Editor's Note: Bernardo Weaver is a Wharton MBA in Finance Candidate and a consultant at the World Bank working on Public Private Partnerships.
Privatizations in the 80’s and 90’s in Latin America proved to be disastrous by many accounts. The success of the Thatcher administration in the United Kingdom did not transfer well to the other side of the Atlantic, at least south of the US. Many Latin American politicians found an easy target in privatizations: The sale of state-owned assets at sub-par value.
Politicians also conveyed the idea that the state and the citizens are identical. As a result, the population thought that their assets were sold at fire sale prices to big international companies. These international companies—often connected with aggressive animals like sharks and lions (and even monsters)—became vilified. Governments did not respect clauses and tariff readjustments, and the famous instability of the region was again reconfirmed.
The development of public private partnerships (PPP) in Latin America always fights against the stigma of privatization. Even though the sale of assets to private companies with little accountability to the government is very different from a PPP, in the popular mind there is a connection. With this kind of stigma, it’s important to be clear about exactly what a PPP is. Here is a basic definition: a PPP is a contract between a government and a private entity wherein the private entity (usually a consortium of companies) is obligated to build an infrastructure asset and manage it for some number of years. As compensation, the government usually pays the consortium during the construction of the asset. Afterwards, the government also allows the consortium to charge users of the asset.
Despite entrenched attitudes against private sector involvement in the public sphere, there are signs that the region has started to change. Propelled by Chile, a leader in PPP’s, the region has even managed to create an innovative bidding mechanism for PPP projects. Working together with Patricio Mansilla, a Chilean Director at Chemonics International here in Washington DC, I recently learned about a very interesting bidding mechanism in Latin America used by the Chilean government to procure concessions.
Chile’s Ministry of Public Works has developed a mechanism based on the concept of the Least Present Value of Revenues (LPVR). The model is very simple: LPVR Bidders submit their proposals, and the bidder charging the least amount to the government wins. This means that the private firm or consortium of firms—called the concessionaire—demands less money from the government than its competitors. The concessionaire typically agrees to build, manage and maintain an infrastructure asset, such as a road, a bridge, an airport, a chain of hospitals, and many other types of public works. The advantage of this model is that there is very little need for supervision from the government side, and that the risk of renegotiation is already included in the premium charged by lenders when the concession starts.
Beautiful road to Vina del Mar in Chile, funded through a PPP
Patricio went ahead to explain to me that normal PPP contracts have a definitive term date. The innovative feature of LPVR PPP contracts is that they always have a variable term date. In other words, the concession terminates when the concessionaire receives a full reimbursement to repay its costs and a profit. In a definitive term date concession, the concessionaire does not necessarily earn a full reimbursement of its costs and a profit. Rather, the passage of time is the only indicator of the expiration of the concessionaire’s term managing the concession.
In contrast, the flexibility of a LPVR PPP mitigates and diversifies potential demand insolvency and financing risks for PPP’s. By providing the Least Present Value of Revenues, investors commit to recover only a certain amount from the concession. After they have earned this amount, the concession reverts to the government. Conversely, if the concession runs into delays, the government will not have to renegotiate with the concessionaire, as the time to earn full repayment is flexible.
Bridge funded with Multilateral Bank investment in Latin America
This model allows for risk transferring mechanisms that reduce the overall risk of insolvency. If the project does not beat earnings estimates, the inherent flexibility means that risk of insolvency is partially mitigated because the concessionaire has more time to obtain revenues. Contracts do not necessarily have to through lengthy renegotiations, as the risk of overextending the time to re-pay the principal amount of debt is already priced in the original lending agreement. The concessionaire can concentrate on operational risk and transfer renegotiation risk. This strategy reduces the insolvency risk of the whole operation.
Hence, the public sector wins a more stable and trustworthy structure for the development of PPP projects. Hopefully, this will reduce the chance of producing chaotic situations like those seen during privatizations in the 80’s and 90’s in Latin America.
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