Strategic PPPs The capability to project

Frédéric Blanc-Brude

f it were not for Slobodan Milosevic and of the Maastricht Treaty, and its corollary straightforward; the service itself is ISerb nationalism, certain things would be budgetary constraints. Defence PPPs perfectly known and easily specified; the different in Europe, not least defence spring from this conjunction of factors: challenge lies in building the right incentive procurement within the EU and a number the need for the Armed Forces to have structure: keeping everyone on board, of PPP deals. Indeed, a decade of peace flexible strategic capabilities at a lower through the highs and lows. keeping and force projection in the former cost. The ships were built to specification Yugoslavia, crowned by the Kosovo This article will look at two not only for use by the MoD but also for operations in 1999, did a lot to change the landmark projects prompted by the British use in the commercial market. When some minds of European leaders regarding what Ministry of Defence (MoD) regarding its of the vessels are not required for military they had to be capable of achieving strategic capacity to move troops and purposes, they are able to earn militarily and with whom. equipment by sea (Strategic Sealift) and to commercial revenue, thereby reducing As far as Europeans were deploy fighter planes over long distances overall project costs. The ships are concerned, the central defence thanks to refuelling aircraft (Future required to be available for service procurement issue had always been Strategic Tanker Aircraft). While the worldwide for routine military transport, interoperability – the ability to work former closed last year, the latter is participation in regular four-yearly together, and with the US, within NATO. supposed to see its preferred bidder exercises, support services in relation to Access to the battlefield, however, was appointed by the end of 2003. Both operational tasks and UK Joint Rapid never an issue: it was their own European projects provide the British military with Reaction Force (JRRF) operations. All six backyard. In the Cold War context, service of such a strategic nature that assets ships are now in use with four in service European forces had to hold their ground can be expected to be used in war zones. IJ under the MoD and two on charter for and wait for transatlantic back up. takes a closer look at each deal and commercial purposes. Transport and force projection was ponders on the limit beyond which private The project reached financial close America’s problem, not theirs. sector contractors can support military on 27 June 2002 and it will run until In 1998, Blair and Chirac met in operations. December 2024. Finance for the project Saint Malo for a first joint statement on was provided by Alliance & Leicester and the matter, and the word then spread 1. Strategic Sealift Lloyds TSB, secured by charges on the throughout the various channels of vessels, project cash flow and relevant European security, namely NATO and the Executive Summary commercial contracts. The successful EU: what Europe now needs is the The Strategic Sealift Service is provided to bidder was AWSR Shipping Limited capacity to project forces, potentially very the British MoD as part of the Private (AWSR), a consortium of shipping far (as far as East Timor) and possibly on Finance Initiative scheme. Its through-life companies including Bibby, Houlder several fronts at the same time. For the cost is estimated to be £950 million. The Hadley, James Fisher and Andrew Weir next few years, Allied Powers would still project provides the MoD with the service Shipping. AWSR provided the service on have to rely heavily on US (and of six standard commercial vessels for budget and on time with the last of the Russian/Ukrainian) strategic transport and military transport, enhancing sealift Roll-On Roll-Off cargo (Ro-Ros) vessels support capabilities, but Europeans were capability by being able to rapidly move being delivered to the MoD in April 2003, now convinced of the need to develop their vehicles and troops to crises spots around 20 months ahead of schedule. own fleets of ships and planes to be in a the globe. position to send their own troops, guns Because of the obvious insurance, The Project and fighter-bombers anywhere they personnel and service delivery issues that The service element of Strategic Sealift, deemed necessary. characterise such a project, Strategic Sealift coupled with the initial requirement for This shift in the European strategic is a good example of what defence PFI is capital investment, makes it good PFI outlook coincides with the implementation about. The financing is relatively material. The possibility to combine

