Public Private Partnership

Pranjal Kapoor

Deloitte

Public Private Partnership

InfrastructureRoad/Highways Sector

Public Private Partnership (PPP)A public private partnership is defined as “a cooperative venture between the public and private sectors, built on the expertise of each partner that best meets clearly defined public needs through the appropriate allocation of resources, risk and rewards.

PPP is a way out to solve public deficit financing. It is done to give rise to speedy infrastructure growth.

The Public Private Partnership has emerged as one of the most important models government use to close the infrastructure gap.

For example, a city government might be heavily indebted, but a private enterprise might be interested in funding the project's construction in exchange for receiving the operating profits once the project is complete.

Why PPP model?There are usually two fundamental drivers for PPPs. Firstly, PPPs enable the public sector to harness the expertise and efficiencies that the private sector can bring to the delivery of certain facilities and services traditionally procured and delivered by the public sector.

Secondly, a PPP is structured so that the public sector body seeking to make a capital investment does not incur any borrowing. Rather, the PPP borrowing is incurred by the private sector vehicle implementing the project and therefore, from the public sector's

perspective, a PPP is an "off-balance sheet" method of financing the delivery of new or refurbished public sector assets.

Characteristics of PPP model:- Shared goals - Shared resources (time, money, human resource).- Shared risk- Shared benefits

How PPP model works?A PPP typically works as follows:

Bidding process. A public sector entity (usually a central government body/local authority) will identify the need to deliver a particular project, such as building a Highway or a hospital. The public entity will advertise the need for such a project and then run a competitive process under which private sector entities will "bid" in order to win the right to deliver the project. The winning private sector bidder is then awarded a "Concession" to implement its solution.

Project Company. A private sector entity will contract with the public entity and raise funds from investors and lenders in order to deliver the project (the "Project Company"). Usually, a new, separate, private company will be set up to be the Project Company in order to insulate the private sector sponsors of the project from the risk of insolvency if

the project fails. This new company is known as a "special purpose vehicle" (an "SPV").

Sponsor. The activities of the Project Company will be managed by one or more private sector companies (the "Sponsor"). Typically, the Project Company is set up as a direct/indirect subsidiary of the Sponsor. The Sponsors are usually the equity investment divisions of large construction or facilities management companies who want their construction or facilities management divisions to deliver the project. This arrangement will be documented in a "Shareholders' Agreement".

Documentation. The Project Company will enter into a contract with the public sector (the "Concession Agreement"). This is the key document detailing the terms and conditions of the project.

Contractors. The Project Company will enter into contracts to enable it to implement the project as it will typically have no employees. There will usually be one entity who is made responsible for the delivery of the facilities management services detailed in the Concession Agreement (the "FM Contractor"), and another entity who is made responsible for the provision of the construction works detailed in the Concession Agreement (the "Construction Contractor"). Certain responsibilities may be sub-contracted to other more specialist entities (the “Sub-Contractors”).

Funding. The Project Company will obtain private funding in order to finance the PPP. Usually, funds are made up of a mix of investments by Sponsors (usually a small proportion of the overall debt) and loans

from outside lenders (the "Lenders"). The Lenders will enter into "Financing Agreements" and "Security Agreements" with the Project Company, under which they agree to lend in return for security over the project. There will often also be "Direct Agreements". Project finance is provided on the strength of the cash flows of the Project Company, therefore the Concession Agreement is key. The payments made by the public sector entity are the sole income stream into the Project Company so if the Concession Agreement is terminated, the Project Company will have no means of repaying its debts. If a project starts to go wrong and the Project Company's right to deliver the contract is in danger of being terminated by the public sector entity then Lenders can rely on Direct Agreements to prevent the Concession Agreement from being terminated until the Lenders have had a chance to "step in" to the Project Company's shoes and attempt to remedy the situation.

Lenders may include commercial banks with experience in project finance, export credit agencies ("ECAs"), multi-lateral agencies ("MLAs") and development finance institutions ("DFIs"):

• ECAs are governmental or quasi-governmental institutions. ECAs provide finance to promote national exports. An ECA can act either as a guarantor, an insurer or a lender. They have different models and they can be government institutions (e.g. ECGD, K-EXIM) or private companies operating on behalf of the government (e.g. Hermes, COFACE).

