The Risk In Public-private Partnerships

By Author: Anthony W Bills
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The Risk In Public-Private Partnerships

Abstract
Private Public Partnership has been found to be one of the most effective ways to minimize the government’s expenditure in funding the public and or social projects without affecting the quality. PPP has been successful in some developing countries though it’s surrounded by challenges and risks. In the formation of PPP, there are several procedures that are followed to have an effective partnership and to avoid variation of interests there after.
Though the private funded projects are effective, they are expensive for they are aimed at making profit while the public funded projects are cheap and infective due to mode used to make decisions
Abbreviation
PPP- Public-Private Partnership
SPV-Special Purpose Vehicle
PFI-Private Finance initiative

1.0 Introduction
Public private Partnership (PPP) can be defined as a partnership between the public and private sector or between the government and private businesses that are funded and operated through the partnership venture of government and one or several private sectors ...
... companies. These kinds of schemes are commonly regarded as P3 or PPP .
The public-private partnership is a contract that involves an authority from a public sector and private sector. In this regard, the private sector involves a private sector providing a public sector with services and assumes the risks, financing and technical support. In PPP, the cost of using the service is agreed by the government that it will fully or partially support the project . The government may provide the public sector with the goods (assets) that may be used in production of; example infrastructure or subsidy with an aim of making the deal look more attractive to the private sector. On the other hand, the government may provide tax subsidies or guarantee annual revenues for a given period of time .
The private sector mostly forms a consortium company after the deal of PPP is formed called the special purpose vehicle (SPV) that is used to maintain and build the assets that have been offered during the contract period. In case the government has invested in the SPV, they share allotted shares equitably with the private sector though not always. The SPV includes the lending bank, maintenance and the contractor company . SPV is responsible for signing the contracts with the government and subcontractors as well who will be responsible for building the facility and maintaining it. In the infrastructure sector, for the urge of maintaining and guaranteeing cash flow makes the PPP the best and prime candidates for the project financing. A good example is a hospital. When a hospital is constructed by a private developer and then is leased to hospital authority. The private developer in this case will act as a land lord providing non-medical services including housekeeping while the hospital will be providing medical services .
2.0 Definition of Infrastructure
Infrastructure can be regarded as basic physical and organizational structures that are needed to facilitate the operations of the society and enterprises as well. They can also be regarded as systems that facilitate services and facilities that are necessary for an economic function. Infrastructure mostly refers to technical structures that help or support the society . These structures include the roads, water supply, telecommunication services and power grids among others. Infrastructures are useful to the society as they facilitate the production of goods and services . In the social context, they refer to facilities like schools and hospitals that are set up with an aim of helping the society achieve some basic needs. In the military, infrastructure refers to things like permanent building and other facilities that are used for the support of the military operations and services .
• Uses of the term infrastructure
There are different uses of the term infrastructure though it depends on where it’s being used. In the engineering sector, the term infrastructure is limited to fixed assets that are in large network and are vital for the services and support of engineering discipline. Infrastructure is used to define all fixed assets that are used in the network of engineering in order to provide a given service or support through the continuation of refurbishing its contents .
On the side of civil defense and economic development, infrastructure is used by planners uses the term infrastructure to refer to institutions like schools, police stations, hospitals and all other institutions that offer public services. In military, the term is used to refer to all permanent structure that are used to support the military services which may include, airfields, offices, communication facilities and other that are permanently stationed in the military barracks .
Critical infrastructure is another widely used term to refer the elements of infrastructure that if damaged, they would cause critical disruption to the society. These may include floods, storms and earthquakes. If the elements like roads, bridges and rivers are destroyed or flooded, it would make it hard for transport of people and goods and it could also cause hardship for rescue and evacuations missions. Infrastructure is anything that supports the community in achieving any aspired goal .
2.1 Arrangements of Public-Private Partnership
Due to the development of globalization in 1980s, the emergence of PPP phenomenon was brought in to account and was widely employed between various public and private sectors. Privatization of several public sectors was so apparent with an aim of increasing efficiencies and reduction of operation costs.