www.infrastructurejournal.com 55 commercial and military activities further 2003, the new ships were eligible for a Germany, and that might well end up enhances the partnership; it allows the subsidy from the EU being paid for by the taxpayer, as the contractor to look forward to substantial Intervention Fund, seven per cent in the signature of the PFI concession is further upsides, includes the sharing of over- case of Flensburger and nice per cent for delayed. The MoD and its representatives heads with the MoD and most Harland & Wolff. can only repeat ad nausea that the project In October 2000, AWSR was named will deliver value for money eventually, preferred bidder1. AWSR Shipping Ltd was once all contractual hurdles have been formed by the British shipping companies overcome, and that since the ships were This shift in the Bibby, Houlder Hadley, James Fisher and non war-like, procurement was subject to Andrew Weir Shipping with the sole EC treaty and public procurement rules. European strategic purpose of bidding for the £950 million The MoD was then expecting to contract. As the SPV, AWSR subcontracts have the PFI concession contract signed by outlook coincides various segments of the project to its 2001 but, for a number of reasons shareholders such as the supervision of including developing reservist regulations, with the construction to Houlder Offshore potential tax and banking regulation implementation of the Engineering, the supply of crew to Bibby changes, finance and post TA911 Line and ship management to Andrew Weir. insurance, the deal was not closed before Maastricht Treaty, and However, AWSR, its financial June 2002. Construction, however, went backers and H&W hit major contract on as planned and the first ships were its corollary budgetary problems soon after the PB delivered in the summer of 2002, when announcement. In order to preserve they were almost immediately sent to the constraints delivery schedules and to avoid losing the Gulf, confirming the importance of timing, expected and substantial subsidy, the the relevance of the preliminary agreement MoD signed a preliminary PFI agreement and the relevance of the choices initially importantly allows for a lower price of with AWSR which enabled them to sign a made by the MoD. service for the MoD. contract with Flensburger and one with In April 2003, Finnish Ro-Ro Under the terms of the operational , on the basis that if the agreement, four of the ships are fully PFI agreement did not go ahead, the MoD would assume responsibility for the employed by the MoD (on take-or-pay The four ships terms) while the other two can be employed shipbuilding contracts. Eventually, by AWSR commercially on the unresolved commercial issues between under MoD control understanding that they are available to the AWSR and H&W led to the MoD taking military in a the event of a crisis and within over the contract for the building of the are paid for by a given timeframe. two ships on the same terms. All costs The MoD needs to have certain incurred by the MoD would be deducted a take-or-pay capabilities available at all times. The from AWSR’s subsequent service charges, embarrassment of British forces being but no interest charges would be added agreement grounded following a delayed PFI project – on. such as the Hawk training deal - is to be In March 2001, AWSR officially avoided at all costs. It is bad for the Service confirmed that contracts had been placed operator Transfennica chartered the last two and very bad publicity for PFI in general. for the six Ro-Ros required by the British ships built for the Strategic Sealift Service, Thus, securing timely delivery was a key MoD for its Strategic Sealift Service. In butnot required for full-time MoD use. part in winning the initial bid. effect, and contrary to a deal like Skynet 5, They are on charter until October 2005. To guarantee that the MoD would the preliminary agreement signed between have its Ro-Ros on time, AWSR proposed the MoD and AWSR at the end of 2000 had The Business Model to have four of them built in Germany the MoD shouldering some risk until the The transaction’s combination clause (Flensburger) and the other two in PFI agreement was signed. made the deal attractive for bidders at the (Harland & Wolff) thus At this point in time, the British tender stage because of the potential for a gaining substantial construction time. Government is under heavy criticism revenue upside. The blend of fee-based There was a further catch: if construction about the deal. MPs and unions talk of a service to the MoD and commercial orders were placed by 31 December 2000 project that took away ship construction revenue is an attractive incentive for and delivery was made by 31 December jobs from the UK to Northern Ireland and sponsors to earn additional commercial

