Tag: Private Finance 2

How does PPP work

Public / Private Partnerships originated in Australia as governments sought new way of dealing with public procurement of infrastructure in the 1980’s. In the intervening periods they have remained similar as a financial model but as governments like to change the name when there is a new administration in a misguided attempt to make it look like a new policy as opposed to a rehash of the old ones there have been various iterations in the United Kingdom.

The last Conservative Government of John Major started using these financial models and they were knows as a Public Private Partnership (PPP). While in opposition Gordon Brown called into question PPP’s and made it clear they would not be used if Labour won the next General Election. So were born the  Private Finance Initiative (PFI) which as the Labour government became tired and ran out of steam were ridiculed by Gideon Osbourne and would not form part of any incoming Conservative government procurement plans. Of course a little tweak here and there and now we have Private Finance 2 (PF2).

Yet in reality they are little changed, save for the minor tweaks.

What are Public Private Partnerships?

Public Private Partnerships are generally where public services or private business ventures are funded and operated through a partnership between the Government and one or more private sector companies.

They allow Government to contract out the design, building and operation of a facility for the benefit of the public to a private sector company usually for a period of 25 to 30 years usually based on a “value for money” test over traditional procurement. In effect government had two ways to procure:

  • A standard procurement structure, in which the Government specified what it wanted in terms of an asset and then paid a contractor to build that asset. The Government then took ownership of the asset, and took on the obligation to maintain it, after it was built; or
  • A PPP structure in which the Government specified what it wanted in terms of a service and either pay a service provider to make that service available, or allow the service provider to retain the resulting revenue or share it with the Government.

However the effective result of PPP is that everything is procured through the PPP model and has resulted in almost every aspect of what the government provided being effectively sub-contracted, through large service providers, such as Capita. There is some miss-guided notion that a private company can run the service for less money and still make a profit than government after factoring in inherent inefficiency. The actual result is usually poorer service. There is a scandal every so often, the culprit is given a token ban from securing government work, but this is soon dropped and they back on the gravy train.

A worked example

For the purposes of this example we will assume the highway authority want to provide traffic relief by building a new toll road (such as the M6 toll which by-passes Birmingham via Cannock in the West Midlands) and maintaining and managing the asset for a 25 year period.

There would clearly be key functions that would need to be considered and evaluated by the PPP operator, such as

  • The cost of building and operating the road would need to secured
  • The PPE contractor would have to engage a designer to determine the layout and specification of the road
  • A contractor would need to be appointed to construct the road
  • A service organisation would be required to clean the road, replace damaged infrastructure from crashes, provide and maintain lighting, institute a “smart” tolling system (Such as at the Dartford Crossing of the Thames River
  • Cyclical maintenance such as resurfacing would need to undertaken
  • A mechanism would need to be established of what the handover procedure is when the lifecycle of the PPP ends

As can be seen this is a multi-disciplinary activity and the government would in effect expect the cradle to grave cycle to be undertaken by the successful bidding organisation. This generally means that the bidders are Joint Ventures (JV) (incorporated or unincorporated) that allow the main Special Purpose Vehicle (SPV) that will hold the effective PPP contract to cover different competencies. In our example the SPV could be made up of a Finance House, Design Organisation, Main Contractor and Service Provider. However despite this make-up of the JV the actual works will still be sub-contracted even to a partner company. This is because the trend has been for these SPV’s to be sold off after a defined period. In effective the SPV is a shell because it owns no physical assets, employs few (if any staff) and exists to own the head contract for the PPP being contracted for.

Risk is obviously a major consideration in these projects because of their complexity and part of the PP process would be for government to transfer risk to the SPV and its agents. This could be done as follows:

