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As iron sharpens iron

Jeff Delmon's picture


Photo: totojang1977 / Shutterstock.com

In my last blog, I compared Public-Private Partnerships (PPPs) with marriage. I had explained that, though very different, the public and private can come together as they each possess characteristics beneficial to the other. Great in theory, but often difficult in practice.

Critics of PPPs abound and listing them here would be impractical. But whether they are auditors, civil society or within the World Bank Group, critics help us improve. We try to respond to our critics, including through blogs such as this one.

Different yet equal

It is folly to presume private and public interests are necessarily aligned, similar to assuming that marriage partners share all the same interests. This presumption misses the power of PPPs. The private sector seeks profit, and this motive drives efficiency, reputation and delivery, where incentives are aligned.

Governments are driven by politics and election cycles. This political motive drives affordability, improved service delivery and community engagement. Can the incentives align? Yes. We at the World Bank Group work with governments to help them understand how to align those incentives. We have also developed tools to assist clients, for example: the Standard Form contractual provisions, the risk allocation matrices, and assembling sample laws and documents from around the world. We continue to try to understand each other better, and to identify the right incentives and the right motivation.

Motives and Motivation

Some of us innately fear the profit motive, and conclude that the private sector is reaping all of the benefits to the detriment of others. This is not unlike marriage, where we spend enormous amounts of time and money trying to figure out what motivates our partners.

For the most part, private investors pursue the most profitable projects: those with revenue streams sufficient to pay debt service and a reasonable equity return. This leaves governments to deliver those projects that do not cover costs; tax monies in essence subsidize services that are not commercially viable.

Hiring experienced transaction advisers can help ensure private investors receive only the benefits necessary to attract investment. The better the project, the fewer the benefits. IFC Advisory services provide such support, as does funding from the Global Infrastructure Facility and other World Bank Group-managed trust funds.

Eventually, you have to pay the piper

Historically, PPPs allow governments to access additional capital, often supported by project revenues rather than the government’s balance sheet. When project revenues come from government (for example, through availability payments), any “off balance-sheet” treatment creates dangerous accounting incentives and may not protect the government from liabilities or fiscal risk. It is important for governments to be aware of these risks and to be transparent in their response. A thorough assessment of a project’s “value for money” is critical, no matter how attractive the financing appears. This is like selecting a spouse based entirely on their looks; great for the wedding day, but quickly becomes a nightmare.

The deferral of payments and liabilities until services are delivered is another strength of PPPs—as well as a weakness. Governments may choose a PPP to defer costs to future governments. This illusion of affordability and viability must be addressed during the feasibility assessment.

The fiscal implications of PPPs are also often difficult to measure, and rarely properly accounted for in government accounts. Either due to ignorance or intent, governments can avoid the issue and not account for nor report the fiscal risks associated with PPPs.  The World Bank Group provides advice on fiscal risk management, and with the IMF have developed a tool that helps measure the fiscal risks associated with PPPs.

But to be frank, a truly honest assessment of the implications of PPPs is often difficult to deliver, both politically and practically. We at the World Bank Group try to elevate this issue every time we advise governments, but the discussion is not always as effective as we hope.

Marry in haste, repent in leisure

Many of these challenges are linked to the negotiation capacity of governments. While private investors often engage high-priced lawyers and advisers to help negotiate investments, governments generally do not, leading to an imbalance of power that can undermine government interests.

There are efforts to address this imbalance. As mentioned, the GIF provides a great service, as does the African Development Bank’s African Legal Support Facility and the IFC’s C3P, amongst others—all help governments to rebalance their negotiation capacity.

Many of us urge friends and family to carry out proper due diligence before getting married. Even if the advice is ignored. Why not follow the same advice with PPPs?



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Making PPPs work: Going to the chapel

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Comments

Submitted by FEMI OBIOMAH on

The crux of this write up in my view is, don't venture without proper counsel. There is need for solid expertise backing for any PPP no matter how small. There is the need for both sides to engage competent hands (marriage counselors?) that would help them enjoy the the partnership.

