitments include:– unrestricted application of service rates– delivery of all necessary permits and approvals by the scheduled date– competition-exclusion commitments– subsidy provisions– use of eminent domain– nonintervention in the project’s construction, financing and operations– compensation in the event of buyout or unilateral termination of the concessionarycontract without operator default. The public authority is increasingly represented by its local-level divisions: regions,provinces, departments, municipalities, which tend to be considered by both publicand private project insurers-lenders as administrative and not political entities, froma risk-related standpoint in bilateral and multilateral agreements. This phenomenonshould only become more acute in the sectors of public infrastructure, water supply,sanitation and energy. This risk of running into a “gray area” might turn out to be anunavoidable obstacle in the development of public-private partnerships. Last comes the risk of social and cultural acceptability. Depending on the specificproject, the public attitude (in particular that of low-income population segments)as well as the positions held by trade unions, pressure groups and non-governmentalorganizations (NGOs) may given the right set of circumstances lead to a risk that isdifficult to accept or shoulder by the private sector. 65
  • 60. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS3. The contract’s sensitive clauses The so-called negotiation phase obviously represents the occasion for the selectedpartner(s) to discuss with the concession-granting entity the set of clauses critical toproject success. Within the highly-interwoven contractual layout shaping all public-private part-nership projects, a number of clauses appear to be quite sensitive and thereby requirespecial attention on the part of both public authority and private firm. The quality built into the various clauses will be determinant to the contract’s legalsecurity, which must be guaranteed by both parties.3.1. Respecting the contractual equilibrium instilled between the contractingparty, the investor and the user All of these clauses actually pertain to the fundamental notion of contractual equi-librium. Without trying to aggrandize this notion, which often winds up concealinginherent pressures within the partnership, awareness needs to be directed to the factthat a public-private partnership, negotiated between two parties, is in reality a three-party contract, in which the user must be included. While not invited to sit at the negotiating table, the user – who typically repre-sents the public-private partnership’s primary source of financing over the long term– eventually makes his presence felt to the two contract signatories. In industrializedcountries, this dynamic takes the form of litigation over service rate hikes; whereas indeveloping countries, it tends to get reflected by social protest or increases in the rateof unpaid bills. The “successful” public-private partnership – completion of the contract term andachievement of the quantitative and qualitative objectives for service improvement– is more than ever oriented away from locking in an income stream for the privatepartner and/or public entity; rather, the “three-party” contractual equilibrium lies atthe heart of negotiators’ concerns. The direct balance of financial relationships between public entity and conces-sionaire must not be overlooked either. In this respect, “financial turnaround” clausesallow the public authority to recover all or part of its outlay at the beginning of thecontract period. From the opposite perspective, within a concession, delegated-man-agement contract or BOT, the concessionaire and/or the banks must be assured ofbeing able to repatriate their profits when the time comes.3.2. Financial clauses The contract’s financial clauses will naturally exert a special impact on the project:they establish or allow establishing the service rate schedule and rate-revision formulae 96
  • 61. The legal frameworkas well as the financial flows between public entity and private firm (in both direc-tions). Meeting clauses are very frequent with respect to rate-setting (see the example ofSouth-East Water in the U.K.); however, even without such clauses, close and regularcontrols are to be expected on the part of the public authority. France’s Council of State has laid down the set of rules applicable to financialclauses by rebuking, for example, rate structures which force the user to bear costsbeyond the actual service provision, or unwarranted payments from the concession-aire to the public entity. When working abroad, all sorts of situations can be encoun-tered, yet it is clear that political sensitivity to rate issues remains a universal6. If perchance the public entity were able to overlook this sensitivity and concentrate solelyon its own financial interests – which is the case in authoritarian regimes – it wouldbe incumbent upon the private firm to recall to the public entity (how paradoxical!)the risk it runs of causing the rate of bill collection to drop and engendering seriousdifficulties. However, the issue of rate levels is far from being the only one requiring closeattention. The definition of rate categories is often equally as important and neces-sitates in-depth economic studies based on a service audit. Lastly, the public-private partnership’s current and future tax system must be speci-fied, to the extent allowed by the constitution. If need be, an article to the law shouldbe requested.3.3. Obligations of the private partner Directly tied to the financial clauses, the contractual conditions stipulating privatepartner obligations must also be drafted with care and precision. A true partnership presumes priority placed on performance obligations as opposedto mere resource obligations, which implicitly assumes that the private firm enjoys themaneuvering room to enable meeting the assigned objectives. To the extent possible, the objectives assigned must be guided by a set of quantita-tive indicators which can be determined consensually. Such a prospect may prove dif-ficult when the service’s information system lacks reliability. In many instances, aninitial audit serves to derive temporary indicators at the time the contract is awarded;these indicators are then confirmed a few months after the contract takes effect, atthe time of a second audit conducted by the newly-appointed private partner (underpublic entity control). Target results are often set gradually (number of service customers connected to thenetwork, drop in number of unpaid bills, service quality indices, etc.); it then becomes6. In this vein, see the work conducted by the OECD: PUMA, Summary memo n°. 3: “The billing ofpublic services to users: Guidelines for improved practices”, March 1998. 97
  • 62. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSnecessary to forecast impacts in the event the public-private partnership deviates fromthe critical path. Special attention must be paid to penalty clauses, which are particularly common-place in BOT or PFI set-ups (see the example of Barnet Hospital) in a situation ofcaptive demand where the end user is unable to intercede as mediator.3.4. Reducing uncertainty and meeting clauses Reducing uncertainty is without a doubt the most arduous exercise within public-private partnership negotiations; it presupposes the involvement of experienced pro-fessionals well-versed not only in the specific economic sector, but in the host countryas well. All of the probable, or even possible, changes in public-private partnership mustbe described in full and their impacts on the public-private partnership’s equilibriumassessed: the term employed here is “background clauses”. The creativity of the plu-ridisciplinary team assigned to draft the contract must at this point be put to the task:the most unfavorable scenarios for contract execution must be evoked and their even-tual impacts discerned. Example: for an electricity distribution concession, a changein energy policy would have to be envisaged; for an airport concession, the construc-tion of a competing facility or the availability of a competing service are cases to benegotiated (see the example on Phnom Penh). Not all events obviously can be predicted; it is therefore necessary to establish aset of general principles applicable to each of the fundamental hypotheses shapingthe public-private partnership project. The inclusion of meeting clauses, which allowcomparing viewpoints from both sides of the partnership, and potential correctivemeasures are also highly recommended (see the example on the Abidjan Airport). In countries exhibiting a strong legal tradition in the area of public-private partner-ship (e.g. France), these general principles stem from the body of jurisprudence whichacknowledges the financial equilibrium of contracts, thereby giving rise to compen-satory procedures for the occurrence of «unexpected events». In countries devoid ofsuch tradition, it would be judicious to stipulate these principles directly in the con-tract and to explore in-depth all hypotheses leading to unexpected situations or tothe application of “Imperial fiat”, i.e. unilateral decisions on the part of the publicauthority.3.5. Breakdown of risks These clauses are also to be introduced in order to translate, as accurately as pos-sible, the breakdown of risks borne by the private firm and public entity, respectively.Such a breakdown, which constitutes the very core of the contract, has been fullyanalyzed in Chapter II-B above and will not be repeated here. 98
  • 63. The legal framework3.6. Public domain status Rules regarding the public domain of property and facilities must also be high-lighted in the contract. The French system for handling concessions and infrastructureleasing contracts incorporates a strong notion of public domain, whereas the Anglo-Saxon equivalent (BOT) and its variants tend to downplay the public domain angle.Herein most certainly lies the main distinction between the two models; in practicehowever, this issue must always be treated and resolved with extreme care, regardlessof the legal framework opted for. Two distinct approaches are possible:– the project’s facilities remain tied to the public domain and, as such, are gener-ally subjected to heavy constraints: inalienability, imprescriptible status, etc. Thisstatus restricts the private partner’s management leeway; procedures would need tobe implemented to waive some of these constraints (e.g. fixing a time limit for thepublic authority to respond to the firm’s request for a status change in the aim ofselling off equipment);– the project’s facilities (especially those resulting from private investment) remainsubjected to a private law regime, thereby allowing for more flexible facilities man-agement practices. If national legislation prescribes the need for public domain authorization, theattempt should be made to incorporate such an authorization into the actual contractor at least to add it as a suspensive condition. When confronted with a complex situation involving project property rights,French law offers a panoply of tools for reaching a fair solution. A line is drawnbetween those facilities/equipment required to be handed over – in most cases, freeof charge – to the public entity upon contract expiration and “recovery” equipment,which only gets handed over (in exchange for payment) should the public entity electto exercise the option. The former belongs to the public domain, i.e. the public sector’sprivate property , whereas recovery equipment remains, up until contract termina-tion, the concessionaire’s property.3.7. Accounting and taxation system The inventory and legal classification/valuation of public-private partnershipproject equipment must be accompanied, in most countries, by specifications as to thetype of accounting and fiscal conventions applied to depreciation allowances, espe-cially if such equipment is to be handed over free of charge upon contract expiration.In this case, a lapse depreciation technique is to be practiced, whereby reserves are setaside during the initial period and then recovered at the end of the contract. However, if the handover equipment is returned to the public entity in exchangefor compensation, a value-based depreciation technique would have to be employed,according to which depreciation allowances will be carried as expenses until contractexpiration. 99
  • 64. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS Practices regarding depreciation and financial reserves – along with the respectivetaxation system – are obviously critical to the public-private partnership’s financialequilibrium; the specific conditions governing their application must be determinedup front once the contract has been signed. In industrialized countries, institutingsuch conditions presupposes involvement of the nation’s tax administration eitherdirectly within the contract or by means of a unilateral commitment included as acontract appendix.3.8. Public entity control measures and regulation Public entity control over contract modifications must also be stipulated. Whilesuch control is vital, it must not be performed as a perfunctory task. In order to preventthis tendency, it is advisable to stipulate different control frequencies and methods,depending on the specific control objectives. For example, an annual control couldbe scheduled for a contract’s accounts and general progress, while a frequency of 3to 5 years would probably suffice for more in-depth audits of the project’s economic,financial, social and physical data. At the beginning of the contract, close monitoring is to be expected in any eventfrom the public entity; experience has shown that this period requires an ongoingdialogue extending beyond mere contractual obligations. Controlling a contract’sexecution is to be incorporated into the body of regulation of the pertinent economicsector. In its strictest sense, the regulatory function ensures that a given economic sectoris operating smoothly by means of both preventing against disruptive competitivepressures and advising the corresponding public authority on appropriate compli-ance measures. In many cases, including France and other industrialized countries,this function is often mistaken for the compliance function. Two scenarios can bedepicted:– first, the regulator can be mistaken for the public contracting entity. The risk ofthe regulator taking action unilaterally in conflict with its own set of interests is thuslow, yet conflicts may arise between its role of contracting party and that of regula-tor in the event of differences raised between public-private partnership partners.In order to avoid such conflict, the public authority can set up and empower anindependent regulatory body;– second, the regulator may be a distinct entity. Such is the case for local public-private partnershipprojects governed by national-level regulation, in general admin-istered by a technical Ministry office. The risk of interference will have already beenexamined at the time the contract is drafted and, in many instances, at the time itis first proposed (see Section 2.4 above). It is clear that no contract can reasonably be signed, especially for a long-termperiod, with the perpetual risk of interference from a sector-specific regulator not 100