  1. Risks that Government want to pass to the PPP SPV would be set out in the contract between the parties, or assumed by the SPV as applicable at law to its activities, such as liability for contamination during the construction phase
  2. As the SPV is project specific and does not own anything physically these risks and obligations are allocated to the various members of the supply chain where applicable or where this cannot happen will be left as a risk the SPV holds with some form mitigation to cover the financial consequences of the risk crystallizing. In effect the cost of this type of risk would be a component of one of the costs of the service
  3. During the construction phase – for example, liability for environmental pollution during construction phase the risks would be passed down by the SPV to a Contractor (who could further pass down the risk to Sub-Contractors) through “back-to-back” provisions in their contracts. In effect this means the Contractor agrees to perform all the defined services the SPV has agreed to provide to the government. The Contractors programme would be of equal length of shorter than the SPV, to build a road to the same specification required by the government in the head contract and to ensure the SPV would not be in breach of contract and subject to Liquidated and Ascertained Damages. (LAD’s) However there would be a “back to back” provision that would make the Contractor liable to the SPV for LAD’s at the same level in the event he was in breach of contract. In effect mitigating this risk for the SPV. The effective purpose would be to leave the allow the SPV neutral and the Contractor managing the risks involved in the construction of the asset
  4. When the road was complete and able to operate as a toll road, the SPV would operate the road and, again, these obligations would sub-contracted to an Operating Company using a similar methodology as detailed in the previous point. However it is possible that not all operation and maintenance risk could be passed to the Operating Company, two examples would be:
  • “Day-to-day” operation and maintenance could be passed on but obligations to undertake periodic, major maintenance, such as resurfacing for wear and tear may not be subcontracted at the start but remain an SPV risk, and contracted for separately when required (where defined in the head contract) or as due when there are sufficient funds and resources
  • “Change in Law” provision are a risk that cannot be evaluated at the start and that the Operating Company could not take on because of the length of the service contract. These risks are to a large extent under the control of government as the legislator. It is likely this would be a shared risk between government and the SPV and be dealt with as and when the risk crystallises following a change in law.
  1. The SPV has to finance the construction and initial operational activities, in effect the construction costs of the road would need to be paid for, and the money for this would need to be repaid from revenue generated by the road when it opened for traffic. The financial model would see the funding requirements should exactly match the SPV’s liabilities to pay its subcontractors. In effect a lean organisation

 Nature of risks with this PPP project

At the simple level the risks would be:

  • Can the road be built on time and to the required specification
  • Can the road be operated as the government requires
  • Will revenue generation be as expected as the financial model will be based on revenue assumptions

We could now expand these sub heading and detail some of the specific further risk that could be associated with each.

Built on time and to the required specification

  • Does the SPV have the necessary access to the site
  • What happens if ground conditions are different from expected
  • What happens if the law relating to road construction changes during the construction period
  • What happens if resources that the contractor is expecting to use are not available or in short supply
  • Who takes the risk that the road costs more to build than expected
  • What happens if a natural disaster occurs

Operated as the government requires

  • Does the SPV have the required access to the site
  • What happens if the law relating to road operation changes during the operating period
  • What happens if resources that the operator is expecting to use are not available or in short supply
  • Who takes the risk that the road costs more to operate than expected
  • What happens if a natural disaster occurs

Revenue generation expectations

  • Has the road been built to specification
  • Is the road being operated according to the Government’s requirements
  • Demand risk: will cars, lorries etc want to use the road
  • Payment risk: will cars, lorries etc want to pay to use the road
  • Are the operating costs, including finance cost fixed or variable

 These risks are typical but not exhaustive and each would require a provision in the contract to deal with. Some we have already looked at in other blog posts such as access (frustration) or natural disasters (Force Majeure). However Demand Risk could be dealt with where government makes up for any shortfall in notional demand. Of course this really means the taxpayer is obligated to pay the shortfall.

However in the alternative these risks would exists under traditional procurement where the accepted norm is to contract out the running.

As the Local Democracy, Economic Development and Construction Act [2009] outlawed Conditional Payment clauses, although this is the standard in PPP contracts where the SPV is created for the sole purpose of procuring the project has no assets and is not intended to have any liability unless it is first paid. Therefore PPP contracts have an Exclusion Order where Conditional Payment provisions will exist, although in the longer term this may need to be subject to further legislation. However because of the nature of the contracts and that they are bespoke, heavily negotiated forms this is a risk known to all parties at the outset.

The Exclusion Order means that provisions in first tier PPP sub-contracts which make payments in such contracts conditional upon obligations being performed in other contracts (such as providing certificates and ‘pay when paid’ clauses) will be effective.  However, ‘pay when paid’ clauses will, generally speaking, continue to be ineffective in accordance with the Local Democracy, Economic Development and Construction Act [2009]


PPP as a procurement model has been with us for over 20 years. It’s a simple and legal way for government to not have to declare obligations as government debt. In an overwhelming majority of cases where a dual analysis of PPP and traditional procurement has been evaluated, the assumptions are skewered to assist in ensuring the PPP option is the governments preferred procurement route. However when costs are well known and become public knowledge PPP proves itself to be poor value for money.

But the reality is it’s here to stay, even if when the current Conservative government runs out of steam and the electorate give another party the opportunity to govern, probably Labour once again once they have dispensed with their insane trip back to 1920’s state control under Jeremy Corbyn and his “brothers” and “sisters”. One thing is sure PPP will continue, it will just be called something else.

Maybe they could call it Stakeholder Hybrid Infrastructure Term Schemes.