MDA Law
Understanding the use of public private partnerships (PPPs) for infrastructure projects in Africa
August 12, 2022
Although there is no standard definition for PPP’s the following is a useful description:
“A PPP is a long terms asset or service delivery agreement established between the public and private sector with the aim of achieving economic development by taking advantage of the private sectors qualifications as well as its capital”
In addition, that:
“PPP is a project finance funding method with payments from the users during the determined concession period and enables transferring of the asset or service to the public at the end of the concession period”[1]
THE HISTORICAL CONTEXT OF PPP CONTRACTS
Partnerships between the public and private sector have been used for a very long time. (e.g. Roman corn distribution during the days of the Roman Empire.)
The 19th Century was the golden age of concessions in Europe.
One of the most renowned cooperations between the public and private sector was the concession granted in 1854 for the construction and operation of the Suez Canal[2].
Closer to home – 99 year concession, to construct and operate the Benguela Railway line granted to Sir Robert Williams on 28 November 1902.
Although this implementation model has a long history, the acronym PPP only gained currency during the 1970’s.
Public Private Partnerships have been widely adopted as a project implementation strategy throughout Africa and enabling legislation and standard documentation is available in 50 countries in Africa (out of a total of 54)
Despite their potential, PPP’s in African countries currently face many constraints[3] such as:
- Undeveloped business environments,
- Lack of knowledge to carry out PPP projects,
- Lack of legal and regulatory framework,
- The reluctance of investors due to the expectations of assumption of major risks,
- Small role of Africa in the global market, and especially in the underdeveloped infrastructure and financial markets.
DESCRIBING PPP’S
The following figure is a typical PPP Contract Structure[4]
PPP Contracts Require[5]
- The involvement of the private sector providing public services / assets
- A long-term relationship
- The distribution of risks between the public partner and private partner aiming to achieve optimal risk allocation
- The bundling of different project phases
- The use of private funds and in some situations, the use of project finance mechanisms.
In South Africa the implementation models have been[6]:
- Design Finance Build Operate Transfer – (DFBOT)
- Design Finance and Operate (DFO)
- Design Build Operate and Transfer (DBOT)
- Equity partner projects and
- Facility management projects
In summary – there are in general, six typical forms of private sector involvement:[7]
– Short-term service contracts
– Management Contracts
– Lease Contracts
– Greenfield Projects (commonly BOT)
– Concessions; and
– Divesitures
COMPARING TRADITIONAL PUBLIC PROCUREMENT AND PPP’s[8]
Traditional public procurement, of infrastructure is financed, generally speaking using taxpayers’ money.
The objective of any public procurement project is to achieve Value for Money.
Therefore, any project, whether it is a PPP or a traditionally procured project, should be undertaken only if it creates Value for Money.
How do we define Value for Money?
Good value for money consists of three constituent components:
- Efficiency– spending well
- Effectiveness,(outcomes) – spending wisely and
- Economy (inputs) – spending less.
There is a fourth E, “equity”, is often added in making the viability assessment of a PPP, which is the extent to which services are available to and reach all people that they are intended to be reached.
This consideration has particular relevance in the African environment.
A PPP may, conceivably, provide Value for Money compared to traditional procurement models if the advantages of risk transfer combined with private sector incentives, experience, and innovation – in improved service delivery or efficiencies over the project life-time are realised – and this could outweigh the increased costs of contracting and financing.
Such an analysis, from anecdotal evidence, demonstrates that PPPs are superior to traditional public procurement. Accordingly, PPP procurement is often favoured over traditional public procurement models.
PPP’s do not offer a miraculous solution for every public sector infrastructure problem. Usually, this kind of arrangement takes longer and costs more. The main drawbacks are mostly related to the public sector’s inability to deal with such structures (lack of experience) , insufficient competition, lengthy and complex negotiations and high transaction costs[9].
PPPs are not a simple formula “one size fits all”. Each project must be arranged to suit the prevailing circumstances of:
- The Public Entity
- The Private Entity
- The Project
- The end user
- Available resources
- Available funding
The reasons for adopting a PPP implementation strategy may be summarised as follows:[10]
- Borrowing and budgetary constraints means this is the only implementation strategy available- probably the most common reason that PPP ‘s are used in sub-Saharan Africa.
- Developing the project sooner rather than waiting for when budget is available.
- PPP’s used for infrastructure projects frees up government resources for use on other projects.
- Private sector efficiency and innovation may produce a better result.
- The public sector is forced into long term planning and budgeting. This enhances the possibility of the project being successful.
- A PPP can avoid construction cost and time over-runs that can be a feature of public sector projects.
- A PPP ensures that long term maintenance is carried out.
Throughout the whole Project life cycle[11], the public partner must ensure to maintain effective control that enables it to react instantly when the PPP strays from the set path, and thus limit the potential damage that may arise.
Therefore, it is crucial that the PPP contract clearly defines the instruments that allow the public partner to intervene in the PPP in order to protect the public interest and avoid consequences for both partners.
Secondly, the PPP contract must define, clearly and in advance, the conditions and consequences of early termination of the PPP, especially in terms of charges, damages, penalties, etc. to which each of the partners is entitled in such cases.
In the African region, investment flows are dominated by three countries – South Africa, Morocco and Nigeria – which collectively account for 54% of total commitments. By contrast, the number of projects spans 48 African countries, of which a quarter concluded PPP contracts entailing little to no investment commitments[12].