  • 65. The legal frameworkacting in the role of a neutral referee. This issue must be settled either in the contractitself or in the sector’s legislation establishing this role of referee and then adoptedprior to the public-private partnership. Efforts must be directed at creating a regulator out of a different mold than aproject controller, i.e. an administrative authority which does not report to the Mini-stry and which will theoretically outlast near-term changes in political preferences.In addition, this authority is to remain neutral in all arbitration held between con-tractual parties.4. Compatibility of the final project set-up with the host country’slegal culture In conclusion, in order to achieve the objectives of a public-private partnership, it isnecessary to pay close and prolonged attention to the legal system being applied. Keepin mind that no ideal blueprint for a national or contractual system exists. Beyond thenecessary precautions taken by investors, assurance must be provided that the project’sultimate set-up is sufficiently compatible with the host country’s legal culture. Hereinlies another guarantee of the public-private partnership’s durability, which is just asimportant as that resulting from the negotiation of the contract’s sensitive clauses. An example of a new legal system for public-private partnership projects in Chile During the 1980’s, the privatization of companies assigned responsibility for running public service networks was considered in several Latin American countries to be a prerequisite for achieving economic efciency. At the beginning of the 1990’s, only little progress had been made due to the typical obstacles created by such ventures. It was at this time that the use of public-private partnership really started to win recognition as a politically-acceptable alterna- tive to privatization. Each country however elected to develop its own brand of public-private partnership formulae. This nding is clearly revealed when comparing experiences in Chile and Argentina. In Chile, public procurement contracts – the simplest form of public-private partnership – were initially introduced with great success. EMOS, the Santiago area water distribution company, had even encouraged its own employees to create private companies to bid on such con- tracts. EMOS went on to become one of the region’s most productive companies, with an incredibly low ratio of number of employees per service connection. At the same time, pen- sion funds dedicated to infrastructure nancing were also being created. National legislation relative to foreign investment was modernized and the types of PPP contracts diversied. Chile progressively adapted its PPP-related legislation in 1981, 1991 and 1994, and set up a stable legal and taxation system to accommodate foreign investment (Decree-Law 600). In Argentina, the use of public-private partnership proved instrumental in stimulating the eco- nomic changes ushered in at the beginning of the 1990’s. In conjunction with the country’s pri- vatization program - 90% completed as of the end of 1994 - some twenty public services were contracted out as concessions, including the Greater Buenos Aires water supply concession (still considered by the World Bank as a model project). In the case of Argentina, public- private partnerships were introduced over a brief period and directly in their most advanced forms. 101
  • 66. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS What are the lessons for a successful legal framework?u A stable and consistent institutional framework, adapted to the public-privatepartnership project (which does not resemble a public procurement contract), isfundamental. It must be based upon an analysis of both the directly-applicablelegal aspects (an ad hoc law often proves necessary) and the indirect regulatoryenvironment.u The public authority must also provide the private operator with a set ofstraightforward and unambiguous procedures, as well as an independent juris-dictional control.u A public-private partnership contract is built around the notion of upholding anequilibrium between the contracting party, the investor-operator and the user.u A contract’s most sensitive clauses are: nancial clauses, the private part-ner’s obligations, background and meeting clauses, property ownership, and theaccounting and taxation system.u The public authority must institute basic regulatory mechanisms in order toconrm the successful execution of a public-private partnership. Such mecha-nisms must not only guarantee neutrality for the private operator, but also enablethe public authority to ensure that the objectives and conditions it has set arebeing met by the operator. 102
  • 68. The field of transportation, including urban transit services, represents one of themajor areas of responsibility involving public authorities in which partnership withthe private sector may lead to significant added value in terms of both efficiencyand quality of service, while allowing the public authority to retain full regulatorycontrol. Three fundamental characteristics in this field exert a critical impact on theways potential public-private partnerships are implemented. The first characteristic is the magnitude of the externalities generated. Transpor-tation does not represent a result in and of itself, but rather a means for performingan economic or social activity. From this perspective, the transportation system ingeneral implies some highly-positive economic and social externalities; on the otherhand, it generates some highly negative externalities as well (environmental, in par-ticular). In the area of transportation, what holds true at the system level is alsoapplicable, to varying degrees, for each component project. As a result, the socio-economic profitability of a full-fledged transportation project – i.e. the added valuefor society that a project be built – is typically quite distinct from its purely financialprofitability – the ratio of direct revenues (e.g. highway tolls, train tickets) to costsfor a given project. A second essential characteristic of a transportation project has to do with thehigh level of infrastructure consumption and with the fact that each new projectrequires a capital investment profile which is difficult to spread over time since thebulk of investment remains heavily concentrated prior to operations start-up. Con-sequently, the portion of total financing needed up front is very high, while theanticipated duration of transportation infrastructure – i.e. its depreciation period –is very long. The third characteristic associated with most projects (to a lesser extent for portsand airports) is the relatively weak level of captive market demand. In almost allinstances, one or several trip-making alternatives are available (different mode oftransportation, different itinerary). Traffic forecasting – and the accompanying rev-enue stream projections – is difficult to perform and naturally accounts for sizablemargins of error, especially for new projects. The impact of these three characteristics results in an extremely high level of riskand often in a rather weak financial return from a social utility standpoint. As such, itbecomes necessary for the public authority to assume heavy involvement, side by sidewith the selected partner, in financing the infrastructure. This involvement couldtake the form of a cash participation or in-kind contributions (e.g. a piece of exist-ing infrastructure, income streams generated from another facility). The size of thisin-kind contribution is often reflected, in the case of public transit systems, ports or 123
  • 69. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSairports, by the fact that the concession involves the operation of an existing pieceof infrastructure over a given period. In this fashion, the public authority has shoul-dered the responsibility for building the initial infrastructure (and assumes the inher-ent risk), while the private operator is responsible for modernization and all subse-quent investment in operations (train stations, airport terminals, container-handlingfacilities, rolling stock, etc.). While these aspects serve to characterize transportation systems as a whole, eachmode exhibits a number of particularities, thereby lending justification to the useof an individualized approach which, in turn, leads to highly-varied types of conces-sions (or other forms of public-private partnership). Part III of this book is devotedto analyzing each of the major categories of transportation projects likely to relyupon public-private partnership:– roads and road-related infrastructure (bridges, tunnels, etc.);– public transit systems running on dedicated facilities;·– airports;– ports. 124
  • 70. A. ROADS AND ROAD-RELATED INFRASTRUCTUREAlain FAYARD, Olivier BONNIN Major highway construction projects and road-related infrastructure undoubtedly give rise, as do large- scale rail projects, to the most complex and complicated forms of public-private partnerships. Two charac- teristics lie behind this assertion. For one thing, the nancial risks involved are tremendous: the sums to be invested are extremely high, dif- cult to smooth over time and necessary in their entirety before any revenue can be generated. The level of trafc (hence revenues) obviously increases only over the long run, whereas depreciation allocations taper off from one year to the next. Moreover, revenue projections prove very difcult to perform: determining the level of interest generated in a new facility prior to its completion is, to say the least, full of uncertainty. It is next to impossible to assign an optimal toll acceptable to the user. The process of deriving road tolls must avoid over-reliance on the economic theory of surplus maximization in order to integrate the psychological factors associated with the user’s perception of toll levels and overall road transportation supply. For major road infrastructure projects, the involvement of the State as a public partner is vital. The level of direct nancial return on such projects tends to be limited, especially compared to the magnitude of the inherent risks. Non-monetary benets to the locality are quite often considerable, wherein lies the necessity of the participation of public authorities.1. A Partnership aimed at the supply of infrastructure The current chapter will discuss under the generic heading of “road infrastruc-ture” three distinct categories: open roads and highways (through unbuilt areas),urban streets and roads, and road-related civil engineering works (bridges and tun-nels). Generally speaking, these types of infrastructure lie within the responsibilityof the public authority inasmuch as road projects are intended to fulfill, first andforemost, the needs of the locality (certainly to a greater extent than the other infra-structure discussed in this book). A road network is of absolute necessity in runninga country, whether in terms of national cohesion, economic development, or mobil-ity. No society can do without a system of roadway connections (dirt strips, roads,streets, highways, etc.) and continue to exist. Building, maintaining and providingaccessibility to a road network are thus essential and logical obligations of the State. Another fundamental characteristic of road infrastructure is that the service(transportation) operations are actually being handled by the end user. The role ofthe public authority or the operator lies exclusively in supplying the infrastructure,yet responsibility for the service itself (i.e. transportation from point A to point B) isleft entirely up to the user. This distinction is critical, in comparison with the othersectors covered in this book. With the exception of roads, the service delivery com-ponent takes on much greater importance than the supply component: for rail trans- 125
  • 71. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSportation or urban utility services, other entities are always encountered, includingat least the service operator and, in some instances, the producer (e.g. water, electri-city). As such, the forms of public-private partnership adopted in the other sectorsinvolve a multiplicity of actors and can present quite varied features, although inmost cases the basic infrastructure is being supplied by the public authority. Forthe sake of simplicity, the term “operator” will be used in the rest of this chapterto refer to the entity assigned responsibility for managing and maintaining the roadand, when applicable, for collecting road tolls. This term, however does not includesupply of the transportation service. Eventually, the use of public-private partnership for road infrastructure projectsencompasses just the supply component and excludes all of the associated serviceprovision (i.e. vehicle transportation or the shipment of freight by truck, which rep-resent the end user’s service, would obviously not be the focus of a public-privatepartnership). This feature makes a public-private partnership difficult to implement,all the more so given that the service provider is none other than the user himself (i.e.the motorist or the truck driver); this situation implies that the final product (the tripfrom A to B) can take on as many forms as there are users, with each one exhibitinga distinct set of characteristics.2. The forms of partnership The use of public-private partnership in road infrastructure projects is reservedfor those instances when the public authority has identified a collective need forsuch a project. This identification process entails a strong level of socioeconomicprofitability for the society as a whole, yet is coupled with insufficient public-sectorfinancial resources and often a significant contribution capacity from users. Theother rationale for introducing public-private partnership stems from the desire ofthe State to relinquish its responsibility for maintenance of highway facilities, whichit thereby seeks to delegate along with the responsibility for highway construction,without being concerned by the effect of user participation. As a result, the forms of public-private partnership for road infrastructure projectsare less diversified than for the other sectors: they span facility financing and main-tenance, with the revenue stream being based on traffic levels and smoothed overtime. Three types of financing participation can be differentiated: complete (or closeto complete) financing of all construction and maintenance; partial financing ofthe construction, combined with maintenance financing; and strictly maintenancefinancing. For each category of public-private partnership, two remuneration meth-ods are applicable: direct remuneration by the user via toll collection, and State sub-sidies (more or less tied to the intensity of facility use). In practice, the mode of remuneration enables distinguishing between the twomajor categories of public-private partnership. If the user pays a large portion of 126
  • 72. Roads and road-related infrastructureconstruction and maintenance costs, the public-private partnership resembles a toll-based concession. On the other hand, if the public authority feels that the usershould not be asked to pay, either because of national policy or a low contributivecapacity (i.e. small traffic volumes), and that the facility serves to support regionaldevelopment goals, the concession tends to feature a system of shadow tolls. In sucha system, the public authority remunerates the builder/operator on the basis of traf-fic levels. Both of these systems can be substituted for one another or even coexist, asdescribed in the insert on Portugal. From a general standpoint, a road infrastructure project provides benefits to soci-ety beyond that enjoyed by the user himself. The very nature of the project inducessizable indirect impacts on the economy, regional development patterns, other com-ponents of the road network, the environment, road safety, etc. A project cannot beexamined solely from the perspective of its financial profitability in terms of what theoperator is able to collect in exchange for added user benefit. It is thus often legiti-mate for the public authority to contribute to a project’s financing. The legitimacyof a road toll, and consequently its acceptability, has been assessed in careful detailin the following insert by Vincent Piron on user-toll concessions. Some uncommonexamples demonstrate that certain projects could be considered as purely private,inasmuch as the public authority has already provided the basic infrastructure andthe private company is merely responsible for developing a complementary facility toraise the overall level of service. Such is the case with State Highway 91 in SouthernCalifornia, whereby a toll road was built on the median divide of an existing freeway,on the basis of the project’s financial profitability alone. However, this case provesto be the exception in a sector where public interest generally exceeds by a widemargin the sum of individual user benefits (i.e. socioeconomic profitability consider-ably higher than the direct financial profitability). An in-depth analysis of the actors and their interrelationships within the frame-work a toll road concession is provided in the first part of Vincent Piron’s insert ontoll road concessions.3. Analysis and breakdown of risks Road infrastructure projects engender, for the use of a public-private partner-ship format, tremendous risks, which require careful examination. For purposes ofsimplification, let’s consider road infrastructure to be characterized by: a sizable ini-tial investment that cannot be easily apportioned; and an income stream beginningonly once service has started up, increasing over the long run, and very difficult toforecast. The level of uncertainty and risk is therefore particularly high. In what fol-lows, we will focus primarily on two types of risks: the financial risk (related to thesize of the initial investment), and the income risk (related to traffic volumes). 127
