Maintaining value for money in the operational phase of PPP contracts

Maintaining value for money in the operational phase of PPP contracts

Michael Burnett, Director, European PPP Forum, European

Institute of Public Administration, OECD meeting of Senior PPP Officials, 18 February 2014

Scope

 PPP contract management – The challenge

 PPP contract management – Common mistakes

 PPP contract execution – What can go wrong

 PPP contract execution – What to do if contracts go

wrong

 PPP contract execution – Examples of responses to

challenges

 Contract execution – Challenges in the new EU

Introduction – Michael Burnett

 Chartered Accountant (c.20 years working in public

procurement)

 Assistant Director, KPMG

 Director, EIPA European PPP Forum (9 years)

 Member, European Commission Stakeholder Expert

Group on Public Procurement since 2012

 Member, Editorial Board, European Procurement and

Contract management and the award process

 Clear specification of contract objectives (including

KPIs, targets for KPIs and how measured)

 Robust performance management régime to verify if

contract objectives being met

 Change protocols for planned/unforeseen change

 Contract conditions giving access to necessary

information

 Means to verify continuing value for money (VFM)

during contract

Challenges in realising procured VFM

 Deals skilfully tendered and astutely negotiated by the

public sector still have to be managed effectively: - Maintaining procured VFM when change needed - Combatting bargaining weakness when change

needed

- Combatting information asymmetry

- Application of performance monitoring régime

 Important to have the right resources and skills in

contract management team (economic operators will usually have more experience)

PPP contract management – Common mistakes

 Failure to plan contract management during

procurement phase

 The “sigh of relief” factor

 Failure to transfer procurement knowledge to contract

management team

 Inadequate contract management resources

 Poor match to required skill set (e.g. training, past

experience)

 Senior management switch off/demotivation of

PPP contract execution – What can go wrong (1)

Ineffective contract management is often a major cause of difficulties in contract execution

BUT ALSO

 Procurement errors by Contracting Authority

 Demand forecast errors

 General economic shocks

 Force majeure event

 Mismanagement/under-resourcing by private partner

PPP contract execution – What can go wrong (2)

 Legislative change (controllable/non-controllable)

 Technological change

 Professional practice change

 Public acceptance change

 Change of political control/orientation

PPP Contract execution – Options if things go

wrong

 Change contract in favour of private partner (e.g.

length, scope, performance targets, payment amounts, payment flow, shift to partial or full availability basis, future revenue/refinancing guarantees, partial debt re-financing, hand-back terms, lower DSCRs subject to lender approval, other risk re-acceptance etc)

 Don’t change and leave responsibility for recovery

with private partner

 Rebalance the contract on the “something for

something” principle

Evaluating options if things go wrong

Determine approach on case by case basis based on:

 Responsibility for specific contract issues arising

 Responsibility in original contract for risk materialising

 Partnering behaviour of private partner

 Scale of recovery needed

 Scope for change (affordable?, foreseen in contract

review clauses? legally permissible?)

 Consequences of failure for public sector

PPP Contract execution – Options for

rebalancing the contract

 Activate LGTT, Europe 2020 Project Bond Guarantees

or other guarantee options (if relevant)

 Portfolio/territorial re-negotiation

 Compensating adjustments by SPV (e.g. more sponsor

equity, new equity investor, acceptance of public sector equity/board representative in SPV, future public sector gain sharing, refinancing with gain sharing, future

enhanced monitoring/certification/audit, future

requirement for performance bond/sponsor parent company guarantees, earlier recovery of asset, lower user tariff, pass through of energy/insurance/sub-letting shared savings etc)

PPP contract execution – Examples of

responses to challenges (1)

Example 1 – NATS

 Causes of problem: General economic shock

(September 11th_{) and over-optimistic demand forecasts}

(but NB also risks in initial financing structure of NATS)

 Nature and scale of problem:

- Project company loan covenants in danger of being breached - Lenders threat to withdraw funding from project company

- Investors unable to provide sufficient extra finance - Threat to functioning of UK Air Traffic Control system

PPP contract execution – Examples of

responses to challenges (1) continued

 Result:

– Need for short-term emergency funding facility of £60m (£30 million from government, matching £30 million loan from NATS bankers)

– Financial restructuring (BAA as new private investor invested £65 million, government capital injection of £65 million, lower overall price cap, upside and downside volume risk sharing mechanism through price adjustments, planned cost reductions, significant replacement of bank debt by bond finance, less tight bank

oversight, less onerous debt covenants, tighter monitoring of future distributions, safeguards re conflict on interest for new shareholder, no need for government takeover)

– No major financial shocks since refinancing, no further public

PPP contract execution – Examples of

responses to challenges (2)

Example 2 – London Underground PPP

 Cause of problem: Ineffective contract management by

Contracting Authority and mismanagement by private partner (but NB also contract strategy errors by

Contracting Authority)

 Nature and scale of problem (Part 1):

– One of the two private partners (Metronet) went into

administration in 2007 (after cost overspends and threat by lenders to withdraw access to loan facilities) and the PPP Arbiter granted only £121 million of requested interim £551 million UP increase for 2007-08

PPP contract execution – Examples of

responses to challenges (2) continued

 Nature and scale of problem (Part 2):

– Three years later the other private partner (Tube Lines) requested £1.3 billion for additional expenditure for upgrades required

compared to estimates of the PPP Arbiter

 Result:

– Termination of PPP and public sector takeover of Metronet and Tube Lines contracts

– In Metronet’s case, public sector paid £1.7 billion to meet guarantee to lenders on early termination

– In Tube Lines case, public sector paid £310 million to acquire shares of project company and assumed £1.3 billion of project company’s debt

PPP Contract execution – Challenges in the new

EU Directives

 Possibility to change contracts to greater extent/more

easily and frequently to include additional works,

services or supplies (Art.72(1)(b) Public Procurement Directive, Art.43(1)(b) Concessions Directive)

- Removal of the “unforeseen circumstances” test - Removal of cumulative limit on total value

- No limit on number/frequency of changes

 Step-in rights for lenders unambiguous? (Art.72(1)(d)

Public Procurement Directive, Art.43(1)(d) Concessions Directive)

 Impact of legislative provisions on number of

European PPP Forum

WEB SITE

http://www.eipa.eu then search for PPP

CONTACT DETAILS

Mr Michael Burnett

Director, European PPP Forum

European Institute of Public Administration Maastricht, the Netherlands

Tel +31-43-32 96 286 E-mail: [email protected]