• MLAs are governmental institutions owned by a number of governments. Whereas an ECA's prime aim is to support national economic interests, an MLA's mandate is to further economic development in developing countries. Major MLAs include the Asian Development Bank and African Development Bank.

• DFIs provide long-term development finance for private sector enterprises in developing countries. Examples include DEG (Germany) and FMO (Netherlands).

Benefits of PPP:

- Public private partnerships allow the costs of the investment to be spread over the lifetime of the asset and thus can allow infrastructure projects to be brought forward by years compared with the pay-as-you-go financing typical of many infrastructure growth.

- PPPs transfer certain risks to the private sector and provides incentives for assets to be properly maintained.

- PPP can lower the cost of infrastructure by reducing both construction cost and overall life cycle costs.

- Private sector involvement could be a good means of having technology enhancement and operational efficiency.

Disadvantages of PPP:- The number of parties involved and the long-term nature of their

relationships often result in complicated contracts and complex negotiations, and therefore high transaction and legal costs. PPP projects can take years to complete.

- There is a risk that the private sector party will become insolvent or make large profits during the course of the project – this can cause political problems for the public entity.

PPP models:- Design Build - The government contracts with a private partner to

design and build a facility. After completing the facility, the government assumes the responsibility of operating and maintaining.

- Design Build Maintain - This model is similar to Design-Build except that the private sector also maintains the facility.

- Design Build Operate - Private sector designs and builds a facility. Once the facility is completed, the title for the new facility is

transferred to the public sector, while the private sector operates the facility for a specified period.

- Design Build Operate Maintain/ Build operate transfer (BOT) - It combines the responsibilities of design-build procurements with the operations and maintenance of a facility for a specified period by a private sector partner. At the end of that period, the operation of the facility is transferred back to the public sector.

- Build Own Operate Transfer - The government grants a franchise to a private partner to finance, design, build and operate a facility for a specified period of time. Ownership of the facility is transferred back to the private sector at the end of that period.

- Build Own Operate - The government grants the right to finance, design, build, operate and maintain a project to a private entity, which retains ownership of the project. The private entity is not required to transfer the facility back to the government.

PPP maturity model - One offshoot of the rapid growth of infrastructure PPPs is that countries remain at vastly different stages of understanding and sophistication in using innovative partnership models.

There are three distinct stages of PPP maturity

Stage one- Establish policy & legislative framework.- Develop deal structures.- Begin to build market place.- Initiate central PPP policy unit to guide implementation.

Stage two- Establish dedicated PPP units in agencies.- Begin developing new hybrid delivery models.- Leverage new sources of funds from capital markets.- Use PPPs to drive service innovation.

Stage three- Refine new innovative models.- Use of more sophisticated models.- Greater focus on total lifecycle of project.- More creative, flexible approaches applied to roles of public &

private sector.

PPP maturity curve country wise:-

Challenges of PPP in India:

- Regulatory environment: There is no independent PPP regulator as of now. In order to attract more domestic and international private funding of the infrastructure, a more robust regulatory environment, with an independent regulator is essential.

- Lack of information: The PPP program lacks a comprehensive database regarding the projects to be awarded under PPP. An online data base, consisting of all the project documents including

feasibility reports, concession agreements and status of various clearances and land acquisition will be helpful to all the bidders.

- Financing availability: The private sector is dependent upon commercial banks to raise debt for the PPP projects. With commercial banks reaching the sectoral exposure limits, and large Indian Infrastructure companies being highly leveraged, funding the PPP projects is getting difficult.

- Project development: The project development activities such as detailed feasibility study, land acquisition; environmental/forest clearances etc. are not given adequate importance by the concessioning authorities. The absence of adequate project development by authorities leads to reduced interest by the private sector, misplacing and many times delays at the time of execution.

Benefits government can achieve by using PPPs -

- Bringing construction forward: - On time and On-budget delivery: Public Private Partnerships also

have a solid track record of completing construction on time or even ahead if schedule.

- Shifting Construction and Maintenance Risk to the Private Sector: Politics and Budget pressures play havoc with proper maintenance of existing infrastructure. There are various risk involved that could hamper the progress of the construction and could also defer the maintenance ultimately imposing huge cost. Well-designed PPPs can ameliorate these problems by transferring certain construction and maintenance risk to the private partner.