  • 73. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS3.1. The financial risk The level of financial risk is maximal in a highway concession since the initialinvestment proves, far and away, to be the greatest expense and the period of opera-tions is very long. Furthermore, income flows increase over time, whereas financialexpenses are decreasing. In addition, the construction period often extends overmany years, while the project is only able to generate revenue once the constructionphase has been completed. Consequently, the project’s financial layout must takethese features into account, by providing for long-term resources and by accommo-dating an initial period devoid of income. Application and enforcement of a programming timetable during constructionis critical to the success of the financing set-up, which allows for very little margin.Even the slightest delay in construction and delivery of a project can prove detri-mental to its viability. From the public authority’s standpoint, herein lies one of theprimary advantages of a public-private partnership. In reality, the cost of construc-tion delays is so prohibitive that a private operator would do their utmost to meetschedules, even up to completing the project ahead of time. It is not that uncommonfor public-private partnership projects to be delivered before the scheduled date (e.g.the M1/M15 motorway in Hungary), which practically never occurs with conven-tional public procurement contracts.3.2. The income risk The income risk is fundamental to road infrastructure projects involving public-private partnership. In general, it is extremely difficult to assess with certainty thefuture revenue streams generated by the planned project. Several factors account forthis difficulty, with the most important one being that the project’s future patrons areindividual users, each one of whom exhibits his own set of characteristics, behaviorand incentives. Determining these characteristics would entail a massive and fine-tuned data collection effort on current trip-making patterns and user behavior. Basicmacroscopic observations of existing traffic flows would not suffice in this context. Yet, even if current user behavior patterns could be discerned, this would still notsuffice. In essence, an accurate assessment is needed of how users would react bothto the presence of a new piece of infrastructure and to the application of a toll, ifrelevant. Several scenarios can be anticipated:• When the new facility is based on shadow tolls, the user is not asked to pay directlyfor using the facility. In this case, his behavior is easier to predict (systematic use ofthe new road, which is supposed to provide better service); the problem then liesin determining the volume of additional traffic induced and the new equilibriumestablished with existing infrastructure.• When a toll is charged on the new facility, which happens to replace or competewith other charged, but less-expensive transportation services, a reference then exists 128
  • 74. Roads and road-related infrastructurefor evaluating the public’s reaction to the presence of this new facility. Such is par-ticularly the case for bridges and tunnels which replace or complement existing infra-structure (e.g. the Prince Edward Island Bridge in Canada). The main uncertaintyconcerns the level of traffic induced by the new facility.• When the toll facility is built in a country where similar facilities already exist, thedata held on existing facilities tend to be sufficient in evaluating the public’s reactionto the toll. Such data can be employed to forecast the reaction of users and determinethe breakdown of traffic flows between the new facility and the toll-free existingnetwork. This scenario is especially true for open toll roads built in a country likeFrance.• Lastly, when the toll facility represents an innovation in a given country, it is verydifficult to forecast the reaction of the local population. Calculating the elasticityof the traffic volume with respect to the toll amount is an extremely complex task.An elasticity of this nature is very seldom linear, as economic parameters alone donot enable evaluating traffic levels. In his insert, Vincent Piron discusses this subjectin depth. A very cautious approach must therefore be favored when addressing thenotion of toll in such cases, as shown in the examples of urban tolls in France orcertain interurban motorway projects in Europe (e.g. Hungary’s M1 motorway). The third aspect to deriving income projections for road infrastructure is morestraightforward: the operations phase starts up several years after the project’s financ-ing has been established and after the initial series of expenditures; moreover, theincome stream may be spread over periods well beyond twenty years. Given this timehorizon, future changes in macroeconomic and social parameters mean that produc-ing reliable traffic forecasts for the existing road network is an impossible exercise,and even more so for new facilities. Trend-line projections can be developed for theperiod beyond 10-15 years to provide an order-of-magnitude indication of revenuelevels, yet any figures based on such projections must be treated with caution.3.3. Other risks The risks described above are fundamental to any public-private partnershipset-up for a road or road-related project. The other categories of risk discussed inPart III-1 of this book are also applicable, yet most can ultimately be ascribed aseither financial risk or income risk. Issues related to procedures, the environment,safety and standards exert a direct impact on the financial risk by causing potentialschedule delays and cost overruns capable of upsetting the project’s financial equilib-rium. The exchange rate risk influences revenue levels, as do macroeconomic risks andthe risk of changes in the institutional and physical environment. This latter cat-egory of risk can be particularly sensitive from two points of view, one of whichconcerns the specific legislation applicable to public-private partnership. The ensu- 129
  • 75. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSing legal interpretation may engender modifications to the terms of the contract (e.g.through structuring toll systems, granting new user rights). These risks are especiallypredominant in countries without any public-private partnership experience, whichare hence required to experiment with new contractual forms. The general contextmust also be taken seriously. Transportation and environmental policy, in particular,can heavily influence the profitability of toll roads and road-related infrastructure.For example, policies encouraging rail transportation in mountainous regions areaimed at significantly reducing the amount of truck traffic, which of course generatesa negative impact on highway toll revenues in these regions. Similarly, the construc-tion of competing infrastructure can also adversely impact revenues.4. Risk limitations4.1. Financial risks As a means of limiting the financial risks associated with project delays, whichcan be detrimental to both the private partner and the public authority, each partymust absorb those risks which it is best able to handle. As a first step, the projectmust be defined in precise terms, a definition which requires a preliminary identifi-cation of the project’s functional attributes from the public authority. All relevantconsiderations must be addressed prior to finalizing the contract, chief among themthe set of technical and environmental standards to meet and the required level ofsafety. A poorly-defined project is likely to be subject to modification during theconstruction phase, a situation which could easily disrupt the project’s equilibriumwith respect to both cost and schedule overruns. Secondly, the public authority is responsible for ensuring, within an acceptabletime frame, that all preliminary procedures have been duly completed; such proce-dures might entail laying the coordination groundwork, acquiring land and ease-ments or obtaining the necessary construction permits and approvals. The risk ofsuspensive recourse or permit refusal can be detrimental to the project. Once the objectives and scope of the project have been specified by the publicpartner, it becomes essential for the private partner to be able to optimize construc-tion and operating costs, a step which implies that the responsibility for the entireproject is put in the hands of a unique consortium encompassing both constructionand operations. This consortium will be asked not only to absorb its own risks, butalso to propose the most optimal solutions for fulfilling the public authority’s set ofobjectives. The role of the operator, asked to bear responsibility for project qualityover the long run, proves vital to this consortium. As regards the actual construction phase itself, the concessionaire must be ableto bear, thanks to adequate and sufficient preliminary studies, all of the envisagedconstruction risks, whether related to the works program or to the (potentially- 130
  • 76. Roads and road-related infrastructureinnovative) techniques employed. Nonetheless, certain risks (e.g. geological) are dif-ficult to predict, and the contract must stipulate the set of standards for resolvingpotential problems, so as to limit the use of recourse as much as possible. In light of the investment sums involved, the least-costly solution which still pro-vides the requisite service quality must be systematically favored. The sizing of theinfrastructure must thereby satisfy two opposing objectives: minimizing the initialoutlay and accommodating the gradual rise in load on the new facility as traffic levelsclimb. Project phasing is typically impossible for bridges and tunnels; however, forhighways built in developing countries with a rising rate of car ownership, staggeredprojects could be envisaged (e.g. a two-lane road at first, followed by expansion to afour-lane highway as traffic allows or necessitates) (see the case study on the MaputoCorridor below). In many instances, the investment required is very substantial and the project’ssocioeconomic profitability is significantly greater than its financial profitability.Consequently, the public authority is bound to participate in the project’s financingone way or another. This participation might take on the form of subsidies, loanguarantees or in-kind contributions consisting of: land, an existing facility free ofcharge to be incorporated into the project, or an adjacent toll facility which wouldgenerate revenues as of the beginning of the construction phase. This latter contribu-tion characterizes some of France’s autoroute systems, in which revenues from exist-ing toll facilities get pumped back into the system to build new highways; it alsoapplies to Portugal, as discussed below. Moreover, arrangements of this type are oftenencountered in the construction of a new bridge next to an existing toll bridge (e.g.the new Tagus River Bridge). In these cases, transferring the former piece of infra-structure constitutes not only a financial contribution, but also enables running thetwo facilities in a coordinated fashion. However, as demonstrated below by VincentPiron, upsetting the use of the preexisting facility may incite strong public reaction(e.g. protest against the toll hike announced for the existing Tagus River Bridge aspart of the concessionary agreement reached for the new bridge).4.2. Limiting and spreading the income risks Dealing with the income risk is an essential step to any toll concession, especiallywhen experience with this type of approach is recent and not sufficient to predictuser reaction to the introduction of tolls. The first step to ascertaining the extentof this risk requires a detailed understanding of existing flows. The success of a pub-lic-private partnership relies primarily herein. In-depth studies must be conductedbeforehand by the public authority in order to determine the scope of its actualneeds. These studies must subsequently be submitted to the project’s concessionaires-to-be for completion and verification. Many projects wind up getting shelved orperforming poorly due to inadequate initial perception. 131
  • 77. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS In his insert, Vincent Piron describes the stakes and criteria involved with respectto public reaction to the introduction of tolls. Anticipating this reaction, albeit easiersaid than done, is fundamental to setting up a public-private partnership. A poorassessment at this juncture can produce a very negative impact both on the conces-sionaire, who would not generate the income necessary and be forced to abandonthe project, and on the public authority, who would change the ground rules at thelast minute under the pressure exerted by users and wind up enduring the financialconsequences. A conservative solution consists of underestimating the users’ willing-ness to pay and placing priority on accustoming them to pay for the use of high-quality infrastructure. The user would then be able to assess the quality of the serviceprovided by the new facility. In countries with an intermediate standard of living,the introduction of a maintenance and development toll on facilities built thanksto State financing may prove to be effective in: improving the quality of the roadnetwork; providing users with a high level of service; and accustoming users to payfor quality, while respecting their financial constraints. User-toll concessions for road facilities Vincent PIRON Within the area of roads and road-related infrastructure, and more specically as regards user tolls, the revenues necessary to cover construction and operating costs stem from two sources: Public Authority subsidies, and user tolls (private vehicles and trucks). The break- down between subsidies and toll revenue is the outcome of a dual economic/social impera- tive: achieving a fair equilibrium is prerequisite to the full success of all projects. 1. The economic benets behind a road concession The economic benets behind a road concession is shaped by three essential principles: – the concessionaire is responsible for both the construction and operations of the facility and, hence, is able to minimize overall “construction and maintenance” costs from a long-term perspective; – the facility is to be sized in accordance with economic criteria; – the project-nancing procedure allows gathering the nancing more quickly than by follow- ing the rules governing public-sector budgets. This acceleration in turn creates a leveraging effect as new technologies or new product development conditions are introduced. These general rules offer considerable exibility in drawing up concessionary contracts. The actors in this process remain the same, yet the breakdown of risks among them varies heav- ily depending upon the specic context; consequently, an entire array of solutions can be envisioned, ranging from a narrowly-scoped public procurement contract to a concessionary contract in which the concessionaire bears all risks. 1.1. Presentation of the actors Let’s consider the case of a concession which ties a local public authority (a municipality, department or region) to a concessionary company. The leading actors (seven in all) are listed below and displayed in the series of diagrams that follow: – the concessionary company itself, represented by its shareholders, whose aim is to realize dividends once the nancial climate allows to do so (arrow 7 in the diagram); – the end customer/user, who pays for the proposed service. This actor is represented by the motorist, the transportation operator, the railway company or airline, which pays a fee for use 132
  • 78. Roads and road-related infrastructureof the infrastructure made available (arrow 1);– the concession-granting authority. This actor holds the power to: determine the level ofservice to be provided, grant a concession in order to ensure the level of service so dened,put a concession out to bid, issue guarantees or award subsidies, and sign the concessioncontract with the designated concessionaire (arrow 2);– the Ministry of Finance, which collects the direct and indirect taxes related to the contractand the income generated (arrow 3);– the lending organizations, which advance the funding necessary to build the facility andthen begin to be reimbursed only once the operation starts (arrow 4);– the construction rm, which is responsible for building the project on behalf of the conces-sionaire (arrow 5);– the facility operator, which collects tolls and performs all necessary maintenance work onbehalf of the concessionaire (arrow 6). CONCESSION-GRANTING AUTHORITY FINAL CUSTOMER Ministry of Transportation Motorists, truckers, airline companies, railway companies, airline passengers 2 TAXES 1 Ministry of Finance 3 CONCESSIONAIRE SHAREHOLDERS LENDERS 4 7 – purely-financial investorsAllocation of 5 6 – project builders-investors funds CONTRACTOR OPERATOR Construction company Diagram 1 – Initial phase: project organization and construction (example of a State-granted concession).In many instances, the same organization lls the roles of several actors. For example, asituation may arise where some of the concessionaire’s shareholders are construction rmsand/or service operators; as such, they will not have the same strategic outlook on the projectas shareholders with a purely nancial interest in the company, since the former are involvedat several stages in the project and accumulate different types of risks and returns.It is also quite frequent for the Public Authority to act either as the concession-granting author-ity, sole shareholder in the concessionary company, tax collector, or even lender! It goeswithout saying that a concession of this type would be run quite differently from one in whichthe majority of shareholders abide strictly by the rules of private investment/management.Alongside this group of lead actors, other necessary actors take their place: legal and techni-cal specialists, whose role consists of validating the project’s underlying hypotheses and thesoundness of the contractual relationships; and the rms assigned to implement toll-collectionsystems. Continual renements in toll-collection system technology has now made it pos-sible to apply a highly-targeted and customer-oriented toll rating structure, thereby enhancingproject feasibility. 133