Submitted by Nancy C Alexander on

In marriage, depending on the country, the woman may or may not have equivalent legal status to the man. In PPPs, depending on the country and the firm, the power relations may be very different. It is crucial that any counselor/negotiator be impartial and represent the interests of both parties to the extent possible. But the World Bank prepared its "Guidance on PPP Contractual Provisions" in a way that is significantly biased in favor of investors. Draft policy conditions which would be imposed on borrowers (e.g., in the Compact with Africa) would require adoption of all or most of the contractual clauses. These clauses have big problems, e.g., 1) Recommending that the risks of war, civil strife, strikes, riots, and terrorism be placed on the Contracting Authority, which could require that the government compensate the private partner. This is inconsistent with international jurisprudence.
2) Restricting the right of sovereign governments to regulate in the public interest (e.g., to provide universal, affordable infrastructure services; reduce greenhouse gas emissions in keeping with obligations under the Paris Agreement; or protect labor and human rights) by recommending that governments protect private partners against costs of compliance with changes in law.
3) Failing to urge governments to make an unequivocal commitment to transparency of PPP project information, PPP contracts, and fiscal commitments (on and off-budget).
4) Reflecting a bias against local law as the governing law for PPP contracts and a preference for foreign or international adjudication over local/national adjudication without addressing the drawbacks of investor-state dispute settlement (ISDS).
For details see the legal analysis: http://us.boell.org/2017/09/15/summary-comments-world-bank-groups-2017-guidance-ppp-contractual-provisions-0
and the key messages from this analysis:
http://us.boell.org/2017/09/15/key-messages-world-bank-groups-2017-guidance-ppp-contracts

Submitted by Jeff on

Great comments and really important observations, and my apologies for taking so long to respond.
Continuing with our marriage metaphor, the imbalance is exactly the challenge. Normally the advisers do not represent the couple, but rather each partner has its own adviser. However, the weaker partner (typically the Government in developing countries) rarely spends much on their advisers, which exacerbates the imbalance. This is where donors come in, to provide funding and technical assistance. Still, the Government needs to listen to the advice given. I am a keen advocate of using a mediator, representing the project (like a disputes review board but during contract negotiation and financial close), to try to create more balance, but this costs more money, in an already costly enterprise, so not very popular except for the largest projects.
The PPP Contractual Provisions give different options, not one set of terms, but allowing for difference in context. For less risky countries, private investors and lenders will take much more risk. For more risky countries, and those less familiar with PPP, the Government will need to take a lot more risk. This is true even in the more developed countries. Chile is now the darling of investors, but in the early days of its PPP program it had to give comprehensive guarantees to attract investors. Similarly in Korea, the early projects required guarantees to attract investment (even local investment); such government backstopping is no longer required.
The public interest issue is an interesting one. Government is always in control. No PPP can stop Government from implementing policy changes (law always prevails over contract), but a PPP might require Government to pay if there is damage to the investor. Governments like to see the business world as flexible enough to respond to such changes in policy. In some cases this is true, but a PPP is not a normal business. It is specifically, and intentionally limited to the one single business on somewhat fixed terms. The PPP company cannot diversify or change its business model to adjust to the new policy context, since that business model is fixed by contract. Using the marriage metaphor, given that PPP is a fixed universe, one spouse can decide unilaterally without considering the implication on the other, how the partnership works (we will not buy a new car, we will not get a new washing machine), but they cannot escape the implications of that decisions. In marriage, the impact of the decision is never really known until it hits the fan, in PPP the implication is clear and ideally quantifiable when the decision is contemplated, which should be a big advantage.
It would indeed be wonderful to convince all Governments to agree to complete transparency on all issues relevant to PPP. With each engagement, we seek to achieve this, and more generally we provide advice on transparency, its importance and some of the mechanisms that can be used. But we cannot force Governments to do this, merely encourage and incentivize. On fiscal commitments, the world bank has a little more influence, and we are working with the IMF to use this influence effectively, but this is not an easy discussion with Governments, whether developed or developing.
Local law is pretty universal in PPP agreements, but lending agreements and other sub-contracts are often under different legal regimes, as local law may not be well adapted to the kind of risk allocation sought, and financiers need to refer to a legal regime that syndicate members and secondary markets understand, otherwise the financing gets much more expensive and the project will be much less affordable for Government. Dispute resolution is different. Unfortunately few countries have court systems and procedures that foreign investors might perceive as reliable or fair. International arbitration was developed for such purposes and is used even in developed countries to protect investors from the vagaries of certain court systems, and as important from the perception of bias. Going back to the marriage metaphor, imagine if in your marriage your mother in law was given the power to decide any marital squabble. In some cases, that might be OK. But in most, it would be unwelcome.
Thanks again for these comments, really helpful and interesting.
Jeff Delmon

Submitted by ADRABO ALOYSIUS STANLEY on

Just like in any serious Marriage; the best are selected. Through practice, many of the challenges can be overcome, not forgetting lessons learnt from earlier ventures. Communication, and consultations on regular basis will make things better.