- Cost Savings: Cost savings in several different forms, maintenance cost and lower cost of associated risk.

- Strong Customer Service Orientation: Private sector, often relying on user fees from customers for revenue, have a strong incentive to focus on providing superior customer service.

- Enabling public sector to focus on outcomes and core business: PPPs enable governments to focus on outcomes instead of inputs. Government can focus leadership attention on the outcome based public value they are trying to create.

Overview of Indian Roads:

India’s road network of over 4.1 million km is second largest in the world consisting of expressways, national highways, state highways, major district roads and other roads. These roads carry about 65 per cent of freight and 80 per cent of passenger traffic. National highways constitute only 1.7 per cent of the road network, but carry about 40 per cent of the total road traffic. Road Transport has emerged as the dominant segment in India’s transportation sector with a share of 4.7% in India’s GDP in 2009-10. The number of vehicles on Indian roads has been growing at an average pace of 10.16% per annum over the last five years. Hence, development of road network assumes paramount importance in the context of a rapidly growing economy.

Investment in Road Sector:

Investment in the roads sector during the Tenth Five Year Plan (2007-12) and the Eleventh Five Year Plan (2007-12) are shown below:

National Highways Authority of India (NHAI):

The National Highways Authority of India (NHAI) was established as a statutory entity under the National Highways Authority Act 1988 for development, maintenance and management of National Highways. Its initial mandate was restricted to a few projects undertaken with external assistance. From 1998 onwards, the Government has been implementing the National Highways Development Programme (NHDP) comprising:

Phase I: Augmenting the Golden Quadrilateral connecting the four largest metropolis.

Phase II: Augmenting the North-South and East-West corridors.

Phase III: Four-laning of high-density national highways connecting state capitals and places of economic, commercial and tourist importance.

Phase IV: Up gradation of single-lane roads to two-lane standards.Phase V: Six-laning of four-laned highways.

Phase VI: Construction of 1,000 km of expressways.Phase VII: Construction of ring roads, by-passes, underpasses, flyovers, etc.

Public Private Partnership in National Highways:

Owing to constraints of public funding, Public Private Partnership (PPP) has come to play a major role in the development of national highways. The National Highways Act, 1956 was amended in 1995 with a view to enabling private investment in development, maintenance and operation of highways. The Government initiated

several other measures in this direction such as declaration of road sector as industry to facilitate borrowing on easy terms and reduction in the custom duties on construction equipment.

Several government initiatives have been taken to enhance private sector participation (PPP) in road sector:

- Viability Gap funding in the form if capital grants subsidy of up to 40% of project cost.

- 100% tax exemption in any consecutive 10 years out of 20 years.- Duty-free import of certain identified high quality construction plants

and equipment.- Allowing FDI up to 100% in the sector.- Long concession period of up to 30 years.- Right to collect and retain toll.- Model concession agreements for state highways.- Standardizing of model bidding documents.

Public Private Partnership downfall in India:

Lately it has been noticed that PPP projects in India are not taking off.

The main reasons:

- Lack of clarity about project objectives: Sponsors sometimes lack consensus about the purpose of and expected outcomes for the project.

- Too much focus on the transaction: The government may view PPPs merely as financing instruments when in fact they represent a very different way of working. This has led to poor operational focus.

- Conflicting interest of multiple shareholders.

- Inflated traffic projections made in the beginning.- Renegotiating contracts: It is the duty of the private company to

continue to meet the commitments originally made in the concession agreement without asking for contract renegotiation.

- There are delays in handling over the entire land in time, inefficient project planning.

- Use of inappropriate business models.- Slowdown in the economy and lack of funding available.- Delayed legal clearances and aggressive bidding have emerged as

two major factors causing problem.

Some recommendations:

- Understanding of proposed assets.- Integration between all parties involved for smooth information flow.- Prudent sharing of risk and rewards among all the parties involved.- Better preparations before the process of bidding for a PPP project.- Ill equipped consultants, selected through lowest bid could also be

the root cause of failure, so choosing the right consultants also plays an important role.

- Government should assist the private partner throughout the project and ensure that the capital invested sees fair rate of return.