  • 79. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSA concession is always composed of three phases: the construction phase, the normal opera-tions phase, and the nal phase, which corresponds to either the buyback of the concessionor its contractual expiration. The three following diagrams depict the nancial ows betweenactors during each of these three phases. The arrows indicate the direction of monetary owsin a conventional concession. CONCESSION-GRANTING AUTHORITY FINAL CUSTOMER Ministry of Transportation Motorists, truckers, airline companies, railway companies, airline passengers 2 TAXES 1 Ministry of Finance 3 CONCESSIONAIRE SHAREHOLDERS 4 7 LENDERS – purely-financial investorsAllocation of 5 6 – project builders-investors funds CONTRACTOR OPERATOR Construction company Diagram 2 – Operations phase. CONCESSION-GRANTING AUTHORITY FINAL CUSTOMER Ministry of Transportation Motorists, truckers, airline companies, railway companies, airline passengers 2 TAXES 1 Ministry of Finance 3 CONCESSIONAIRE SHAREHOLDERS LENDERS 4 7 – purely-financial investorsAllocation of 5 6 – project builders-investors funds CONTRACTOR OPERATOR Construction company Diagram 3 – Final phase (buyback of the concession). 134
  • 80. Roads and road-related infrastructure POPULATION CONCESSION-GRANTING AUTHORITY FINAL CUSTOMER Ministry of Transportation Motorists, truckers, airline companies, railway companies, airline passengers 2 TAXES 1 Ministry of Finance 3 CONCESSIONAIRE SHAREHOLDERS LENDERS 4 7 – purely-financial investorsAllocation of 5 6 – project builders-investors funds CONTRACTOR OPERATOR Construction company Diagram 4 – Tacit contracts.1.2. Tacit contractsAll of the ties between actors are to be formalized by means of contracts, regulations, laws,shareholder agreements, guarantees, etc. The legal instruments will guide actors at the stageof the contract’s signature and stipulate reactions to given circumstances. Yet, two typesof tacit (unwritten, difcult to formalize, not well-known) contracts also exist: one betweenthe population and the concession-granting authority, the other between the group of users/customers and the population as a whole.Prior to granting the concession and initiating the bidding procedure, the political decisionto build a facility and divide the ensuing costs between taxpayers and users has alreadytaken place. These two populations are far from being one and the same. All State (or local)residents pay taxes and express their opinions at the ballot box. The customer, on the otherhand, is an economic agent who determines the acceptability of paying a given amount at agiven time for the service proposed by the concessionaire at that very moment. Only a por-tion of the population is composed of actual customers, yet the other portion of the populationbenets indirectly from the presence of the new facility (less congestion on the road networkconstitutes a benet for all residents, whether motorists or not) without having to pay anytoll.The two types of tacit contracts thus bind the concession-granting authority with the popula-tion in setting tolls at an optimal level, i.e. whereby each population category considers itis paying the right price given the corresponding benets, either indirectly (through taxes),directly (toll), or in a mixed form (a toll facility subsidized up to 50%, 70% or even more by taxrevenues).The following diagram presents the various actors in the concession by indicating all of thelinks existing, explicitly showing both political relationships and the social acceptability of tolls,between the population, the concession-granting party and the customer. 135
  • 81. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS2. Socioeconomic and nancial assessments: the purpose of a rate structure2.1. Socioeconomic assessmentThe construction of a public works facility or a piece of transportation infrastructure createswealth. This wealth, however, is not easy to assess over the service life of the facility sincethe changes induced on the local standard of living and mode of operations get introducedvery gradually, settle in for the long term and remain difcult to dissociate from the country’soverall evolution. One economic observation is clear and uncontestable: the wealth createdis no less than the cumulative sum of what customers are willing to pay for use of the facility.Such a perspective however overlooks:– the indirect benets generated for non-users thanks to the resultant improvement in overalltrafc conditions;– the economic surplus derived for users beyond the toll they pay;– the increase in land prices in the zone where trafc conditions have been alleviated;– the increase in land prices in zones benetting from enhanced accessibility (reduced accesstime) as a result of the new facility.It is difcult to evaluate the sum of these four sources of creation of wealth («creation ofvalue» would be the term used in private microeconomic theory). Yet, several indicators canprovide an order of magnitude. For example, the value of time spent consuming transporta-tion resources, which the public authority ascribes to all trip-making, multiplied by the numberof hours saved thanks to the new facility yields an indication of the benet reaped by the non-user population.The rise in market price of land located adjacent to the new facility can be evaluated usingdata on actual transactions. Yet, all property sales gures must be adjusted to account formarket trends throughout the targeted zone.On the other hand, a comprehensive assessment of the project must also include the adverseimpacts induced (noise, air pollution, threats to the groundwater table, etc.).Eventually, by comparing the many examples of user-toll facilities, it can be determined thatthe socioeconomic benet generated is on the order of 3 to 5 times the present-value amountof the tolls collected. Herein lies the justication behind the rather systematic granting of sub-sidies, either as in-kind contributions or in cash, from the State or local public authorities tothe concessionaire at the beginning of the construction phase.2.2. Financial assessmentOrganizing an infrastructure project through use of a concession formula necessitates, at thetime of groundbreaking, the availability of all funds dedicated to the project: subsidies, capitaland bank loans. At this stage, each of the actors is to submit the nancial projections on whichits involvement has been based (capital investment, revenue, operating costs and taxes).The entire range of hypotheses are then combined within the framework of a nancial model,which in turn provides each actor with a view of the life of the concession over time. The onlysources of revenue to be taken into consideration are the nancial income from tolls and cashsubsidies.As regards the evaluation of revenues, the issue of which principles to apply for basing ratesnaturally gets raised. Several options exist for setting tolls:– maximize revenues for the concessionaire;– attain the socioeconomic optimum;– incorporate the nancial constraints of lower-income households.The rst method leads to high tolls, with an eventual rate increase during rush hour. Thesecond leads to a lower toll rate, thereby at times generating less income yet accommodat-ing decisively higher trafc levels. Experience has shown that what often gets perceived asthe socioeconomic optimum actually turns out to be the nancial optimum and that revenueis maximized at a toll rate distinctly lower than what trafc models suggest! The third method, 136
  • 82. Roads and road-related infrastructurewhich consists of adjusting the toll to meet the constraints of lower-income segments so asto expand the potential customer base as much as possible, generates less income and thuspresupposes the authority’s willingness to grant a subsidy.Choosing from among these three methods lies exclusively in the political arena. At stakeherein is the decision of how best to divide revenue between the taxpayer and the facility’sfuture customers. To perform this division, it is incumbent upon the public powers to beapprised to the greatest extent possible of customer behavior with respect to the payment oftolls. Section 3 below is devoted to this topic.3. Keys to the political acceptability of a toll facilityA study of various toll facilities has led us to identify three key parameters:– the frequency with which the average customer uses the facility;– the degree of toll obligation imposed on potential customers;– the country’s practices with respect to toll facilities.3.1. Frequency of useWhen the subject of building a toll road gets raised, the potential customer will be led to evalu-ate the cost of this new service from his vantage point. In Western societies, most householdsnow reason in terms of a “monthly budget” and, for a handful of major expenses, an «annualbudget». Whereas taxes and the purchase/ insurance of a vehicle are typically drawn out of ahousehold’s annual budget, housing, food and gasoline tend to lie within the monthly budgetand compared with a household’s monthly income. A toll paid on a regular basis, such aswhen crossing an entrance to an urban center (e.g. Oslo, Singapore) as part of a daily com-mute, will immediately be assimilated as a monthly cost and hence evaluated in terms of thehousehold’s income and savings power. The same does not apply for highway tolls, whichare paid only infrequently and whose cost gets absorbed by a more substantial expense ( travel, trips for family reasons). For the purposes of this article, we will reason in“annual” terms and assume that the annual commute budget is equal to 11 times the monthlycommute budget.The assessment of a toll’s level of acceptability is directly related to the frequency of use bythe average customer for bridges or tunnels, or in the case of an urban entrance toll. Take the example of either Oslo’s urban toll or Lisbon’s Tagus River Bridge. The geographicdivision between employment sectors and residential sectors is such that the majority of resi-dents in entire districts pay toll for their daily commute trips. Add in a couple of extra tripstowards the end of the week or for evenings out, and the total monthly spending in tolls comesto around 45-50 times the amount paid for a single crossing, or some 550 times the amounton an annual basis.In contrast, for facilities such as the Prado-Carénage Tunnel in Marseilles or the A14 motor-way in the Paris region, it can be observed that the majority of trips are generated by individu-als paying toll just 4 or 5 times a week, thereby drawing down their monthly budget in theneighborhood of 20-25 times the toll amount and 250 times for the annual budget.When examining connecting motorways, the frequency of use falls even lower: the numberof trips generated per household is best taken as an annual gure. For a household enjoyingthe use of a holiday home (easy to reach by motorway) during vacation periods and summerweekends, the number of annual trips is on the order of 25 to 30, thus 20 times less than thefrequency of commute trips.In some cases, the difference between urban and interurban facilities is very distinct, with thetwo extremes being an urban entrance toll (e.g. Oslo, Singapore) and the yearly holiday tripon the interurban motorway. In other instances, this distinction is not as sharp: the networkingof cities has given rise to more frequent (up to 200 a year) and shorter (40-60 km) interurbantrip-making. For this reason, some motorway operators now propose specic passes. 137
  • 83. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS 3.2. The degree of obligation This notion is a complex parameter, which we have taken as representative of the extent of choice available to the trip-maker in deciding whether or not to pay toll. Several examples help illustrate the degree of obligation: Paying for automobile insurance or the annual motor vehicle tax obviously represents a 100% degree of obligation. The degree of obligation associated with a toll road can be measured as the ratio of the capacity of the toll road to the total transportation capacity available in the particular corridor, including public transit services. The construction of a toll bridge following the dismantling of a ferry service carries with it a very high degree of obligation, whereas for a newly-built toll highway located adjacent to a toll-free two-lane road, the degree of obligation is quite low. Mountain tunnels display a high degree of obligation, since avoiding them means adding considerable distance, hence time and cost, to the journey. Introducing a public transit line alongside a toll road reduces the degree of obligation. Whenever public (tax) money is invested in the construction of a toll facility, the argument can always be forwarded that this money could have been allocated to the construction or improvement of a toll-free facility, possibly with less stringent standards. A certain degree of obligation to use the toll facility, imposed by the public authority, is thereby present and only increases as the alternative routes or modes become less attractive. Toll facilities are logically categorized therefore by these two parameters: – frequency of use; – degree of obligation imposed on the motorist. Diagram 5 presents a sample of typical road operations. Some appear twice if the facility happens to be used by two distinct categories of customers: frequent users and occasional users. In these cases, the facility’s various frequency levels, from exceptional use (once or twice a year) to daily use, have been cumulated. This procedure was followed for the A14 motorway, the Ile de Ré Bridge (in France) and the Nice metropolitan bypass road. When a facility is only subject to tolls in one direction, we divided the toll amount in half in order to represent the actual nancial cost for each use. The same rationale was adopted for the Dartford Crossing. 700 Nice Oslo Singapour A 14 Bypass road 3F 5F 600 12 F Lisbonne 5FFréquency (number of trips/year) Golden Ile de Ré 407 Toronto Gate 5F 500 10 F 7F Israël Marseille Dartford 11 F Prado Carenage 400 Crossing 12 F 8F Natural obligation Istanboul Artificial obligation 6F 300 Artificial obligation: Lyon TEO Toulouse obtained by 16 puis 7 F 5 puis 0 F reduction of exixting 200 capacities (e.g. Californie d 15 F Nice A 14 contournement 30 F SAPN 7F 100 Tunnel du 35 F AREA Mt-Blanc Ile de Ré Vehicle insurance Eurotunnel 60 F 110 F 55 F and taxes: 3,500 250 F Autoroute de lEst 0 50 F 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Degree of obligation Diagram 5 – Political acceptability of a toll facility (high frequency of use: rates for use passes). 138