There are several factors that are considered before arranging for the PPP to avoid contradictions there after. These factors include;
• The risks involved in the process
• The benefits that will be achieved through the application of the process
• The cost of the process
• Who would take which risk and how to manage it

In the arrangements of the PPP, the above phases are crucial and must be taken care of effectively.
In phase 1, the decision to contract or build an infrastructure is done and decisions are hard to amend or reverse. This is where the government lays all avenues that are required to contract the private sector to work on the project.
Phase 2- The government in this phase evaluates the decision and the project that is to be contracted to the private sector. The government is ready to select a partner who would partner with the government to complete the project.
Phase 3- the government selects the partner they would work with from the private sector applicants. The selection could be based on the price the company would charge the government or duration they would take to complete the project
Phase 4- After the selection of an appropriate partner who will work with the government to complete on the project, the partners are ready to start on their work. They now work together being guided by the agreements they put down to govern the partnership.
2.2 Risks in a Public-Private Partnership
Most of the developing countries have once or more tried to pursue PPPs in either public infrastructures and also in public goods. In the entire world, in 1990s, it was estimated that the worldwide investment amounted to about $131 billion. There has been a decline in PPP over the last years. Investors have on the other hand realized that these kinds of investments are costly and returns are not as high as they would expect. There are several issues that have been raised by the PPPs that include the government dissatisfaction of the results given, investors withdrawing from the projects as well as public protesting against these risks .
PPP have been proved to be the best way to increase potential output and also have economic benefits in the provision of public services which on the other hand have economic benefits through innovation and the using of available resources to have better management. The use of PPP has enabled the government to shift the risks from them to private sector. The major objective of the PPP is to have the government and the private sector benefit and have the consumers served well .
There are different types of risks that are associated with public-private partnership. When the negotiation is at the negotiation stage, both parties must be able to recognize the risks associated, who bears them and also why they should bear them. This will be the best way so as both parties will be able to recognize the risks and the best way to share them as well as increasing benefits and reduce the losses that may be associated with the proposed PPP. The government and the private sectors are stake holders in the proposed PPP and their concerns should be well integrated in the project. In poor countries, the poor and the society in general are also considered as stake holders and their grievances must be integrated with the project in order to benefit all together and their concerns must be integrated with the with the project at every stage and process of negotiations. The most important thing at this stage is to list all risks associated with the PPP and look for the most effective method of solving them through the use of the best tools.
The table below shows the types of risks that are usually ignored by the PPP during the life long projects
Party Affected by
and/or Assuming
Risk Type of Risk
Private Sector Design, construction, and maintenance risk:
includes day to day operational and management risks, delays in acquiring necessary permits, problems with subcontractors,
completion risk, and cost and schedule overruns.
Demand/revenue risk:
includes unexpectedly high or low demand compared to initial market assessments.
Political risk:
changes in government, changes in public policy, corruption and favoritism, lack of sanctity of contract, and arbitration difficulties.
Currency risk:
unexpected severe depreciation or appreciation of currency that affect the service provider’s ability to pay investors.
Public Sector Political risk:
potential changes in public policy
Bankruptcy risk:
Private company declares bankruptcy while working on a contract.
Closure Risk:
The inability of the bidding party to reach financial closure.
Land risk:
expropriation and eminent domain issues, difficulties
acquiring land.

The table has been retrieved from http://www.louisberger.com/berger/macro-iqc/papers/ppps_conference_10-9-06.pdf on 12th May 2010
3.0 Financial Perspective on Risk Management in Public-Private
At the present, the state will rarely provide public facilities and services. Instead, this is done through a public- private partnership (PPP) in which a private company is involved in the ownership, construction or financing of a facility for utility by the public sector. The private company in this case becomes the supplier while the public sector becomes the client . Since public-private partnership has become a popular way of procurement all over the world, the management of the risks involved has an issue worth investigating. A risk is an uncertain possibility of an occurrence of something that would be detrimental to the financial status of a business establishment. It is therefore imperative for the business world to have the necessary knowledge especially when dealing with the government. Lack of the necessary skills for allocating, transferring and mitigating risks has led to poor publicity of PPP. Risk management is the proactive process of identifying and taking the necessary steps to in order to reduce the chances of a risk occurrence and mitigating the consequences of the risk w if and when it happens. The managing team usually comes up with an action plan to allocate the risks. Risks can be allocated by:
 Transferring the risks to the private sector or contracting party.