56 www.infrastructurejournal.com revenue on an investment. To tailor the of the transaction took place on 27 June guarantee at the construction stage, all six PFI transaction to get the fairest pricing 2002 and involved a total of 84 separate vessels are privately owned by AWSR. At on the deal, some specialist aspects from agreements. the end of the concession contract, or in PFI standardised contracts were used, It was first thought to use leasing the event of early termination, there is and commercial-use clauses were then finance, a standard feature of the scope for the MoD to buy the ships back. added. maritime world, to finance the deal. But However there is no automatic ‘call’ Still, according to Max Gladwyn, the uncertain tax treatment and prospect option and all six vessels could MD at AWSR, this level of commercial risk of adding another layer of complexities supposedly return to the commercial is rare within the PFI market. “Profitability convinced the MoD to go for traditional market. Lenders thus take a significant is dependent on the ability to employ two debt financing. £175 million of limited portion of the risk, especially in the event ships in the commercial market,” he said. recourse was provided to AWSR by of early termination on the part of the Conversely, MoD advisers Simmons & MoD. Simmons confirm that in the event of commercial revenues above target levels the Legal Issues MoD would then receive a share. The ships will fly The ships will fly the British Merchant Although revenue from commercial Navy flag, even while they are under the use is only guaranteed if there is a need for the British Merchant operational control of the MoD. it in the market, AWSR takes risk on Navy flag, even The project involved the first use of finding commercial business for the ships; 180 “Sponsored Reservists,” individual this risk is taken into account in the rates while they are officers recruited for the service are for the service. Thus, lost income from employed by the PFI contractor (or its ships being called out of commercial and under the crewing sub-contractor) under normal navy into MoD use is automatically merchant terms and conditions. However, compensated for. The four ships under operational control they also enter into a parallel contract with MoD control are paid for under a the MoD in which they agree to become guaranteed take-or-pay regime, thus of the MoD Sponsored Reservists under the Reserve securing some of AWSR cash flow. Forces Act 1996. As a , they could be Conversely, if the MoD was to use the called out as members of the Royal Naval entire Ro-Ro fleet for a substantial amount traditional debt financing supplied by a Reserve. of time, the fee charged to the MoD would consortium of Lloyd TSB Bank and It was not clear at first if personnel also cover all projects costs, confirmed Alliance & Leicester. Each lender manning the ships would be sponsored Simmons & Simmons. provided 50 per cent of the debt and reservists at all times. The contractor was Max Gladwyn, managing director of treasury products required to fund the originally planning to use multinational AWSR Shipping, told Infrastructure Journal acquisition of the ships. The loan was crews for commercial activities. According that the Strategic Sealift Service was priced at 100 bp. to Nick Greenwood at KPMG, the MoD unusual in that many MOD projects are not In the event of default by the “paid a premium” to have sponsored suitable for private market. “Our project is contractor, lenders would first step in reservists manning the vessels at all time, a bit of a one off. We’re using our asset in with their own team, but the MoD would which gave benefits to the MoD in the the commercial market. You won’t see most likely end up taking over the project. flexibility of service. The extent to which much of that,” he said. The triangular relationship between this had an impact on the price of service is AWSR, the MoD and the lenders works unknown. Financing well as long as it is balanced. Any Sponsored reservists do not have, strictly Because shipbuilding subcontracts had to imbalance, even though unlikely, would speaking, the status of Armed Forces be placed long before the main PFI soon prompt the MoD to take over assets personnel. They are paid by the contractot concession contract was signed, interim providing such a vital service. even while serving the MoD, but receive a arrangements had to be made for the The four consortium members, premium paid by the MoD when called financing. Barclays Bank provided interim well-established British shipping industry out for service Edwin Godfrey at finance to allow the interim agreement companies, have each contributed Simmons & Simmons says the call out of between AWSR and the MoD to be 25 per cent of AWSR’s £13.4 million seamen as reservists will be exceptional, implemented. equity. but the ability to do so provides a degree The commercial and financial closing Even though the MoD offered its of security that the service will be carried