Submitted by Dr. Mohamed Taher Abdelrazik Hamada, Ph.D on

The World Bank is responding to critics of (PPPS)with open mind not with narrow
mind , because consturctive critics help us to improve (PPPS) seeking profit for the sake of sustainable development . (PPPS) have beneficial characteristics to each other that make them deserve the help of the World Bank and other big donors.
Good governments should be realistic and non biased to deliver improved services
to their countries.
These kinds of good governments all over the world are very helpful to the
donors agents such as the World Bank , as much as these donors are beneficial to these governments.
All these agents should collaborate to motivate each other and build a wall of trust among them to deliver services with the least possible costs and
avoiding risks as much as they can , and also comeing up with the right allocations.
Yours Very Respectfully,
Dr. Mohamed Taher Abdelrazik Hamada, Ph.D
Senior American Citizen
Retired Professor at Strayer University, USA
Address
[redacted]

Submitted by Muhammad Azhar Khan on

Very good writing, being a professional expert and student of PPP i learnt much from this blog and WBG development

Azhar

Submitted by Patricia Sulser on
Threshold Decisions are Critical. A private sector perspective: I think Jeff makes a great point about the various critical early decisions that can be decisive in the success of a PPP. First, is the decision to engage the private sector at all for the delivery of the proposed public service (i.e., a proper value-for-money analysis for the particular sector and project). The second is the selection of a quality private sector developer/operator—ideally one that has a solid track record of delivery and trust with other governments. For both of these decision points, governments (especially fragile and conflict affected countries) should indeed engage competent financial, technical and legal advisors. (The WBG and others have many financial and other resources available to governments to do so).

Proposed Phased Approach to Risk Allocation. The risk allocation as among the private and public stakeholders is, as several of our colleagues have pointed out, critical, and governments should again retain competent international advisors whom the government trusts to provide properly benchmarked advice, including “difficult” advice. Government also needs to be prepared to implement that difficult advice. At least for PPP projects for which an international developer/operator or consortium is selected as the winning bidder, I propose that neither the WB nor its member countries reject, out of hand, the assumption of political/country risks or changes in law etc by governments that do not have an established track record of attracting and rewarding private international investors/operators. Instead, I respectfully observe, continuing the marriage analogy, that one should think of the allocation of risk as a phased arrangement as in marriage—at first, the government may need to accept more risk than it might ultimately like in order to build trust and confidence in its commitment to the private sector (including committing to private sector making a reasonable return on its investment if it has performed as expected and committed) and to its citizens. (Naturally the building of trust goes both ways and development milestones and key performance indicators go a long way to aligning the private sector’s interests with the governments’). After having built the confidence of the private sector (which can take years), a government may be able to roll back on the protections it is willing to assume.

Value of Getting a Few Early and Quick Wins. It is extremely valuable for a government wishing to attract the private sector to simply get a few success stories on its books, even if the risk allocation is not “ideal” from the public sector’s perspective or comparable to the risk allocation in other countries (which may, incidentally, be farther along in sector reforms and have a track record of PPPs or other private sector projects).

WBG Additionality. Perhaps as important (if not more important) as is the “perfect” allocation of risks from the public sector’s perspective, I support the WB, consistent with the Cascade, in its focus on how to support governments not only with our own and mobilized capital, but especially on the provision of political and country risk products, and on mobilizing blended and concessional (and local currency) finance pieces to leverage the financing and commercial structures of a PPP, where necessary. The WB and others have relevant PRI products, some of which do not require back-to-back government indemnities. There are also some excellent blended finance and concessional pieces that can be brought to bear, including through the Private Sector Window. Finally, the WBG’s financing of actual projects can be an extremely effective way (possibly the most effective way) to identify the obstacles to private sector engagement in a country or sector and a wonderful opportunity for the WBG to crowd in the necessary legal, regulatory and policy (and general business enabling environment) support a government may need, independent of any upstream work being done outside the context of a particular project.

Good Will and Flexibility/Creativity. Finally, like all good marriages, a PPP requires all parties to accept each other’s legitimate interests/perspectives and to assume good faith of each other (and to act in good faith), and to remain flexible to resolve the inevitable challenges that arise and creativity to come up with solutions that may require compromise on all sides and a realistic view on the best alternatives to the PPP itself.

Patricia Sulser
Chief Counsel, Global Legal Team Leader
IFC, IFC InfraVentures

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