 By having the public sector agency takes the responsibility of the risk.
 By having the contracting company and the government or public sector shares the risk.
Risk management is undertaken throughout the time span of a business transaction or contract. This includes the stage of planning, the stage of carrying out, the stage of operation and the stage of disposal of renewal of the contract.
3.1 Legal Perspective on Risk Management in Public-Private Partnership
In public-private partnerships, the objective is to achieve the value for the money that is paid. Risk management does not require each party to try to push the risk to the other party. It implies transferring the risks to the party (i.e. the public or the private sector) best suited to handle them. If the private sector takes responsibility of a risk that they can handle, then they will be able to charge an appropriate price considering the risk responsibility. However, if the public sector asks contactor to take responsibility of a risk that they are not suited to take, then the cost of this extra risk will be passed on to the price hence reducing the value of the procurement. From a legal point of view, the parties involved are supposed to allocate risk as follows:
 Retained risks- the public sector takes care of these risks on the assumption that all other risks will be the responsibility of the contractor.
 Appropriate timing- there is no specific time that risks should be transferred to the contractor. This depends on the lifespan of the procurement.
 Competitiveness- both parties should negotiate on which risks each party is willing to take. The private sector, who are better versed than the public sector with the procedures. The two parties need to take care to choose the risks that they are best suited to handle. This is the essence of risk allocation and risk transfer.
 Risk statement- the definition of the reward allocation should be clearly stated and agreed upon before the procurement.
 Guidance- detailed guidelines are provided for risk allocation and risk transfer.
 Genuine risks- the partnership is required to ensure that the private sector genuinely takes the transfer of the risk with no guarantees of indemnities payable to the private contractor by the public sector.
 Risks retained by the public sector- these include risks arising from a wrongly specified order.
3.2 Applications of Risk Management Strategies in Public-Private Partnership Procurement
A Public-Private Procurement is a transaction in which the government and a private company sign a business contract. Risk management is undertaken throughout the time span of a business transaction or contract. This includes the stage of planning, the stage of carrying out, the stage of operation and the stage of disposal of renewal of the contract .
3.3 Caveats about Privatization
Privatization refers to the transfer of government owned enterprises to to the private ownership. All or part of the state owned enterprise may be transferred. This is usually carried out by the government sells shares in the enterprise. Once this is done, the government ceases to control the enterprise. The management of the enterprise goes to private hands . This leads to more reliance on the private sector and less on the state. Privatization is the current trend in developing countries and in the post communist states where virtually all enterprises were owned by the state. In the process of privatization, both the public and private sectors are actively involved. It a process in which the set up transforms from one which strongly depends on and is controlled by the government to one that is more or less in the hands of the private sector. Even after privatization, the government still retains the responsibility to oversee the smooth running of the private sector in the manner that business is conducted by the latter.
4.0 Potential Advantages And Disadvantages Of Private Finance Initiative Deals
Under the Private Finance initiative (PFI), the projects, the projects that would have relied on the public money to complete, rely on the private financing. Governments use PFI finance PPP projects for the aim of improving public services . There are some advantages that are associated with this and disadvantages as well.
• Advantages
PFI is believed to be advantageous for a number of reasons including;
1. PFI provides value for money. Though its expensive for the government to use private funds in funding public projects that borrowing the money directly, its more effective compared to when the government is using the money directly even though is borrowed from the private sector and this on the other hand saves the government the cost that would be used in borrowing.
