The Evolution of Financing Conditions for PPP Contracts: Still a Private Financing Model?

While most chapters in this book deal with different aspects of PPPs in the broad sense of the term (traditional procurement, concessions (user-pay PPPs), availability contracts (public-budget pay PPPs), this chapter mostly focuses on availability contracts (as most PFIs in the UK and Marchés de Partenariat in France), and the term “PPP” refers exclusively to them in this chapter.

In a sample of infrastructure projects, Flyvberg (2009) assessed that cost overruns amounted to 20.4% in road projects and 64.7% in rail projects.

Nevertheless, with PPPs, the public entity cannot really be guaranteed that the payment flows will be predictable from the moment the contract is signed and stable over time. Firstly, contracts quite naturally include price adjustment clauses. Secondly, they are subject to frequent renegotiations (see Chapter “Renegotiating PPP Contracts: Opportunities and Pitfalls” in the second part of this book). Incidentally, the latter may be considered ambivalently. First, renegotiations may proceed from a phenomenon of contractual holdup. Once the threat of competition has been removed, the public entity’s contractor may adopt an opportunistic behavior and exploit the gray areas of the contract (which can never be complete in the economic sense of the term) to renegotiate it to its own advantage (see Guasch, 2004). A frequently renegotiated fixed-price contract soon becomes a cost-plus contract, which essentially amounts to a double inefficiency for the public entity, with a risk premium ex ante and low incentive quality ex post. Renegotiations may also be associated with new requests from the public entity to bring about a change in the service. For the public entity, such requests can generate additional costs that may lead to reevaluate the economic appropriateness of the contract [25% of cost overruns in PPP projects in the construction phase are related to changes initiated by the public authority, according to a study by Standard & Poor’s (2007)]. Nevertheless, they can be essential to satisfy the mutability requirement of the public service. Besides, renegotiations are fundamental in a long-term contract to maintain the economic equilibrium of the contract, which is a sine qua non condition for the efficiency of the partnership relation.

For the public entity, private financing can also take on a significant interest in terms of budgetary equilibrium management. As observed by Dewatripont and Legros (2005): “PPPs could be seen as attractive for governments, which try to make their accounts good by (ab)using accounting rules that not correctly capture their assets and liabilities.” Indeed, a PPP investment does not affect public accounts—in particular the level of debt—in the same way as an investment realized in the traditional way. Partnership arrangements can appear all the more attractive as they are likely to allow the entity not to consolidate (i.e., recognize) in public debt the amount of investments associated with the financed asset. In times of serious budgetary constraints, recording the infrastructure as an asset in the contractor’s balance sheet, and subsequently recording the debt as one of its liabilities, can seem like a decisive advantage for the concerned public authority (Marty, 2007). Resorting to PPPs can therefore appear as a mechanism of public debt derecognition that is all the more expedient as the debt is high and subjected to a ceiling imposed by rules of budgetary discipline (Helm, 2010; Maskin & Tirole, 2008). However, the use of PPPs as an off-balance sheet instrument is only possible to the extent that budget and accounting regulations offer a favorable framework for implementing such derecognition strategies, and one where market operators accept that the asset and associated liability be recorded in the private contractor’s accounting statement. The private operators’ ability to record the debt in their balance sheet is therefore a first retraction force. A second one has to do with public accounting rules themselves, which must provide a regular, sincere, and faithful image of the public entity’s net situation. Paradoxically, the adoption of the International Financial Reporting Standards (IFRS) by private stakeholders has favored a better recognition of the commitments associated with PPPs in public accounts. Indeed, private international accounting standards are based on a control criterion that leads all companies involved in PPP contracts not to recognize them in their accounts. Adjusting to the practices of private actors, combined with a will to translate commitments associated with PPPs, has led the authority in charge of establishing public accounting standards to adopt a standard reflecting the IFRS. In October 2011, the International Public Sector Accounting Standard Board (IPSASB) thus enacted a new standard on the accounting recognition of commitments made by public authorities as part of PPPs (IPSAS 32‐Service Concession Arrangements‐Grantor), established on that basis. As for the UK, it directly implemented the IFRS for the establishment of its public accounts, abandoning its initial accounting standards that proved to be far too favorable to derecognition strategies (Hodges & Mellet, 2012).

If only because this capacity must be rated by financial rating agencies.

It would actually be more fitting to use the expression “limited-recourse arrangement,” in that the equity capital contributed by the sponsors constitutes a second source of guarantee. The higher the share of the latter in the pool of the special purpose vehicle, the lower the risk of default on debt service. The existence of additional guarantees, provided by sponsors, multilateral financial institutions, or the contracting public authority, is also likely to reduce the probability of the special purpose vehicle defaulting. As we will see in the next sections, the existence of such guarantees admittedly contributes to the reduction of the financing cost—by lowering the risk premium required by investors, but it equally reduces the external financiers’ incentives to ensure the strength of the arrangement and the proper execution of the contract. The public authority will therefore be all the more exposed to risks of adverse selection and moral hazard.

A second related advantage has to do with the fact that private investors will be less reluctant than a public decision-maker to reevaluate a project whose costs are becoming excessive (De Bettignies & Ross, 2009).

A covenant is a clause inserted in a loan agreement providing for anticipated debt repayment in case of nonfulfillment of the objectives assigned to the SPV.

Here, the British case is characteristic. Net public investment now only represents 1.5% of the GDP for fiscal year 2014–2015, against 3.3% in 2009–2010. Forecasts for 2019–2020 predict that this effort will represent 1.2% of the GDP, a rate which is admittedly higher than in 1997–1998 (0.5%) but still far below the needs for investment in British infrastructure. This low level of public investment, despite very low long-term interest rates, has to do with objectives of public debt control. The British government’s ambition is that investment projects designated as having priority (Infrastructure Pipeline 2014) will be financed up to 64% by private investors, 14% through cofinancing, and only 23% by public funds (Rhodes, 2014).

These are letters of intent whereby banking establishments or auditing companies recommend subscribing to a firm’s debt. They vouch for the sincerity of the financial data provided by the firm in question.