  • 84. Roads and road-related infrastructureFour categories of facilities can be distinguished:– facilities whose use is both frequent and mandatory; included in this category are urbanbridges, the urban access tolls in Oslo and Singapore, Lyon’s northern bypass road (“TEO”)prior to upgrading the adjacent boulevard to four lanes, and the southern access into Tou-louse (the Roques toll facility);– facilities whose use is frequent, despite a low degree of obligation; included herein are thePrado-Carénage Tunnel in Marseilles, the A14 motorway in the Paris Region, the Torontobypass road (A 407), a segment of toll road parallel to a toll-free highway in California(SR 91);– facilities whose use is infrequent for non-reimbursed households and for which an alterna-tive mode (e.g. Channel Tunnel, high-frequency trains) or even a free mode (high-quality toll-free road) exists;– facilities whose use is infrequent, yet which remain almost fully mandatory (e.g. the Ile deRé Bridge for vacationers); we also include in this category all mandatory expenses, such asmotor vehicle taxes.Within the four use categories depicted in Diagram 5, distinction can be drawn between:– high frequency and limited obligation, with toll rates varying between 10 and 15 francs, usedby a high-income customer segment (fourth quartile);– high frequency, coupled with a high degree of obligation, exhibiting toll rates in the range ofjust 5-6 francs since the customer segment begins as of the second quartile;– low frequency, with the toll rate tied to the price of alternative means of transportation andthe corresponding degree of obligation.As a case in point, the Lyon bypass road, whose toll rate was initially set at 16 francs duringrush hour, proved to be too expensive to appeal to the entire second quartile; for this reason,the population reacted disapprovingly when the road was rst opened. Yet, this reaction wasnot encountered with either the Prado-Carénage Tunnel, the A 14 motorway, or the SR 91 inCalifornia, whose recent service start-up incited no emotion whatsoever. At the other end ofthe spectrum, the toll now charged on the preexisting Tagus River Bridge in Lisbon is heavilyunderpriced, three times less than the Bosphore bridges in Istanbul, even though the Lisbonpopulation’s standard of living is substantially higher. Since the start-up of the new bridge inApril 1998 and the widening of the preexisting bridge in November 1998, road trafc over theTagus River has increased by 40%. For political reasons, the Portuguese government stillholds the toll down on the old bridge in the year 2000, preferring to supplement the shortfallin toll revenues by a budget allocation from tax income. However, this situation might not lastand the toll level, very low today, might be pushed higher; with user passes being proposedto mitigate the impact on frequent users.In order to address the concerns of the facility’s frequent users, the operator will be propos-ing a system of passes, aimed at segmenting the customer base and maximizing the eco-nomic surplus generated for the entire locality through achieving an optimal use level. Thiswill necessitate the following segmentation:– one-time crossing (exceptional use);– pass for a xed number of crossings;– monthly pass;– half-year or even full-year passes.In 1999, the toll on the A14 motorway in France stood at 37 francs for one-time use; the passfor a xed number of journeys brings the rate down to 20 francs, and the monthly pass bringsit down to 12 francs.From a classical standpoint, toll rates are based on the output from trafc models developedto represent trafc ows during rush hour. A nancial optimum is then sought by modulatingrates as a function of the presumed “willingness to pay” of the local population. This willing-ness is established using a marginal cost approach to evaluate what an individual, given thechoice between two routes or two modes (public transit vs. private automobile), is willing tospend in order to save time. This largely depends upon household wealth and standard ofliving. 139
  • 85. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTSThe marginal nature of this approach presupposes that decision-makers are able to obtain aprecise and well-documented segmentation of the local population’s standard of living, sincea toll-pricing strategy using average values is too crude to base a projection of trafc owsand revenue streams and tends to stir vehement public reaction from low-income households.The incorporation of low-income households (rst quartile) can take the form of subsidiesgranted to individual population groups (e.g. partial reimbursement of the user’s pass by theemployer).The resultant toll rate must then be reviewed in light of the three parameters previously dis-cussed: frequency of use, degree of obligation, and country-specic practices. It is apparentthat whenever facilities exhibit a high degree of obligation, trafc models lead to expensivetolls, hence neglecting the facility’s potential use by lower-income households. From a politi-cal perspective, the opposite decision will be favored. If a high-quality alternative mode isavailable within the transportation corridor, a high toll rate could be maintained on the infra-structure; if not, the toll charged will have to be signicantly less than what the model pre-scribes.The tolls charged on well-accepted facilities yield an annual cost per vehicle ranging from2,200 francs for an almost completely mandatory toll (Oslo) to 6,500 francs for a toll witha very low degree of obligation (the Paris Region’s A14 motorway). The Nice bypass road,featuring a particularly low toll rate, happens to be a beltway as opposed to a radial accessroad, thereby inducing less pressure on demand. The same applies to the tolls charged on allbypass roads if the objective is to have through trafc skirt the urban area.3.3. Country-specic practicesThe third parameter involved in determining the political acceptability of tolls is the impres-sion given of having to pay in addition to the normal tax amount. This fundamental psy-chological parameter varies considerably from one country to the next, and even from oneroad connection to the next. Let’s take a close look at a few examples:In Norway, given the country’s physical layout, reliance on short ferry rides to move fromisland to island is taken for granted. When such a ferry service gets replaced by a bridge andthe bridge toll remains the same as the cost of the ferry, users accept the new facility with-out difculty. The same can be said to explain the public’s acceptance of the Prince EdwardIsland Bridge in Canada, the rst bridge in Lisbon opened in 1966 and the Izmit bridge projectin Turkey. The replacement of a ferry service by a bridge does not impact the obligation to pay,as this obligation had already been instilled into the user’s habits. Yet, keeping tolls constantwithout any hikes to account for ination results in the service’s undervaluation, a situationdifcult to turn around.In both France and Italy, for some fty years now, tolls have been charged on interurbanmotorways. Motorists have come to recognize, and accept, that it is preferable to pay a tolland benet from a high-quality road for infrequent long journeys than to cope with saturatedtrafc conditions. Yet, this mindset did not spread into other European countries, whose infra-structure had been in a better state of repair.Motorways in the vicinity of urban areas have, until now, remained free of tolls. A poignantexample in France is the round of negotiations held leading to the partial buyback of: theA4 toll road near Paris, the A43 in the Lyons area, and the A64 in Toulouse. The suburbs,socioeconomically less well-off than the central cities, were not about to «pay their commute»when they were already paying for the extra time spent commuting!Individuals tend to reason by applying the principle of “a fair tradeoff». Since taxes normallygo towards paying for infrastructure, the use of infrastructure «should logically” be free ofcharge inasmuch as the service provided is considered as already paid for. If a toll were to becharged, then some additional compensation would be necessary. Such compensation maytake the form of: an accelerated construction schedule; participation in a consensual urbanrenewal program; a freeze on tax hikes on the grounds that the facility’s nancing is being 140
  • 86. Roads and road-related infrastructureshouldered by the customer and not by the taxpayer; or any other rationale which can berecognized, understood and accepted by the population. The municipality of Oslo conducteda series of preference surveys several years before their decision to implement an urban tolland now regularly polls user satisfaction, with survey results being released for publication.One of the keys to this effort is the extent of information provided to local residents concern-ing the use of toll revenues.Diagram 6 displays the operating cost for a small car, while Diagram 7 presents the break-down of the industrial cost before taxes, the after-tax cost (VAT, tax on petrol, etc.), the urbantoll (3,000 francs/year), and a hypothetical parking cost (4,500 francs/year); these graphshighlight the proportion paid out in taxes. It is clear that the urban toll is merely a complementto the other costs and is perceived as such, necessitating even further sound justication.A special case is encountered when the degree of obligation is high, subsequent to a volun-tary measure introduced by the local area’s transportation authority to cut back the free com-ponent of existing road services. An issue only in urban areas, this approach is a subtle oneto implement since the segment of the population not using the new facilities, who continueto pay taxes and whose travel time continues to increase, have every reason to protest.It can be observed that the dismantling of a toll-free road or urban open space is easily acceptedprovided the user-taxpayer acknowledges that this capacity reduction goes hand in hand witha perceptible advantage (e.g. urban renewal projects in connection with the Strasbourg andGrenoble tramway systems, pedestrian malls, waterfront restoration work in Oslo). Such is notat all true however when capacity is reduced solely to increase trafc volumes on the toll facilitywithout any tradeoff in terms of urban amenity. In this instance, public reaction will be directlytied to the toll amount charged and the relative afuence of the local population. 160 000 Used, gas-powered: 10,000 km/year Used, diesel-powered: 15,000 km/year New, gas-powered: 15,000 km/year 140 000 Transit pass: 450 FF/month 120 000 100 000 Cost in francs 80 000 60 000 40 000 20 000 0 0 1 2 3 4 5 6 Year Diagram 6 – Costs to operate a small vehicle. 141
  • 87. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS Cumulative cost in francs 1996 140 000 120 000 before taxes 100 000 after taxes 80 000 60 000 40 000 20 000 0 0 1 2 3 4 5 6 Year Diagram 7 – Breakdown of operating costs for a small gas-powered used car (urban setting-use: 10,000 km/year).Diagram 8 shows the rise in the monetary cost relative to a 10-km urban automobile triprepeated 600 times a year at a toll rate of 12 francs and a low degree of obligation. Lower-income households only use the facility on rare occasions: the monetary impact of the toll isweak. For those population groups using the facility on a regular basis, the increase variesbetween 50% and 120% of the initial per-trip cost, depending on whether the comparison ismade with respect to average cost or perceived cost. The corresponding toll amounts rangefrom 3,000 to 9,000 francs depending on the household’s level of income. 140% Percentage added to the initial cost 120% 100% of the trip 80% In comparison with average cost 60% In comparison with perceived cost 40% 20% 0% 0 200 400 600 800 Annual income in 1994 ’000 FF Diagram 8 – Increase in per-trip monetary cost (10-km urban trip, toll rate: 12 FF).4. Key guidelines for instituting acceptable tollsRegardless of the quality of studies conducted prior to instituting a toll, in particular for urbantolls, three unknowns remain pervasive:– How will the public react to the facility and toll rate structure?– How will decision-makers react to the unknown nature of the public’s reaction? 142
  • 88. Roads and road-related infrastructure– What lines of communication should be opened with the public to enhance understandingand acceptance of the toll?Over time, experience and lessons continue to accumulate, revealing a certain behavioralrationale which will enable further advances in predicting public reaction to the introductionof tolls and hence in sharpening the quality of projects and project nancing methods. Onesensible approach consists of working with all modes of transportation together, within theframework of an urban transportation plan with heavy public backing and reasonable nanc-ing pressures. Stockholm’s «Dennis package» (a master plan encompassing both infrastruc-ture and urban transportation), by virtue of its consensual nature which called for including thedesiderata of all political parties, cannot be completed as initially planned due to excessivecosts: the entire equilibrium of the project as well as of its nancing has to be rethought.The principle behind tolls stems from three basic advantages:– trimming public debt and budgets;– generating an economic surplus, to be transformed into monetary income;– having the customer and not the taxpayer pay for services, which helps support the eco-nomic approach to basing choices.It would be regrettable to see past and present mistakes tarnish the image of a source ofnancing that not only accommodates the perspective of a sustainable city with smoother-owing trafc inside its central district, but also provides a powerful resource-redistributioneffect from businesses to households and from afuent households to those with more limitedmeans thanks to monetizing the creation of economic value in order to cut taxes.The previous examples have illustrated a few of the leading guidelines for estimating a toll’slevel of acceptability:• If customers are having a portion of their tolls reimbursed by their employer, they naturallybecome less sensitive to the toll rate; the only concern has to do with control.• If a toll facility provides additional capacity without reducing the capacity of existing toll-freeroads, it tends to be well accepted. In this case, the facility represents additional transporta-tion supply for those interested and able to pay for it.• If a toll facility has required the injection of public subsidies, its toll rate must be held lowor else low-income taxpayers, who use the facility only rarely, will be given the impression of«paying for the rich».• The geographical coverage of the region paying out the subsidy must be broad enough toencompass the majority of future facility customers.• The order of magnitude of a toll cost must resemble that of any consumer good (purchaseof a newspaper, a drink, a lottery ticket, etc.).• Such a representative consumer good must obviously come from the zone where the facil-ity has been located. The principle of equal application of the law does not mean equality inthe acceptance to pay tolls. Oslo’s urban toll was designed so as to include the city’s poorerdistricts inside the toll belt. A uniform toll rate all around Paris would raise a problem in thatwhat the more afuent west side deems as acceptable is not necessarily so on the east side.• An urban facility is more intended to ensure a given travel time, thereby capable of inducingbehavioral modications, rather than simply generate time savings.In conclusion, and perhaps here lies the essential point, a transportation program cannotbe dissociated from an urban planning program. It takes a united and sincere motivation tobeautify the city in order to accept paying an urban toll. 143
  • 89. FINANCING OF MAJOR INFRASTRUCTURE AND PUBLIC SERVICE PROJECTS What specic features concern the concession-granting authority?u Roads represent a sector in which two distinct activities can be associatedwith the concession/delegated management contract: construction and/or main-tenance.u Two types of nancing can be envisaged: direct nancing by the user (in theform of tolls), and indirect nancing by the State, depending partly on trafc volu-mes. This latter mode, while considerably less risky for the operator, allows thepublic authority to spread the infrastructure payment over time.u The socioeconomic return is often quite a bit higher than the nancial prota-bility, thereby lending justication to the public authority’s participation in the pro-ject’s nancing.u The strength of the builder-operator partnership (hence the use of a singlegeneral contractor) is essential in limiting the risks of cost overruns and scheduledelays.u The income risk is very high for toll facilities: it is composed of: an overall trafcvolume risk, a price level risk, and a price/demand elasticity risk. The income riskmust be divided between the concession-granting authority and the concessio-naire according to the benets each party can expect to reap from the project.u The political and social acceptability of the toll is independent of the classicaleconomic model and must be used to determine the appropriate rate-settingpolicy.u In order to evaluate this acceptability, the toll rate must incorporate both thefacility’s frequency of use by the average customer and the degree of user obliga-tion. It depends on the specic context of each project and the particular country’spractices.u The public authority and the service operator must do their utmost to informand convince the public of the value of a toll-based system, by means of well-adapted and durable marketing policies and awareness-building campaigns. The network of French highway concessions In 1960, France was lagging tremendously with respect to its highway network (only 173 km of its highway network had been built). Concessions were created during the 1960’s by call- ing upon mixed-economy companies; and in 1970, the number of kilometers in the national system had reached 1,570, with over 1,000 under concessionary control. However, even this construction pace was considered insufcient, and the use of concessions intensied by call- ing upon strictly private companies. Unfortunately, the oil shock occurred just as some vast highway projects were gearing up; the private companies, with the noteworthy exception of Coroute, ultimately had to be bailed out by the State. Moreover, the State began occupying a dominant position in the mixed-economy companies as of the second half of the 1980’s. 144