www.infrastructurejournal.com 57 out as required (reservists cannot refuse to contractor is the ownership of the commercial insurance cannot be applied serve in a war zone), while economising contractor’s shares. Within the Strategic (i.e. a war zone). on the use of limited armed forces Sealift contracts, there are checks on personnel. Maritime trade unions helped the change of control of the shareholders of Conclusion to set up the structure, providing good AWSR. While MoD advisers Simmons & The Strategic Sealift Service project was prospects of long-term employment for Simmons are adamant that there is considered a success due to its overall value their members. no ‘black list’ country-wise or company- for money as well as incorporating unique wise, it is understood that the informed concepts for PFI defence in areas of Risks opinion of the MoD would be taken shipping and maritime. The deal is described as ‘robust’ by most into account before any shares in AWSR are “The Ministry of Defence is participants. The project is ‘designed to sold. increasingly recognising the cost savings cope’ says Nick Greenwood at KPMG. achievable through long-term collaboration Third party revenue and commercial Insurance Issues with the private sector. In this project risk in general are the main risk areas as far All six vessels are insured as commercial innovative means of reducing costs were as AWSR is concerned. The fact that the vessels, although there is a recognised risk adopted based on a blend of commercial and vessels can be called up at short notice of such ships being damaged, mainly MoD use of the vessels. Significant cost restricts the areas of the world in which because transporters were targeted in more benefits are a major factor in the increased they will be able to operate in commercial recent conflicts. Moreover, when used by role of PFI in defence that we are seeing across use. The impact of ships being called back the MoD, the Ro-Ros’ cargo is usually Europe,” said David Coulter at Norton Rose. from commercial service to meet the MoD’s much more valuable than the asset itself, Simmons & Simmons’ partner JRRF operational needs was priced into the which is rather unusual in the world of Edwin Godfrey agreed, saying the defence charging rates offered during the maritime insurance. sector is one of the better areas of PFI, competition for the service provision. In the event of ship loss that could noting that the MoD has considerable Performance risk can also be an issue jeopardize delivery of service, there are a procurement experience. but according to all participants the service number of mitigation possibilities, credit regime is such that each member of including the leasing of less- 2. Future Strategic Tanker the consortium is strongly incentivised to performing vessel for a given amount Aircraft deliver service. The deal includes structured of time. Provisions were made for the re- pay and performance regime which instatement of vessels where it is economic Executive Summary provides for deductions for to do so, and for mitigation by the This project will allow the Royal Air underperformance and wider provisions contractor in the event of the vessels not Force the use of privately-owned dealing with default debt and interest. being provided for service. refuelling aircrafts, allowing for long- Another aspect of the provision of The MoD remains, however, the range RAF and allied action. The British service to the MoD for a privately owned insurer of last resort for situations where MoD would pay for the provision of this capability on the basis of availability and

Figure 1: Strategic Sealift Project Information AWSR Shipping Sponsors: Andrew Weir Shipping, Bibby Line, James Fisher & Sons and Houlder Hadley Shipping. Each participate to 25 per cent of £13.4 million equity Debt: £175 million Lead arrangers: Lloyds TSB and Alliance & Leicester Group Interim Finance: Barclays Technical advisers to sponsors: Holder Offshore Engineering Technical advisers to banks: Marspec, part of Lloyds TSB Legal adviser to concession awarder: Simmons & Simmons Legal adviser to sponsors: Berwin Leighton Paisner Legal adviser to banks: Norton Rose Financial adviser to concession awarder: KPMG Financial advisers to sponsors: Ernst & Young Tonnage and tax advice: Watson Farley & William

