Governments and PPP Risk

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Toll PlazaWhat does a government body seek in relation to Risk in a PPP?  Surprisingly it is not about passing all the risk off to the private sector.  It is more about value for money. 

Before request for tender for a PPP comes to market, the relevant agency in the sponsor Government will have undertaken up to two years of preparatory work.  This project definition phase is set out in the guidelines for procurement prepared by most of the Australian state governments.  For example, the NSW Treasury Guidelines set out two early stages of work comprising the identification of funding needs and the selection of procurement strategy.  If a project makes it to the stage of request for tender for PPP, it has already been through a thorough risk analysis from the Government perspective.  In addition, a Public Sector Comparator (PSC) has been prepared and the determination of the procurement strategy stage of the business planning process has determined that the PPP procurement method would deliver Value for Money (VFM).  Infrastructure Australia provides detailed instructions on the preparation of a PSC.  These guidelines provide a standardised approach to calculating VFM in infrastructure projects.  In the preparation of the PSC analysts attempt to price all risks which have been identified in the project initiation phase.  The result is a base, risk adjusted cost for the project assuming delivery under a public sector delivery model.  As most of the subcontract services available to the private sector can be adopted by the public sector, the only way to make a PPP delivery model VFM is to achieve transfer of risk to the private proponent at a price less than the cost of maintaining that risk with the public sector. This is often referred to as transferring the risk to the party best able to manage it.

For example, a PSC should include costs associated with a delay in delivery of the project.  There is considerable public information (for example, this by Infrastructure Partners Australia) which supports the view that PPP projects are delivered with lower levels of cost overrun and lower levels of time delay.  Accordingly, when a government organisation analyses the project risk based on its own experience of cost and time overruns on similar projects, the cost of risk will be higher than when the investors in a PPP undertake the same analysis.  When the private sector bid is submitted incorporating a risk adjusted price, the assessors will compare the price to the PSC with no further risk adjustment on the grounds that the delivery risk will be transferred to the proponent.  On this basis, the private offer will be better value for money than the public sector delivery model and will be adopted.  However, if the project runs into trouble, the PPP SPV should not be looking to the Government agency to re assume the risk for free, because the VFM conclusion would then be invalidated.  Risk has a price.

As is pointed out in many publications, but very clearly by Queensland Treasury, it is not the government’s intention in a PPP to transfer all risk, but rather to transfer risk optimally. Inappropriate transfer of risk will carry a premium and cause the VFM consideration to tip towards any of a range of other delivery or procurement models.  In other words, governments are seeking sufficient transfer of risk to make the PPP delivery option VFM.

Most of the state governments provide indicative or preferred risk transfer tables in their guidelines, Queensland here for example; or Partnerships Victoria guidelines here. In addition, a fuller list with more project specific analysis would normally be included in bid documents.  However, these generic lists are only starting points for discussion and the real allocation happens in the development of the project documents and the commercial analysis of the bid. 

The yardstick applied by government throughout the whole process will be the VFM assessment, and the comparison between the cost of transferring the risk and the cost of assuming the risk.  If this comparison moves against the conclusion that the appropriate delivery mechanism is the PPP, then the whole project may be transformed to a public delivery process.

Government officials do not work in a vacuum.  They operate under the approval of cabinet, with narrow delegations.  They face detailed audit by both the Auditor General and the various public accounts committees of parliament.  They face public scrutiny and the oversight by various corruption prevention institutions.  So it should not be a surprise that when the risk allocation is fixed, it stays fixed.