  • 90. Roads and road-related infrastructureRegardless of their shareholder composition, concessionary companies have helped shapethe nature of highway projects and strengthened the network in developing a system of del-egated management for both project construction and operations. Thanks to the efforts ofthese companies, France now boasts one of the world’s most extensive and modern motor-way networks, with a total road length of nearly 9,300 km, 7,000 km of which are under con-cessionary control (including 800 km run by the private company Coroute). Concessionshave also been relied upon for road-related infrastructure projects (e.g. the Normandy Bridge,the Ile-de-Ré Bridge, the Mont-Blanc and Fréjus Tunnels in the Alps). Urban projects, such asthe Prado-Carénage Tunnel in Marseilles or the A14 and A86 motorways (in part) in the ParisRegion, have also been set up as concessions. Summary statistics on the French autoroute network (1/1/1999). Total road length of the network as Jan. 1,1998 ............................................. 9 309 Interurban highways ..................................................................................................... 8 319 – of which toll roads ................................................................................................... 7 048 – of which toll-free roads ......................................................................................... 1 271 Urban highways .................................................................................................................. 990 Length of the French road network under concessionary control (1/1/1999). SANEF ......................................................................................................................... 1 254 km SAPN ................................................................................................................................ 354 km SAPRR ........................................................................................................................ 1 707 km AREA ................................................................................................................................ 366 km ASF ............................................................................................................................... 1 976 km ESCOTA .......................................................................................................................... 430 km ATMB ................................................................................................................................ 107 km STRF ................................................................................................................................... 55 km COFIROUTE ................................................................................................................ 799 km 145
  • 92. A. A DRAFT TYPOLOGY OF PUBLIC-PRIVATE PARTNERSHIPRémy PRUD’HOMME The term “infrastructure nancing” has been coined to cover the range of issues related to the provision of public-sector goods and services. Such goods, for which exclusive reliance upon market forces proves inadequate and public authority intervention mandatory, can be sorted into three broad categories: purely public goods, external effect-inducing goods, and natural monopolies. All three overlap by virtue of their use of infrastructure facilities, thereby tying up large quantities of capital for long periods and making them good candidates for public-private partnership. These goods and services vary to a great extent when assessed on the basis of four key parameters: size of infrastructure-related investment, degree of technical sophistication, fee-generating potential, and the optimal geographic service supply zones. The type of public-private partnership entered into will obviously depend on this set of parameters, yet reliance on the private sector involves the objective of the public- private partnership as well. The method of service payment chosen will also inuence the actual provision of the public good or service. Ultimately, public-private partnership-type contracts are to be classied according to: the type of private- sector involvement (facilities and/or service provision), the compensation basis adopted, the capital outlay, the contract’s lifespan, to name some of the most commonly-employed indicators. The use of public- private partnership can thus take on a wide variety of forms, within a continuous and multidimensional context, even though certain buzzwords and acronyms (e.g. Concession; Build, Operate, Transfer - BOT,; or more recently Project Finance Initiative - PFI), have focused attention on just a handful of features. The forms of public-private partnership in the domain of infrastructure financingare indeed numerous, especially in France; deriving one or several typologies would,in no way, be a futile exercise. The expression «infrastructure financing» has creptinto common usage as a convenient term for a designation which is still misleading.What needs to be stressed here is not exclusively, or even primarily, the financing perse of a piece of infrastructure, but rather the provision of goods or services by meansof infrastructure for the purposes of public amenity. The public-private partnershipcan and must be focused on precisely this notion of goods/service provision. At thisstage, it would be most fruitful to pause and examine the nature of these goods. Generally speaking, most of these goods are privately-owned, with the marketserving as the ideal institution for providing the goods demanded by consumers atthe most efficient cost. This generalization, however, is subject to a good numberof exceptions. Certain goods, which also display a high level of consumer demand,cannot, and must not – in the interest of the consumer himself – be provided bymarket mechanisms alone so as to prevent against any market dysfunction. The spe-cific instances of market failure have been well studied by economists. The first cat-egory of such market incapacity pertains to what have been designated as the “pure”public goods (e.g. national defense), to which no group can be denied access or ben-efit. The second category concerns goods whose consumption results in the genera- 333
  • 93. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTStion of external effects, the inherent cost of which is not typically passed onto theconsumer (e.g. wastewater and sanitation services). The third category encompassesthose goods whose marginal cost decreases with production volume and which giverise to natural monopolies (e.g. rail transportation). For all three of these categories,the private sector, or more precisely the market, is not able to function adequately,thereby necessitating a certain measure of public-sector intervention. Within thisconception however, no room has been allotted for the introduction of any valuejudgment whatsoever; all economists, including the most vehement free-market pro-ponents, agree on this point. The list of such “public” goods, which when combinedaccount for roughly 20% of the GDP in industrialized countries, is indeed a longone. To this list «social» goods (e.g. education and health services) would have tobe added; while the market could produce this category of goods and services, pre-vailing societal opinion has deemed that neither the quality nor the quantity pro-duced would meet expectations and that public intervention would prove essential.These social goods, whose definition necessitates a value judgment in the first place,account for another 20% share approximately of GDP.1. Infrastructure and public goods From the standpoint of our examination, these public and social goods exhibittwo main characteristics: they have been created through the use of infrastructure;and they are inherently predisposed to a public-private partnership-type organiza-tion. Each of them can be associated with the specific infrastructure or facility usedfor its production. Table I after, which in no way claims to be exhaustive, matchesgoods with their “source” infrastructure. It can be added that all public goods, including those held by the private sector,are also produced with capital. It appears however that the level of capital used toproduce public goods (i.e. infrastructure), in relative terms, turns out to be higher.Such goods normally demonstrate less geographic mobility: a factory can ultimatelybe relocated; a tunnel can’t. This type of capital often displays a longer lifespan thanprivate capital. Moreover, some of these goods are referred to by employing the nameof the infrastructure responsible for producing the good: the word «sewer» is com-monly used to refer to wastewater and sanitation services, “roads” designates roadtransportation, “school” serves as a generic for indicating not only the facility itselfbut education in general, etc. Yet, this overlapping terminology can be misleading;a primary danger lies in mistaking the development of a piece of infrastructure forthe provision of a public service and, in so doing, overlooking the implementation,operations and maintenance, which prove as essential to the service as the physicalexistence of the infrastructure. In the following sections, even if the word infrastruc-ture does at times creep into the discussion, the emphasis is wholly placed on theprovision of goods and services to consumers and/or intermediate producers. 334
  • 94. A draft typology of public-private partnership Table I – Public goods and services with their corresponding infrastructure. Public good/service Related infrastructure Education Primary/secondary schools, universities, etc. Health Medical offices, clinics, hospitals, convalescent homes, retirement homes, etc. Defense Military barracks, warehouses, workshops, etc. Civil Security Stations (fire, police), facilities/equipment, etc. Justice Courts, prisons, etc. Culture Museums, theaters, cinemas, etc. Transportation: air Airports, radar stations, control towers, etc. road Roads, highways, bridges, tunnels, etc. rail Railway lines, train stations, signaling, etc. waterway Canals, locks, etc. maritime Ports, lighthouses, etc. urban transit Subways, street networks, information systems, traffic signals Telecommunications Lines, satellites, switching stations, cables, etc. Electric power Power plants, transformers, power lines, etc. Water supply Dams, pumping stations, piping networks, water purification plants, etc. Sanitation Sewer systems, wastewater treatment plants, etc. Street lighting Streetlights, etc. Recreation Parks, public gardens, stadiums, gymnasiums, swimming pools, etc. Postal services Post offices, mail processing centers, delivery vehicles, etc. Religion Places of worship, cemeteries, etc. Research Laboratories, offices, etc.2. Public goods and the private sector The second key characteristic of these public goods and services is their strongpredisposition to a public-private partnership format. The very nature of their provi-sion must obviously include a certain number of “public” precepts. It is coupled in allcases with a share of private involvement. A fully self-sufficient public entity, capableof producing on its own all of the pencils, automobiles or whatever else needed foroperations, is not easy to envisage: there is no such thing as a purely public supply ofgoods. Even national defense agencies, despite the presence of weapons and militaryinstallations, still rely upon the private sector for the majority of supplies1. Publicgoods and services are therefore always produced jointly by the public and privatesectors. The public aspect within the provision of public goods and services is notabsolute, but merely relative, and can be assessed for the most part in comparativeterms. The critical issue should not be focused on the underlying principle of thepublic-private partnership itself, but rather on the magnitude and specific condi-tions. The premise inherent in a public-private partnership is already legitimate andits importance recognized.1. Up until recently, France had been in a paradoxical situation whereby its military aircraft were beingproduced by a private manufacturer while civil aircraft were being contracted to a public-sector corpora-tion. 335
  • 95. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTS Why should a private component be introduced into the provision of publicgoods and services? The answer is for reasons of economic efficiency: for a giveneconomic cost, the private sector is generally able to produce in greater quantity andat higher quality than a public authority. This rule however is obviously exposed to anumber of exceptions: cases of inefficient private firms and efficient public agenciescan be easily cited2. Nonetheless, from an overall standpoint (based on the findingsof many studies, conducted principally in the United States), the opposite is true.Four reasons or explanations can be forwarded to justify this statement. The first of these pertains to the economies of scale potentially realized by the pri-vate sector. This reason may seem paradoxical, in that a firm’s capacity to outperformthe State is difficult to conceive, yet it must be kept in mind that the public sector isnot necessarily synonymous with the State. A sizable proportion of the public goodsand services listed in Table I display distinctly local-level characteristics and, in prac-tice, are supplied by local and regional authorities; the move towards decentralizationhas served to increase this proportion. The major public service supply groups onthe market tend to be much larger than their client local authorities. Furthermore,and such is the case for the French market, these major groups pursue export-relatedactivities, which contribute to their expansion while reducing their average costs.Indeed, the wealth of experience gained in this field has nurtured the private sector’sunquestionable expertise.3. Diversity in the array of public goods and services The types of public goods and services, whose actual provision entails a certainproportion of private-sector involvement, are far from being identical; both the scopeand conditions relative to the PPP depend for the most part on the characteristicsof the specific goods under consideration. It is thereby necessary to emphasize andanalyze this diversity in the public goods and services encompassed within a public-private partnership framework. From this vantage point, four aspects appear to becritical: the magnitude of the infrastructure, technological complexity, ease of feecollection, and size of the production or consumption zone. Table II summarizes theoutcome of this analysis. The magnitude of a piece of infrastructure varies from one public good to thenext. While very important for road transportation, urban transit, telecommunica-tions, electricity distribution, water and sanitation services, and street lighting, theinfrastructure necessary to run education, health services, national defense, civil pro-tection, research and the justice system remains fairly minimal. The production func-tion inherent in these latter goods and services requires, above all else, a properly-2. It has been shown, for example, that the cost of adult education provided by the private sector istwice that of the public sector (R. Prud’homme, “Quand le public fait mieux que le privé”, Le Monde,July 19, 1994). 336
  • 96. A draft typology of public-private partnershiptrained labor force. With respect to just the infrastructure-financing component, it issafe to say that those goods and services relying most heavily on infrastructure proveto be the most suitable candidates for a public-private partnership. Table II – Characteristics of public goods and services. Infrastructure Technological Ease of fee Size of local magnitude complexity collection zone Education 2 4 2 1-4 Health 2 5 2 4 Defense 2 3-5 1 1 Civil Security 1 3 1 2-5 Justice 1 4 1 4 Culture 2 3 4 4 Transportation: air 2 5 5 4 road 5 3 4 4 rail 4 4 5 3 waterway 2 2 5 3 maritime 3 3 5 4 urban transit 4 4 2 5 Telecommunications 5 5 5 2-5 Electric power 5 4 5 2-5 Water supply 5 4 5 5 Sanitation 5 4 1 5 Street lighting 5 2 1 5 Recreation 4 2 4 5 Postal services 1 2 5 3-5 Religion 2 4 2 2-5 Research 2 5 1 5 Note: A score of 1 indicates that the characteristic under consideration (infrastructure, tech- nical complexity, etc.) plays a less signicant role in the supply of service, while a score of 5 suggests a very powerful inuence. The scores listed in the above table reect the assess- ment of the author and are therefore open to debate. The magnitude of a piece of infrastructure varies from one public good to thenext. While very important for road transportation, urban transit, telecommunica-tions, electricity distribution, water and sanitation services, and street lighting, theinfrastructure necessary to run education, health services, national defense, civil pro-tection, research and the justice system remains fairly minimal. The production func-tion inherent in these latter goods and services requires, above all else, a properly-trained labor force. With respect to just the infrastructure-financing component, it issafe to say that those goods and services relying most heavily on infrastructure proveto be the most suitable candidates for a public-private partnership. This category of public goods and services also exhibits wide variations in termsof the degree of technical sophistication required. Some such as street lighting, publicgardens and open space, and postal services rely upon straightforward and tried-and-true technologies, whereas others such as medical and health services, air trans-portation, telecommunications, and research necessitate more complex and rapidly- 337