58 www.infrastructurejournal.com usage, and payment will only be made for FSTA: AirTanker, led by EADS, and operandi of armies worldwide, tanker when the service is delivered to a Tanker Team led by BAE and Boeing.2 aircrafts provide the two giants with a new satisfactory standard. Like the Strategic The latter is arguing that its proposal for arena for confrontation. Sealift PFI, assets not used by the MoD FSTA, based on former British Airways will be available for commercial use, with Boeing 767-300ER airliners, would cost The project certain spatial and timeframe restrictions. 20 per cent less to operate per year than FSTA was nominated as a potential PFI The 27-year PFI project would have A330-200 being promoted by its rival, project in 1997. Following Initial Gate through-life costs of £13 billion. Service AirTanker, which says A330’s longer approval in December 2000, the project is expected to commence in 2008, with range and greater fuel load and Airbus launched a formal assessment phase full service capability being reached by frame make its proposal the most designed to confirm whether PFI could 2012. attractive one. offer best value for money. An ITN was The MoD is still to announce a It sounds simple enough, and close issued in December 2000 and the two preferred bidder, and according to enough to the Ro-Ro deal. But the choice consortia submitted their first formal bids numerous sources close to the deal, should faced by the MoD in the coming months is in July 2001, and final bids were received do so before the end of 2003. If the not just about a trade-off between cost from both consortia in April 2003, and Strategic Sealift PFI is any guide, FSTA refined the August 2003 Assessment of should not present any major problem to these bids is now underway. finance or structure. The Strategic Sealift The refuelling contract will replace The deal, however, can only go the current RAF fleet of 33 Tristars and 10 ahead once another battle has been fought: deal had its share of VC10’s with about 20 converted jet the everlasting struggle between North airliners. America’s and continental Europe’s controversy, mainly Under the intended PFI arrangement, aerospace consortia to overtake each the RAF will have use of the aircraft when others’ dominant position. In that respect, because of the they need them, but the through-life risks of corporate initiatives and alliances will play ownership will lie with industry. The MoD a key role, but the outcome might well be sensitive and fragile will pay for the provision of the refuelling determined by the ability of European capability on the basis of availability and leaders to put together a coherent defence nature of ship usage, and payment will only be made policy. when the service is delivered to a building employment satisfactory standard. Thus, the RAF would Background continue to retain responsibility for all The Strategic Sealift deal had its share of in the UK military tasks, whilst the contractor would controversy, mainly because of the own, manage and maintain the aircrafts sensitive and fragile nature of ship and also provide training facilities and building employment in the UK. The rest and range. some personnel. Like with Sealift, since the of the matter was relatively Two things differentiate this deal RAF will not need all of the aircraft in the straightforward: ship building is still a from Strategic Sealift. Firstly, the nature of deal all of the time, the contractor will be relatively competitive market, four the aerospace industry: a typical case of able to earn extra revenue by using spare consortia entered the bidding process and ‘first mover advantage’, usually followed by aircraft for commercial operations. as long as the Ro-Ros do not end up like ‘barriers to entry’ and eventually by However, the RAF would always have first the USS Cole, the deal is what both government-sponsored, protracted warfare call on all the aircraft in an emergency. The officials and sponsors like to label a win- between contenders. The costs of doing MoD insists that the RAF is buying a win situation. business in this market are such that only service, not a number of tankers. It is not yet the case of the FSTA few, sometimes only one, can survive. The MoD expects the following from deal (Future Strategic Tanker Aircraft). Secondly, the extreme political the selected contractor: The PFI project that will allow the Royal sensitivity of this industry makes the stakes Air Force to use refuelling aircrafts even higher. The EADS versus Boeing • Provision of aircraft, spares, Special-to- when they need them, while ownership struggle is not new, but as fleets of military Type Ground Support Equipment and of assets will rests with the private air tankers are reaching the end of their management of Government Furnished industry. useful life on both sides of the Atlantic, and Equipment; Two consortia are in the running as ‘force projection’ becomes the modus • Training of flight crews and all other