STANDARD FORMS AVAILABLE
In any PPP arrangement there are obviously a number of Contractual relationships that must be catered for, as illustrated hereunder:
The Special Purpose Vehicle (SPV) will obviously enter into a PPP with the Public entity which makes provision, for design, construction, financing, operation and maintenance of the facility or service.
Some observers[13] have commented that standard form contracts such as FIDIC or the NEC may not be appropriate for PPP’s due to the fact that they are designed for conventional project delivery methods.
It should however be noted that FIDIC are planning to release in 2024 a standard form contract for PPP Projects including a concession agreement and direct agreements that are currently not covered by the Silver Book.
It is therefore apparent that if EPC contract services are required the FIDIC Silver Book, or one of the NEC Suite of documents could be used.
Alternatively, if it is a Design Build Operate (DBO) arrangement the FIDIC Gold Book, or the NEC4 DBO Contract may be suitable.
CREATING A SYMPATHETIC ENVIRONMENT FOR THE ADOPTION OF PPPs
Since the 1990’s there has been widespread adoption of PPP’s across Africa as a project implementation strategy as demonstrated by the number of countries where enabling legislation has been implemented.
To this extent therefore, Africa has a level of maturity in the PPP market. There have been some successes as well as failures.
Current recommendations for improving the environment for implementation include[14]:
- Changing legislation to make public engagement mandatory during the entire project life cycle.
- Establish guidelines to encapsulate the scope, procedure to be followed and approach to public participation.
- Encouraging more people to participate in the process by adopting diversified methods to garner public opinions, such as on line surveys, public forums, face-to-face interviews, and
- Paying attention to special groups.
Key features for the successful implementation of PPP’s, are the following[15]:
Political Support: It is essential that any PPP has strong political support as well as consensus from opposition parties.
Political Interference: At the same time, government must resist the temptation to interfere with a PPP Project (for example limiting a toll concession’s ability to adjust its tolls).
Sectoral Reform: PPP’s do not exist in isolation of the environment. Big differences between existing facilities and those provided by the PPP may prove problematic.
Affordability: The price for the service is key and must be affordable for the end user.
Risk Transfer: This is a key element of PPP’s but it must be understood that all risks can never be completed transferred.
Governance: Appropriate governance structures are required.
Currency risk: With the exception of Nigeria and South Africa, local finance markets (in Africa) are unlikely to be able to provide the long-term finance that is required. This means thar borrowing in a foreign (hard) currency will be necessary.
Asset Reversion: The PPP contract must set out clearly the condition that the asset must be in when it is returned.
Legal, Policy and Institutional Frameworks[16]:
The rise of infrastructure PPPs in Africa is closely linked to sector reforms that were implemented across the continent throughout the 1990’s.
Political Risk:
The state is an active partner in PPP, which means that investments respond to sovereign risks or risk perceptions[17].
Local Capacity:
PPP structuring requires specialist skills to undertake feasibility studies; arrange financing; draft terms of reference for contractors, bidding documents, and concession agreements; and negotiate contracts[18].
There is also a need to retain expertise to monitor contract implementation and compliance with performance targets.
Financial Considerations:
The revenue derived from a PPP contract has to be calculated to cover:
• The design and development of the PPP
• The project operating and maintenance costs
• The investors required return on their investment
Payment to the PPP entity (the special purpose vehicle) is usually linked to progress of the development and the achievement of key performance indicators (KPI’s).
Project Financing[19] relies primarily on cash flow rather than a corporate balance sheet of the value of the physical asset and is in two forms.
Investments made by the project sponsors (Investors) who develop the project. This is usually between 15% and 40% of the development cost.
Loans received from lenders (debt) who receive a fixed rate of return. There is no up-side to their involvement, but they can lose their investment if the PPP goes badly. Lenders finance the balance of the project (not financed by the investors) of between 60% and 85% of the project cost.
Commercial risk[20]:
PPP’s structured as project finance operations, for example, BOT’s, often seek non-recourse debt (i.e., debt guaranteed only by project cashflows) which means that the availability and cost of financing is highly sensitive to perceived commercial risks. This includes performance or price risk, resource risk, demand risk and revenue risk, among others. Commercial risk can be managed through instruments such as government guarantees or credit risk insurance.
For the same reasons that general foreign direct investment responds to stable macroeconomic environments, PPPs fare better in countries with lower inflationary pressures, stable exchange rates and investor-friendly foreign exchange management policies. Private capital investments into infrastructure assets are mostly foreign currency based, given the need to source capital equipment from foreign markets. However, revenue streams are typically local currency based, introducing foreign exchange risk for private investors. In addition, because the private partner is often foreign or would have accumulated foreign currency debt to facilitate its participation in the transaction, currency convertibility and transferability are important considerations. For related reasons, so is inflation.
CONCLUSION
The Covid-19 pandemic has had an adverse effect on economies around the world. This has resulted in a slowing down of economic activity in general and PPP projects in particular, some of which have been cancelled.
Those same economic strictures will result in public funds being limited and that will, it is suggested, be good for PPP adoption across Africa, if infra structural development is going to take place, which it must.
There is therefore no reason to expect that borrowing and budgetary constraint will not remain as the main reason for adopting PPP’s and that this will be the implementation strategy of choice since this could be the only implementation strategy available in sub-Saharan Africa.