  • 97. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTSevolving technologies. It must be underlined that in this field, evolution may takeplace very quickly. Services such as water delivery and sewerage, which for a longtime had been associated with reliable and relatively-unsophisticated technologies,are now instituting extremely refined techniques in areas like water/wastewater treat-ment and billing. Given the private sector’s technological superiority, which hap-pens to be even more pronounced in cutting-edge and high-paced disciplines, themore technically-oriented services readily accommodate greater levels of private-sector involvement. Another fundamental feature, from the standpoint of a public-private partner-ship format, is the relative ease with which a service can concretely be remunerated.This feature varies considerably from one service to the next: consumption-basedfees can be levied without great difficulty for services like water delivery, telecommu-nications, electricity distribution and rail transportation; however, this is impossiblewith respect to national defense, street lighting, sanitation services, the justice systemand research, which mainly lie in the category of purely-public goods, a categorywhich cannot be paid for by service users alone, but instead draws its resources fromtaxpayers as a whole. For other types of services (e.g. road transportation), a systemof tolls, despite its cost and inefficiency in purely economic terms, may be optedfor. In yet other cases (e.g. education or health services), a fee-based system is techni-cally feasible but gets voted down for sociopolitical reasons. In this domain, as inmany others, technological advances can allow shifting the boundaries between onecategory of good or service and another; as a case in point, only with the advent ofthe time-stamped ticket machines (a relatively simple device, in reality) a short timeago did it become possible to collect street parking fees. The smooth functioning ofurban toll roads has not yet been fully attained, but improvements are on their waythanks to developing technologies. In general, as it becomes easier to set rates for apublic good or service, greater private-sector involvement in the provision process isalso easier to introduce. Public goods and services display varying degrees of local specificities. Their pro-duction and/or consumption zones vary in size: some, like defense or research, canonly be laid out within a national or international framework, while others, likestreet lighting, sanitation, water supply or urban transit, must by definition remainlocal in scope. Still others, such as education, prove to be more complex inasmuchas the primary school market is not at all coterminous with that of secondary orhigher-level education; furthermore, the optimal zone over which an educationalprogram should be formulated is not necessarily contiguous with the provision ofactual instruction. A service’s spatial dimension entails a dual focus: technical andjurisdictional. A service lends itself more readily to private intervention as its scope ofactivity becomes more locally dominated. The justification for this lies in the privatesector’s stronger advantage over smaller local- or regional-level authorities than overlarge-scale or State-level authorities, as discussed above. 338
  • 98. A draft typology of public-private partnership In summary, the tolerable (and, by the same token, optimal) level of private involve-ment within a public-private partnership-based service rises as the service becomesmore: capital-intensive, complex, conducive to rate-setting, and local-specific (i.e. asthe tally in Table II increases). Water supply, for instance, a service which relies heavilyon major infrastructure, which makes use of continually-evolving technologies, whichis easily subject to rate-setting, and which remains focused on the local level, lendsitself very well to a major dose of private sector input; it comes as no great surprisethen that water services are typically provided by private companies. These considera-tions must be taken into account when establishing a public-private partnership’s setof conditions. Each individual service requires a customized form of public-privatepartnership. In theory, no one single set of conditions is best. Some forms are simplybetter-suited than others for a given technical and institutional setting.4. Diversity in the set of public-private partnership objectives The public-private partnership format, as highlighted above, pertains to the pro-vision of a public good or service. Yet, this provision can be viewed from severalperspectives, each of which can be the focus of a separate public-private partnership.For our purposes, four such perspectives will be examined: decision-making, pay-ment, production and financing. The provision of a public good or service involves making a certain number ofdecisions. It must be decided: whether to produce the service in the first place, forwhich group of recipients, at what price, under which financing conditions, usingwhich means (technologies), with which targeted level of service, and on some occa-sions on which bases for rationing access. For decisions of this type, reliance on aPPP framework must remain limited or absent. The decision-making process mustlie within the “public domain”, as dictated by the very notion of what constitutesa public good or service. Any role for the private sector must be severely limited.This point is indeed crucial. In some circles, the presence of the private sector,as manifested by use of the term «privatization», is an all-or-nothing proposition,with the choice of provision formula being narrowed to 100% public vs. 100% pri-vate. Such a position is completely inappropriate in light of the four-dimensionalnature of the provision process itself: privatization may apply very well to just oneof these dimensions, but in almost all cases does not apply well to the decision-making dimension. The claim has even been made that the public authority’s capac-ity to perform its decision-making function can only be enhanced by delegating itsproduction function. There is no such thing as a free public service in that the cost of setting up andrunning a service has to be picked up somewhere along the line. A service’s paymentmust be assumed either by the user, through service fees or tolls, or by the taxpayer,or by a combination of both. Payment by the user could be considered as a form 339
  • 99. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTSof private-sector involvement, due to its resemblance with the method of paymentfor privately-owned goods. The choice of mode of payment is never straightforward;technical, social and economic parameters must all be taken into consideration.From a technical point of view, a price can be ascribed to public goods and serviceswith varying degrees of difficulty; some do not allow conducting any kind of pric-ing. The classical case is related to the category of purely public goods (e.g. nationaldefense): such services are not to be exposed to mercantile forces, since those whowould be unwilling to purchase the service could not actually be deprived of its ben-efits. This entire category has to be financed through taxation. Others however, suchas water supply, can be easily bought and sold. The boundary between what can bepriced and what cannot is obviously subject to modification; in sync with the paceof technological change, this boundary has been shifting in favor of the setting ofrates. All of the services subject to user fees are not necessarily billed out as such forreasons of social equity, yet it should be pointed out that the social impacts of tax-based financing (and hence of zero user cost) are far from conclusive. Should thetax turn out to be regressive or even proportional (which is often the case with localtaxes) and should the free public service be consumed primarily by the well-to-do(which is also often the case since the act of consumption entails time, knowledgeor a specific location more accessible to the wealthier social classes), offering thisservice would then be tantamount to having the less well-off pay for the more fortu-nate. Ultimately, considerations related to economic efficiency must be taken intoaccount. The service fee, depending on the fee structure and the specific amounts,influences both demand and consumption levels. A zero fee, for example, leads tohigher consumption and potentially to wasteful consumption. The third dimension to the provision of a public service pertains to the produc-tion side. This dimension lends itself to private-sector involvement more easily thanthe other three. Yet, the very notion of “production” can be divided into a number ofdistinct sub-dimensions, which cannot - and must not - be incorporated in a similarfashion into a public-private partnership perspective. For purposes of simplification,the four most prominent of these sub-dimensions have been identified as follows:– engineering services, which can easily be subcontracted to the private sector;– construction of the infrastructure facilities, even more easily subcontracted;– management functions, which entail the production of the service using the builtinfrastructure, also quite often easy to delegate to the private sector, albeit less so thanconstruction;– and infrastructure maintenance operations, which can generally be conferred to theprivate sector without much difficulty. The final component involves the public service’s financing. This dimensionshould not be confused with that of the service’s payment (through taxes or userfees). As mentioned earlier, due to the reliance on sizable and long-lasting infrastruc-ture for producing many public services, heavy capital investments are required up 340
  • 100. A draft typology of public-private partnershipfront. Such outlays may be financed either by the public authority through tax hikesor by the private sector in the form of bank loans or equity. This dimension to publicservice provision is independent of the other three. The situation could be envisagedwhereby a fully “public” service (i.e. one that has been approved, paid and producedby the public sector) is actually financed by the private sector (i.e. by means of banklending). Conversely, a primarily “private” service (paid by users and provided by pri-vate companies) could be envisaged in which the infrastructure is financed throughpublic monies. Table III below summarizes the preceding discussion. Table III – The extent of private-sector involvement by public-private partnership objective. Public-private partnership Degree of private-sector involvement objective Decision-making Limited or inexistent Service payment Variable, depending upon the applicability of the pricing structure Production Engineering Rather broad Construction Very broad Management Rather broad Maintenance Very broad Financing Variable, depending upon the means of payment and the borrowers financial strength The number of combinations in the choices available is infinite. In consideringjust the payment, engineering, construction, management, maintenance and financ-ing dimensions to service provision, along with just two possible strategic positions(all-public or all-private) for each dimension, the number of combinations alreadycomes to: 26 = 64 types of public-private partnership. In reality, the number of pos-sibilities is much higher since other dimensions can be added into the assessmentand especially since a purely public vs. private dichotomy for every single dimen-sion represents an extreme oversimplification. From this perspective, the multiformnature of a public-private partnership is clearly apparent. Some dimensions however should perhaps be weighted more heavily than others,and their combination may lead to simpler typologies. This approach has beenadopted in Table IV, which focuses exclusively on production and payment, withthree potential payment positions: payment by the taxpayer, payment by the user,and a mixed payment – relatively widespread in practice – by both taxpayer and user.With this set-up, six categories can be distinguished, each of which has been illus-trated using a French example. Keep in mind however that this framework merelyrepresents a sample public-private partnership typology; others, perhaps equally asrelevant and incisive, could also be proposed. 341
  • 101. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTS Table IV – A sample typology of modes of public service provision. Means of payment Public production Private productionPublic: through taxation/the taxpayer Purely public model Supply contract (National defense) (Waste processing)Private: through service fees/the user Public monopoly Concession contract (EDF - electric power supply) (Water supply)Mixed: through both taxation and Subsidized monopoly Subsidized concession contractuser fees (SNCF - national railway) (Local bus services outside of Paris)5. Content of public-private partnership contracts A public-private partnership almost always takes on the form of a contract enteredinto between a public entity and a private firm. The combination of different typesof public entities (national, regional, local, municipal, intermunicipal, etc.), coupledwith the different types of private firms (major industrial group, small- or medium-sized firm, mixed-capital company, etc.) could be used to develop an initial typologyof public-private partnership contracts. However, a better approach would surely beto examine the content of public-private partnership contracts themselves. As men-tioned previously, this content varies widely from one contract to the next, depend-ing on the type of public good or service under consideration as well as on the con-tract’s set of objectives. Nonetheless, at least two main parts are always included:specifications of the private firm’s production; and terms of the firm’s remuneration.Other parts of the contract, pertaining to potential conflicts and their resolution orto eventual revisions, must also be added. Table V presents an overview of the varioustypes of private-sector missions and possible remuneration formulae stipulated in apublic-private partnership contract. Table V – Possible contents of public-private partnership. Services provided by the private firm Remuneration of the private firm Infrastructure, without service: By the public-sector entity (price): Design Fixed price: Construction Immediate Maintenance Deferred Service, without infrastructure: Proportional pricing: Limited management On the basis of the service provided All-encompassing management On the basis of financial outlay Both infrastructure and service: By the user (service fee) Service, with initial infrastructure Mixed (service fee and price) Service, with additional infrastructure The private firm’s missions can, depending on the nature of the contract, relateto the provision of the infrastructure alone, to the provision of the service alone, orto the provision of both. 342