www.infrastructurejournal.com 59 FSTA personnel; members are, in effect, the world leaders in the MoD. • Engineering and logistic support; the field. In September 2003, Tanker Team As it was the case for the original • Provision of Sponsored Reserve Air and (BAE SYSTEMS, Boeing, Serco and impetus to develop European strategic Ground Crew; Spectrum Capital) announced that British capabilities, the key to the FSTA deal may • Fleet management. Airways, Marshall Aerospace and Smiths lie in policy-making at the European level. Aerospace had joined its team, in an effort Indeed, in the context of the nascent Contractual Options to sway the MoD with across-the-board Common European Defence Policy, the Terms and conditions will be based on the expertise, low cost options, an even more French and the British could be thinking MoD standard PFI terms tailored to meet ‘British’ team and the promise of many jobs of combining their air refuelling the specific requirements of FSTA. The in the UK. capabilities. contract will include a specially developed Should the team be selected, British The French are already in the market payment mechanism based on availability Airways could support the transition of to buy eight refuellers, but are thinking of and usage charges and a service credit its fleet of Boeing 767s into RAF service doubling that number. It has now emerged regime to incentivise performance. and support aspects of the civil that French and UK defence officials are The contract will include fixed prices operations required by the FSTA discussing combining their contracts to for the services to be provided with contract, while Marshall Aerospace make the aircraft “inter-operable”. appropriate VOP condition. Prices will be would convert the BA fleet into refuelling AirTanker proposes to supply new Airbus linked to output based indices and will tankers. aircraft to the RAF, and it is unlikely that include a substantial firm element. the French Government would agree to buy Opportunities for gain sharing will also be Air Tanker: flank manoeuvre its tankers from elsewhere. iJ sought. Again, this is roughly the same idea Meanwhile, the continental contender is Frédéric Blanc-Brude than for the Ro-Ros. Regarding the doubling its bets and also announced in manning of the aircrafts, the same system of Septembre, that EADS will commit Euros 1 The four short listed bidders were the ‘sponsored reservists’ is to be developed. 80 million of company funding in Sealion consortium which included BAE Systems, the Stena shipping line and others, Nickolas Bliss of Freshfields, developing technology and systems to Maersk, a UK subsidiary of the Danish- advising Tanker Team, explains that all position itself as a strong competitor for the based shipping company Maersk A/S, financing options are still on the table, from US Air Force’s future aerial tanker Novomar, a company linked to the Belgian debt financing to leasing through banks to modernization requirement. Cobelfret group, and AWSR. bonds. What will determine lenders’ EADS, with one foot already in the 2 EADS, which owns 80 per cent of Airbus, enthusiasm will be the underlying MoD (Skynet 5), is determined to create its leads AirTanker, which also comprises France's Thalès, and Britain's Rolls-Royce commitment of the MoD to see this service comparative advantage in the air tanker and Cobham. The Tanker Team includes in place. market. It is investing massively into Britain's BAE Systems, Boeing, Serco and There would also be take-or-pay product and business development, and Spectrum Capital. agreement for MoD usage, while the attacking Boeing’s established position on contractor could use the remaining assets in all fronts, including at home. the commercial sector. The Policy Element Tanker Team: reinforcements High ranking British sources recently arrive confirmed that intense lobbying by the Tanker Team’s main argument is its Franco-German consortium had made a experience in delivering the service. It positive and very favourable impression at

Figure 2: Future Strategic Tanker Project Information Bidding consortia: • AirTanker (EADS, Thalès, Rolls Royce and Cobham) • Tanker Team (BAE Systems, Boeing, Serco, Spectrum Capital, BA, Smith Aerospace & Marshall Aerospace) Project total cost: £13 billion Legal Adviser to Tanker Team: Freshfields Legal Adviser to MoD: Simmons & Simmons Financial Adviser to Tanker Team: Deloitte Specialised Finance, Spectrum Capital Financial Adviser to MoD: KPMG

60 www.infrastructurejournal.com