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PPP Introduction and Overview

12.3. Contracts for Managing Services or Existing Infrastructure

Contracts for the procurement of services or management of existing infrastructure can be divided into two categories.

  • “At-risk” long-term management or service contracts that can be regarded as PPPs (these are service PPPs, not DBFOM contracts); and
  • Contracts that are regarded as conventional O&M or service contracts.

“At-risk” Long-Term Management or Service Contracts

Contracts whose scope is only maintaining or operating infrastructure or a service may be regarded as PPPs (in the broad sense or according to the broad definition proposed by this PPP Certification Gude), as long as they transfer significant risks, are performance oriented and have relatively long terms[24].

Some examples of these types of PPPs are as follows (please note, the terms are only intended to be indicative):

  • A 7-year contract to manage the tariff collection for a water supply service in a city, with performance penalties and bonuses (for example, based on increases in billing ratios).
  • A 15-year public transport bus-operating concession where the PPP partner finances or renovates the fleet of buses and operates the service (including ticket collection). The revenue is based on the fare box plus subsidies, or on a service payment per kilometer.
  • An IT management contract with a term of 7 years, where a public entity or governmental department contracts out the supply and maintenance of IT equipment and systems.
  • A 12-year contract for the limited refurbishment and management of an existing public facility — including cleaning, catering, waste management, and maintenance (for example, a school, a public building office, and so on) — based on the payment of a rent in the form of availability payments, significantly subject to quality adjustments.
  • A 10-year contract to manage waste collection services in a city under a fixed fee per year subject to quality deductions.
  • A concession for the clinical services in a public hospital (usually including the medical equipment).
  • A 10-year contract for street cleaning and gardening in a city, where the PPP partner is compensated by an annual fixed rent, subject to deductions based on Key Performance Indicator (KPI) targets.
  • A 10-year O&M contract to operate and maintain an existing toll road, where the private partner´s revenue is an agreed percentage of the toll collected, or a fixed amount subject to availability and/or quality deductions.
  • A 40-year concession to operate and maintain an existing toll road which is highly profitable (see Box 1.10 below).

Some of these projects include a material initial investment (for example, buying a new fleet for the bus transport service). The rationale for these contracts to be considered “management contracts” or “service contracts” rather than DBFOM is the relative amount involved in the initial investment/financing. For example, for most bus concessions, investment is only in the renovation of a limited number of vehicles per year, so the predominant cost for government and the private partner is an annual cost.

As noted, consideration about whether something falls into the category of being a PPP is a question of degree and judgment, so any management contract where there is significant initial investment could easily be classified as a private finance PPP.

It should be noted that none of these contract examples should be regarded as a PPP when the revenue of the private counter party is on a cost plus basis, reflecting the actual costs incurred rather than pre-agreed amounts. Payment on this basis transfers little, if any, risk.

Short-Term Services and Conventional O&M Contracts

Any contract that does not include the features mentioned above for a service PPP will not be regarded as a PPP.

Conventional O&M contracts will usually be based on the cost plus concept, and/or focus on payment for the means (inputs) rather than the results, under highly prescriptive contract documents. Such short-term service contracts or other conventional O&M or maintenance (M) contracts are suitable in many contexts and they have the advantage of flexibility.

BOX 1.10: Long-Term Leases or Concessions for an Existing User-Pays Infrastructure as a Special Case of Management or Service PPP with Significant Private Finance. Asset Monetization Schemes.

When a government owns and operates (usually through a SOE) existing infrastructure (especially in the transportation field) for which either users are charged or other economic operators pay for the use (for example, airlines in an airport or cargo ships and cruise liners in a port), and the business is profitable (generating financial returns), the government may be willing to incorporate a private partner into the infrastructure operation and/or management for a variety reasons.

The government may decide to retain the ownership of the cash generated by the business but improve cost management and service quality. This may be done by tendering out a management or a service contract which externalizes the actual management of some areas (such as tariff collection, ordinary maintenance, and so on). It may even include long-term maintenance or significant upgrading of works (creating a DBFOM contract of a secondary stage type). This may be done by paying the private partner for the operational costs (subject to deductions or to volume risk) and retaining direct ownership of the excess revenue.

However, there are a significant number of cases where the government decides to transfer the overall O&M responsibilities (usually including major maintenance, that is, the lifecycle cost management) together with the economic rights of the business. Therefore, the task of revenue collection is transferred to the private partner. This is done with the objective of raising funds from the financial value of the infrastructure as an asset. This is a typical case in toll road projects.

Whether such a transaction provides value for the government will depend on receiving a fair price for the asset and, above all, what will be done with the proceeds. With the funds raised by the asset monetization, the government may develop other infrastructure, attend to other public needs, or reduce its level of debt. The utilization of the sale proceeds may be managed by creating a dedicated fund for infrastructure development, with the proceeds of these concession sales being one of the main feeders to this fund. FONADIN in México is an example of this approach.

There are other approaches, including a combination of uses for the sale proceeds. The important point is that when there is a clear and sensible plan to apply those resources, which is properly communicated to the public/tax payer, it is easy to obtain the necessary political consensus and wider public consent.

An example from US of a lease arrangement for the Chicago Skyway[25].

In December 2004, the Chicago City Council approved Mayor Daly's proposed allocation of the $1.83b Skyway proceeds. It agreed that $875m will be set aside to establish a $500m long-term reserve fund, and a $375m medium-term annuity the city can use to smooth the effects of economic cycles and stabilize the need for additional revenues. It was stipulated that $100m will be invested over the next five years to improve the quality of life in the city's neighborhoods for people and businesses. The largest portion of that $100m — $28m — will fund "safety net" programs that will bridge the gap for Chicago's residents most in need, including many who have suffered from the effects of a slow national economy and what the City calls inadequate federal and state funding for critical programs. This includes a city program Plan to End Homelessness, home heating assistance programs, assistance for the disabled to make home modifications, affordable housing and homeowner programs, job creation and training through re-entry programs for ex-offenders and a new Small Business Development Fund, and facilities and programs for children and seniors such as after-school programs, Meals-on-Wheels, and senior satellite centers.

The remaining funds will be used to pay off $463m in Skyway debt, $392m in long- and short-term debt, as well as to pay other existing city obligations, the City says.

Toll Road News, December 2004

Other approaches to realizing the value of the funds raised by a project using private participation include the following:

- The government receiving a combination of an upfront concession fee and a minority stake of shares in the PPP project company (with the ability to sell it in the future);

- Imposing a yearly fee on the private partner in the form of a fixed payment or as a percentage of the revenue (see chapter 4.4); and

- Reducing the lease term so as to recover back the asset sooner.

These types of contracts are regarded as private finance PPPs, and most of the information included in this PPP Certification Guide is applicable to them.

[24] While there is not a universal consensus about when one may properly talk about the long term, contracts below 5 years are generally referred to as short term. For service management or maintenance, 2-4 years are not long enough to merit the concept of PPP as those terms do not allow for a proper transfer of risk associated with costs and results.  Ten years is commonly regarded as long term, but 7 years and above may be regarded as a sufficient term for these types of contracts to be regarded as PPPs, although this is a question of judgement.

[25] See Chicago Sky Way case study in “Paving the Way: Maximizing the Value of Private Finance in Infrastructure” (WEF, 2010), page 106. 

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