  • 102. A draft typology of public-private partnership As regards the infrastructure alone, this mission can encompass one or severalof the three dimensions alluded to above: design (or engineering), construction andmaintenance. In the frequently-encountered case where the contract has been estab-lished for all three dimensions, a key issue gets raised: should the public entity engagea single fully-integrated firm or rather three distinct firms? Anglo-Saxon practices andlegal precepts have, for a long time, called for a more pluralistic approach, whereasFrench practices have been inclined to favor singularity. Each formula presentsadvantages and disadvantages. Singularity, or reliance upon a single company, carrieswith it the guarantee of overall compatibility and generates economies of informa-tion. If the firm commissioned to build a piece of infrastructure knows in advancethat it will also be assigned maintenance responsibilities (and, often, service manage-ment functions), it will be less tempted to sacrifice the long run for the short run,and thereby less likely to opt for less-expensive solutions during construction whichresult in higher maintenance costs down the road. If the engineering firm contractedto design the project has also been retained for the construction phase, considerabletime will be saved and coordination mishaps avoided. The downside of a singularapproach lies in the removal of competitive pressure. In the traditional Anglo-Saxonsystem, three calls for tender are held: one for design, one for construction and thethird for maintenance and/or operations management. In the French system on theother hand, only one is held: for all three dimensions lumped together. Weighingthe theoretical pros and cons of such an “all-in-one” strategy could be discussed adinfinitum, yet observation of practices over the past few years at the internationallevel would suggest that the singular approach is in fact winning converts. A coupleof trends help support this observation: integrated French firms or firms operatingwith French-fashioned methods being awarded an increasing number of contracts;and, perhaps even more pointedly, Anglo-Saxon firms displaying a greater propensityto become fully-integrated, capable of incorporating engineering/design, construc-tion and operations management responsibilities. With respect to service-only contracts (without the infrastructure component,which in this case is built and owned by the public authority), the distinction can bedrawn between missions relative to the entire service and those relative to just one orseveral narrower aspects of the service, such as infrastructure maintenance or labormanagement. In the majority of cases however, the contracted missions will pertain to both theproduction and management of infrastructure, i.e. the overall service provision. Awell-known distinction can be drawn between contracts which call for producingall of the infrastructure and those which call for producing only the additional infra-structure required either to meet the forecasted increase in demand or to introducea new technology. The issue of infrastructure ownership is important, yet not essential to the public-private partnership. In general practice, the public entity retains ownership of the 343
  • 103. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTSservice’s infrastructure. In those instances where the infrastructure is owned by theprivate entity, this status is usually only temporary: once a predefined period of timehas elapsed, the private firm retrocedes ownership to the public authority. It is criti-cal to point out that in the area of public service provision, the public sector alwayshas the last word, even when the private sector has been “delegated” to ensure fullprovision of the service and to undertake all necessary capital investments. The private firm engaged in a public-private partnership contract obviouslyexpects to be remunerated. The contract always establishes the conditions of suchremuneration, which correspond with one of the two following scenarios: First, the private firm can be directly remunerated by the public entity, in whichcase the remuneration takes on the form of a price or fee, along the lines of a pricepaid when two private firms conduct an ordinary transaction. This price howevercan be determined in a multitude of ways, based on either a fixed price or a propor-tional price. The fixed price, as stipulated in the contract, is intended to remunerate the serv-ices performed by the private firm; it may be revisable, by applying for examplea price indexation formula, and subject to schedule overrun penalties or, muchless commonly, to early completion bonuses. This fixed sum is typically paid inits entirety once the construction phase has been terminated, with the possibilityof intermediate instalments during the course of the construction work. Recentlyhowever, a deferred payment scheme has been gaining prominence, according towhich the remuneration gets spread over a potentially much longer time frame (10 to15 years) through periodic payments. In this case, the contract encompasses a basicservice provision contract plus a loan agreement: the private firm is thus responsiblefor the service’s production as well as its financing, while the public authority coverslong-term debt through tax revenues. In general however, the authority relies uponbanks for its financing needs. The price paid by the public entity to the private firm can also be proportional,but proportional with respect to which parameters? To the actual service provided,as in the case of household waste disposal where remuneration is normally based onthe volumes removed and/or processed. The service provided, which often includesa distinct qualitative component, must be defined using utmost care and coupledwith a fine-tuned monitoring system. Shadow tolls represent another example ofproportional remuneration. According to this system, a private entity builds a roadat its own expense; users then benefit from the infrastructure free of charge; andthe concession-granting public entity remunerates the private firm on a pro-ratabasis depending on the number of vehicles traveling on the new road segment. Thisproportional-remuneration system differs substantially from that of capital outlays;it can be found in the areas of research, supply of military equipment and, to apartial extent, urban bus transit. The private firm covers all of the expenses “neces-sary” to ensure provision of a public service; the public entity then reimburses these 344
  • 104. A draft typology of public-private partnership expenses plus a small profit margin. Even when accompanied by mandatory cost- control measures, this system lacks a strong cost-minimization incentive. Remuneration of the private firm can also take on the form of a price or service fee paid by the user. Many possible formulae could be adopted to base such a user fee, including: average cost, marginal cost, the Ramsey-Boiteux function, binomial distributions, discriminant. Each presents a distinct set of advantages and disadvan- tages. Both the structure and amount of the user fee are obviously not to be left to the discretion of the private firm, but rather carefully stipulated in the public-private partnership contract. The contract also specifies how this fee is to evolve over time. Lastly, the remuneration may be mixed, thereby combining a component of user fee with another component of price or subsidy. The price paid to the private firm could take on the form of a guaranteed minimum or of a subsidy proportional to the service provided. The amount of such a subsidy should increase as pressure mounts on the level of the user fee. Here again, the range of formulae conceivable – and cur- rently in practice – is very broad. 6. Characteristics of partnership formulae From a more analytical perspective, certain characteristics inherent to public- private partnership-specific formulae, whose diversity in terms of both objectives and contractual contents have already been discussed, do merit further examination. Three in particular, which happen to be very closely tied to one another, will be raised herein: the contractual period, the private firm’s capital commitment, and the breakdown of risks between the public and private sectors. The duration of public-private partnership operations is highly variable and can span the short term (1 or 2 years), the medium term (2-5 years) or the long term (10+ years). The private firm’s capital commitment - the amount of funds invested and the investment period – also varies considerably between the two ends of the spectrum. As shown in Table VI, a general correlation can be drawn between the contractual period and the level of capital commitment. Table VI – Capital commitment and contractual periods. Type of contract Degree of private capital Length of contractual commitment periodTechnical assistance Very low 1 to 2 yearsOperations and maintenance Low 2 to 5 yearsLeasing Moderate (capital flows in the system) 5 to 10 yearsConcession of an existing network High (influx of new investment) 10 to 20 yearsBOT (concession for a new piece of infrastructure) Very high 20 to 40 years The public entity responsible for negotiating contracts thereby finds itself in a predicament. On the one hand, it would like to negotiate short-term contracts so as to maintain greater flexibility over the long run. Being in a position to renegotiate 345
  • 105. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTSthe contract more frequently enables the public entity to solicit (or at least threatento solicit) outside competitive bids, hence to take greater advantage of the economicefficiency associated with the private sector. The rationale behind calling upon theprivate sector would, in the first place, tend to favor short-term contracts. Yet, on theother hand, a company’s capital commitment depends directly upon the length ofthe contract: for a three-year contract, for example, no company will agree to a heavycapital investment requiring fifteen years to be fully depreciated. Yet, experience hasshown that a good number of public services are indeed provided with such levels ofcapital investment. The technological rationale behind the provision of public goodsand services would thus plead in favor of long-term contracts. It then becomes essen-tial to seek out the appropriate middle ground between these two points of view bynegotiating contracts which are long enough to benefit from extensive capital com-mitment and short enough to benefit from a healthy dose of market competition. Ingeneral, the size of the capital investment determines the length of the contract. The provision of public goods and services, to a greater extent than most otheractivities, involves risk-taking; the nature of these risks is both technical and com-mercial. The technical risk concerns, first and foremost, the cost of building theinfrastructure. Since many infrastructure projects require “customized” facilities forsite-specific and service-specific reasons and since the construction schedule spans along period of time, cost projections are difficult to develop with accuracy. No oneeven bothers to keep track of the number of projects whose actual cost winds upexceeding the projected cost. The commercial risk concerns above all the use of thefinished infrastructure and is also quite difficult to assess. The set of explanatory vari-ables related to infrastructure use is so vast (income levels, price, consumer prefer-ences, the presence of competing infrastructure, technological factors, etc.) and souncertain, especially for longer time frames, that even the results of the most sophis-ticated forecasting models often prove wrong. Here again, the number of instances inwhich actual use rates differ radically from the projected rates is no longer recorded.In sum, uncertainty exists with respect to both the expenditure side and the revenueside (at least when a user fee is charged), hence the presence of risk. The public-private partnership contract must address this risk through devisingformulae that: minimize risk or at least the inherent uncertainty; distribute all resid-ual risk “equitably”; and/or transfer the risk to an insurer. Some systems for provid-ing public goods and services are indeed more prone to introduce forecasting errorsthan others. In particular, entirely-public systems would naturally tend to minimizecost forecasts and inflate use rate forecasts: the civil servants responsible for the fore-casts, the politicians responsible for project-related decisions and the contractorsresponsible for the works program are all relatively immune to the consequencesof such errors, which would be borne by the taxpayer, and they stand to gain when-ever additional investment is approved and carried out. They are thus prone to pro-duce involuntary miscalculation. A preferable system would be one in which those 346
  • 106. A draft typology of public-private partnershipresponsible for producing and sanctioning forecasts hold a stake in the accuracy oftheir work. Such is the case when the private sector is remunerated on the basis ofactual use rates and then required to absorb any cost overrun. Incentives aimed atimproving accuracy in forecasting can help reduce the risk of introducing error, butcertainly not eliminate it altogether. A certain degree of risk will therefore always have to be shared or assumed. Theconditions laid out in the public-private partnership contract are to, either implic-itly or explicitly, define the way risk is to be divided. Formulae in which the publicentity assumes all risks are definitely to be avoided: the private partner would in noway be motivated to minimize costs and maximize use rates. Also to be avoided arethose formulae in which the private firm absorbs all risks: the public entity’s apparentadvantage here is merely superficial, as the private firm is in fact required to protectitself against any excessive risk (a point its bankers would never overlook) and wouldpass on the cost of such protection to the public entity in the form of higher pricesor user fees.7. The necessity of adopting a case-by-case approach A framework for analyzing the various forms of public-private partnership withrespect to financing infrastructure projects has been forwarded herein. The processinvolved widening the scope of the public-private partnership for the entire provi-sion (and not just the financing) of public goods and services (and not just the infra-structure necessary for their production) because this broader angle of assessment ismore relevant. The investigation has focused on the diversity of these public goodsand services, which cannot be treated using a generic approach, as well as on thediversity of the potential - and actually applied - solutions and formulae. Claimingto be “for” or “against” the public-private partnership format is not at all relevant.Instead, emphasis should be placed both on defining, for each given situation, theoptimal role of private-sector involvement with respect to each of the service pro-vision dimensions (decision-making, payment, engineering/design, construction,management, maintenance, etc.) and on negotiating one or several contracts thatclearly stipulate the missions and remuneration bases, with due consideration paid tothe contractual period, the breakdown of risks, and the private sector’s capital com-mitment. Such a framework definitely lends itself best to a customized approach as opposedto any standardized packaged formula. Table VII below reflects an attempt at a typol-ogy which, by virtue of heeding the advice of Valéry who stresses that “all thingssimple are untrue but all things complicated are useless”, proves to be neither toouseless, nor too untrue3.3. Borrowed from the French Ministry of Public Works. 347
  • 107. FINANCING OF MAJOR INFRASTUCTURE AND PUBLIC SERVICE PROJECTS Table VII – Different types of public-private partnership. Option Operations & Capital Commercial Asset ownership Contract maintenance investment risk periodPublic agency (non-public-private Public Public Public Public –partnership) managementService contract (Outsourcing) Public/private Public Public Public 1 to 2 yearsManagement contract Private Public Public Public 3 to 5 yearsLeasing Private Public Shared Public 8 to 15 yearsConcession of existing network Private Private Private Public 25 to 30 yearsBOT (Build, Operate & Transfer) Private Private Private Public => Private 20 to 30 yearsPrivatization Private Private Private Private indefinite APPENDIX : Primary types of contracts underlying a public-private partnership Concession The concessionaire carries out all of the capital investment, operates the resulting service and is remunerated primarily through service fees paid by users. The facilities are to be handed over to the oversight public authority at the end of the contract period. Leasing The lessee manages either the facilities side or the operations side of the project and is remu- nerated primarily through service fees paid by users. Equivalent to the Anglo-Saxon Mana- gement Contract (plus a “success fee”). BOOT (Build Own Operate Transfer) Within a project financing framework, several private entities – via a series of contracts – finance, build, own and operate an infrastructure facility designed to accommodate the set of needs established by the public authority, which in many instances acts as guarantor for the project. Ownership of the facility is to be transferred to the public authority upon expiration of the contract. BOT (Build Operate Transfer) A variant of the BOOT contract, whereby facility ownership is transferred to the public authority once the building phase has been completed. BOO (Build Own Operate) A variant of the BOOT contract, whereby facility ownership remains in the hands of the private investors beyond the contract’s expiration. Reverse BOOT The public authority finances and builds the facility, and then confers service operations to a private firm which assumes ownership as the building phase winds down. 348