9.1 How to Conduct the Market Sounding

An effective market sounding exercise provides an opportunity for a structured dialogue between the private and the public sectors at early stages of the PPP process. This not only tests the viability of the project’s details, but it also obtains precious feedback on how aspects of the project should be defined to ensure private sector participation and foster competition.

The key aspects of the generic process for market sounding relevant to its success are as follows.

When to conduct the market sounding? There is an optimum moment for market soundings. This cannot be too early during appraisal, when the project description is too broad to provide any effective description of the government’s intentions in terms of size, capacity, and project scope. Conducting market sounding too early makes the government sound imprecise and the relevant questions will not yet have been identified and therefore cannot be asked.

The sounding also cannot happen too late, when the project definition is too detailed, as it leaves little room for effective private sector feedback. This makes the private sector lose confidence about its ability to effectively influence the process. The basic rule is that the fundamental aspects that describe the project (in terms of the technical requirements, financial model, and preliminary contract structure) should be advanced before the sounding starts, but they still need to be flexible enough to accommodate the feedback received. A good estimate is that the middle of the Appraisal Phase meets these criteria. The market sounding exercise can be repeated during the Structuring Phase, especially when changes in the structure have taken place or when a refined contract needs to be tested with relevant market players.

Who to sound out? The government needs dialogue with experienced providers of the infrastructure and services. This enables the government to collect expert opinions on market conditions, technical aspects of the project, and the allocation of risks. Experienced providers might not exist in particular countries, especially if the project is a first in its sector. A good practice in this case is to search, as far as possible, for international providers that can offer international expertise in a particular type of project. New entrants should also be heard, especially to search for ways to eliminate unintended barriers to a competitive procurement.

Besides the prime targets (industry players that are prospective bidders), a second group of companies are lenders (especially commercial banks) which can offer finance for the project. They might provide relevant insights about the drivers for commercial feasibility as well as the general market conditions for a specific sector. The government should also consider including international financing agencies and multilateral development banks in the market sounding exercise, diversifying the perspective on bankability offered by the consulted companies. It is good practice to keep an updated list of potential providers and banks and their stated or historic interest by sector and project size.

How to conduct a market sounding? The market testing may take a number of forms, such as meetings with individual companies, general/industry meetings, or written communication. The information may be provided through a presentation, a project information memorandum or even, at a more advanced stage, by publishing the draft contract for comment (when market sounding is produced during structuring).

It is good practice to produce a formal project information memorandum (also known as a Project Note or project summary) as the first step for sounding the market. This document should describe the project details that have been defined up until that moment and clearly point to the still uncertain aspects of the initiative. A very transparent approach should be considered, and the project obstacles identified should be clearly stated. Hiding weak spots only amplifies the problems for later stages when legal issues might arise due to the proximity to the Procurement Phase.

There are several possible ways to approach the private sector once the project information memorandum is prepared. In any of these approaches, it is very important to encourage formal contributions by the companies, so as to obtain structured opinions on the matters that arise. Examples of common practice are as follows:

• The project information memorandum can be posted online and a request for written comments can be made to all the companies identified as relevant. A project open-day (also referred as “industry meetings[32]”) should be organized in which companies (prospective bidders but also lenders and advisors) are encouraged to visit a data room and watch presentations made by the project team and provide feedback;
• One-to-one meetings can take place. These typically produce effective results. In this case, the project information memorandum and accompanying material should be the main guideline for the presentation. Detailed documentation should be produced during the meetings; and
• Running polls or delivering a questionnaire to ask the interested parties about the most relevant points for the authority, but without discouraging them from raising other potential points from their own perspective.

What issues should be sounded? There is no precise good practice as to the aspects of the project that should be tested through engagement with the private sector. It depends on the type of project and sector. The relevant rule is to test all the significantly uncertain aspects of the project. Good practice is to include all points in the project information memorandum, emphasizing the aspects to which government is seeking feedback. Some common points are as follows:

• The scope of the project, in terms of infrastructure design and the preliminary output specification;
• The main technical risks identified that might affect the ability of potential bidders to deliver the infrastructure and the services;
• Expected Capex and operational expenditures (Opex);
• The payment mechanism and other revenue schemes envisaged;
• The general aspects or risk allocation already defined;
• Financial assumptions such as the debt conditions and cost, and the tax and accounting assumptions;
• Proposed timetable for the period from procurement to the commencement of services; and
• Proposed contract structure, including risk allocation.

Farquharson and others, in their book How to Engage with the Private Sector in Public-Private Partnerships in Emerging Markets, indicate a list of practical tips for successful market sounding. This is reproduced below in box 4.9.

A few strategic issues need to be considered during the whole process of market sounding.

First, the project team should ensure that there is no confusion about the role of market sounding. The companies invited should understand that they are not bidding or providing any formal expression of interest. Furthermore, the participation in the process, whichever approach is chosen by the government, should not offer any advantage in the subsequent procurement process, and it must not provide the participants with any information that disrupts a level playing field for future bidders. This should be equally communicated to the companies participating, as well as those not participating in the market sounding process.

The second relevant strategic issue is the need to filter the private sector’s recommendations for biases. It is only natural to assume that the comments and feedback provided meet the interest of the private companies issuing them. The project team needs to consider this reality when interpreting the feedback. It is important to highlight that the objective of the market sounding is to allow a broadly competitive procurement and not to adapt the project specifications to one specific bidder’s demands. In the same context, general feedback that suggests unbalanced risk allocation on the government can create difficulties for positive conclusions in the affordability assessment, as well as for the Value for Money evaluations discussed below. Thus, the feedback obtained must be carefully considered in order to avoid manipulation of the project structure by the individual companies or the market in general.

Finally, the team responsible for the sounding must have expertise, be knowledgeable about the project, and be respected by the market they are trying to sound. This is why governments commonly use external advisers, experienced in the project’s industry, to help conduct effective market sounding.

If these three strategic issues are taken into consideration, the market sounding is an indispensable tool in the effort to develop a project capable of providing effective VfM for users and taxpayers.

However, the risks associated with lack of transparency and governance need to be mitigated.

9.1.1 Transparency and Governance[33]

When considering the need to sound the market, the project team needs to bear in mind that the proximity of the project team to potential bidders might give rise to suspicions of corrupt behavior.

In fact, extreme care should be taken in order to guarantee the highest level of transparency during the market sounding exercise. This means the use of some or all of the following initiatives.

• Documenting all the meetings, decisions, and procedures;
• Providing access for the public to all documents shared or produced, including a specific web page where interested parties may offer their comments and suggestions (provided that they are previously identified as professionals or participants in the industry);
• Leaving a clear audit trail of all the feedback provided by the private sector;
• Inviting audit institutions to participate in the process, including in the meetings with the private sector; and
• Recording the meetings with individual companies on video, for the exclusive use of audit Institutions.

In some cases, where corruption is a relevant issue in the infrastructure market, good practice may be to avoid conducting any meetings with individual companies, and to only conduct the market sounding exercise using the other approaches mentioned above.