2. The private sector will on the other focus on the market competition therefore increasing innovation and fresh ideas.
3. The other advantage that is sought in this is the transfer of risks from the public sector to the private sector. It’s believed that the private sector handles this kind of risks more effectively compared to the public sector.
• Disadvantages
Even though there are advantages that are associated with the PFI, there are some disadvantages as well and they include;
1. Even though the PFI are seen to be more cost effective, there is no difference with the cost that would have been used by the public sector on funding the project
2. The amount of money that is borrowed determines the risk that is associated with the loan. The level of risk that can be obtained by the private sector and the public sector are relatively equal and therefore there in no risk that is being saved in that matter.
3. The other disadvantage that is associated with the PFI is that the projects that are funded by the Private sectors are too expensive. This forces the authorities to cut their budget in a considerable amount in order to keep up with their budget.
4.1 The Public Sector versus Private Sector Decision
There are notable differences between the private and the public sectors decisions making processes. In the private sector, also regarded as a profit sector, the decision making process is smoother and effective compared to the public sector where the process is filled with contradictions and conflicts. These processes are attributed to the roles each sector plays in the society . In private sector, which sells the service, they are more accurate in any decision that they make because it must bring profit to the company while in public sector, the decisions that are made are for individual benefits and they care less about what could be spent because it’s the society’s money that is being used . These on the other hand, contribute to the variation of the results that are achieved in both sectors.
4.2 Allocation of Risk
In the PPP, risks are allocated to the party that is believed to handle them more efficiently as well as managing them at the lowest possible cost. In most cases, in this kind of arrangements, risks are therefore allocated to the private sector because it’s believed they would handle them effectively because of the incentives awarded and also in the efforts to control costs . Risks allocations should on the other hand help the private sector to perform more effectively and efficiently in order to avoid more cost in the project which might not have any benefits at long last . There are several factors that are considered when sharing the risks because it’s always a complex issue due to making decision on who will carry the risk and at what price. Each and every project is always unique and there is no any special way that is applicable to them all. They vary in side and mode of approach that on the other hand have varied risks.
The following should be conserved when arranging for risks allocation ;
• The allocation of risks should be consistence with the conditions in the market and also should be compared with previous projects that were undertaken, their expectations and what was achieved for the sake of minimizing the tender costs.
• There should be a consideration of what would be the probable risks that may arise during the project’s life
• There should be an incorporation of flexibility during the life of the project so as to accommodate any external risk that may arise during the life of the project.
The allocation of risks usually takes place during the initial stages of contract negotiations and identification takes place before any signing of the contract by the consortium or the private and the public sector. The public sector must do its feasibility study before the proposal issued concerning the market and risk analysis. The analysis should include what kind of sources the public sector should bear and which risks on the other side should be shifted to the private sector . On the other hand, the consortium should be able to demonstrate that the risks that are associated with the proposed PPP have been fully identified and there are ways that have been recognized and identified that will be used to manage those risks. All parties should also ensure that the debts that are associated are assessed and could be managed .
4.3 Governance of Partnerships
In most cases, the governance of the assets in PPP arrangements, the government looses the control of facilities to the private sector. Even though the clause sometimes protects the public interest in the PPP arrangements, the arrangements are much concerned with the terms of agreements and also the in protecting the interest all players .
In this type of partnership, retains the overall ownership of the assets though they will be governed by the private sector. This is done through the private sector affermage which usually occurs between 5 and 15 years. The public sector is also responsible in making the decisions unless it’s specified by the agreements of the contract and in this regard, the private sector bears more risks compared to the public sector in order to cover its costs as well as generating some profits out of it .
5.0 Conclusion
PPP has been a success and a failure in different ways in the public projects. The private sector has been concentrating much on the profits its making from the project while the public sector is looking on how much is saving from the project. This has affected the aspired results for the projects. The governance of the PPP projects has been controversial since both parties are looking for ways to hold the governance of the projects which has also affected the main target of the project.
With the inclusion of the SPV in the projects, it has been possible to realize success since it has been responsible of managing the finances and the managerial of the projects hence increasing the efficiency of the PPPs.

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