Flexing PPPs VALUE FOR MONEY ON PPP EXPANSIONS OBTAINING VALUE FOR MONEY ON PUBLIC PRIVATE PARTNERSHIPS THAT WILL BE EXPANDED WWW.DLAPIPER.COM Contents 1 Introduction ...................................................................... 4 2 The PPP model ................................................................. 5 3 Building additional flexibility into PPPs .....................11 4 Alternative delivery models �����������������������������������������13 5 Which is best? .................................................................15 Case studies ..........................................................................16 Our broader infrastructure and construction team .....26 Summary A number of major transport projects are presently being delivered under Public Private Partnership (PPP) contracts. In each case, it was likely from the outset that the new transport system would be extended during the life of the PPP contract. However, PPP contracts can be inflexible, relative to other contractual delivery models, when it comes to making changes to a project. This lack of flexibility can leave government vulnerable to private sector profiteering on the commercial terms of significant extensions. This paper considers how governments can manage this vulnerability when contracting under a PPP contract. It also considers whether alternative contractual models might provide government with better value for money over the longer term. 3 FLEXING PPPs 1. Introduction Many recent rail projects have But the PPP model is known to be This creates some very significant been delivered as Public Private inflexible when it comes to making challenges for government, Partnerships (PPPs) including changes to a project. It is inflexible which can impair government‘s Stage 1 of the Sydney Metro, and because PPP contracts are long ability to obtain value for money light rail projects in the Gold Coast, term in nature, and involve on the extension. Canberra and Sydney. many more parties than more traditional publicly funded This paper unpacks the challenges In each case, it was expected that contract delivery models. associated with extending a rail the system would be extended network that is being operated during the term of the PPP contract. On each of the projects previously under a PPP contract. It considers Indeed, stage 2 of the Gold Coast referred to, customers will want the measures that governments light rail project opened in 2017, and the extension to be operationally can implement in response to a detailed business case for Stage 3 integrated with the part of the these challenges, and their likely is being developed. Likewise, network covered by the PPP effectiveness. The paper also Stage 2 of the Sydney Metro project contract. Customers will not want considers whether alternative is under construction, a business to switch vehicles at the point contractual models might provide case for the second stage of the where the extension joins on to better value for money over the Canberra light rail project is under the network covered by the PPP longer term, once the cost of consideration, and future extensions contract. To achieve this outcome, extensions are taken into account. to the Sydney light rail system from the relevant government must Kingsford to Maroubra, Malabar or secure the agreement of the La Perouse have been proposed. multiple parties involved in the PPP. 4 WWW.DLAPIPER.COM 2. The PPP model 2.1 Australian PPP bears the risk of demand by users The service payment PPP model was models (and consequently, revenue from preferred for each of these projects In Australia, the PPP model is user charges), being less than what because private sector investors and generally used to describe contracts was forecast. In the case of service lenders had lost their appetite for that incorporate two key features: payment PPPs, demand risk is demand risk on greenfield transport typically borne by the government. projects, mostly as a result of the • the bundling of design, failure of numerous toll roads to construction, maintenance and Of course, there are many variants achieve their patronage forecasts. potentially other services into a to these two basic models. Indeed, The service payment PPP model was single contract; and demand risk can be allocated also preferred over a user-charge differently under either model. model because user charges would • the use of private sector finance. only cover a portion of the operating There are two basic PPP models There have been periods when costs in any event. Government that are applied to infrastructure user-charge PPPs have dominated also wanted to control fares, service projects in Australia. The feature the Australian PPP landscape. levels, and the development of the that distinguishes one model from Most Australian toll roads were surrounding transport network, the other is the primary source delivered under a user-charge PPP which was more easily achieved if of revenue used to repay the model. The user-charge PPP model government bears the demand risk. private sector finance. In one case, was also applied to a number of rail the primary source of revenue infrastructure projects including The challenges discussed in is charges imposed on users of the Adelaide – Darwin railway, the this paper apply equally to both the infrastructure. These PPPs Brisbane Airport rail link, and the user-charge PPPs and service are known as ‘user-charge PPPs’. Sydney Airport rail link transactions. payment PPPs. In the other case, the primary source of revenue is a service However, in more recent years, Before covering the challenges (or availability) payment from the it has been the service payment associated with extending a rail government, which are known as PPP model that has dominated, project being operated under a PPP ‘service payment PPPs’. including in relation to road and contract, we will explain in more rail infrastructure. It is the service detail the PPP model that has been A key difference between the two payment PPP model that is being applied to recent rail projects, and models is who bears demand used on the rail projects mentioned the reasons why government may risk. In the case of a user-charge in the introduction. have chosen to use the PPP model PPP, the private sector typically for these projects. FLEXING PPPs 2.2 Overview of PPP model used on recent rail projects The basic contractual structure that was adopted for Stage 1 of Sydney Metro and the light rail projects in the Gold Coast, Canberra and Sydney is shown in figure 1. FIGURE 1: BASIC PPP STRUCTURE FOR RECENT RAIL PROJECTS Government PPP Contract Debt Equity Debt Financiers SPV Equity Investors D&C Contract O&M Contract D&C Joint Venture Operator In each case, the relevant between one or more major civil • an Equity Subscription Agreement government agency entered into a engineering contractors and, in the with each Equity Investor, under PPP contract with a special purpose case of each light rail project, a light which each Equity Investor agrees vehicle (SPV) established by the rail vehicle and systems supplier (the to contribute a fixed amount of successful bidder. The PPP contract D&C Joint Venture). In the case of equity into the SPV; and requires the SPV to finance, design Sydney Metro Northwest, the rolling • a Loan Facility Agreement with and construct the rail system stock and rail systems supplier was the Debt Financiers, under which (including the rolling stock) and then a subcontractor to the D&C Joint the Debt Financiers agree to lend to operate and maintain it through Venture, rather than a member of it. a capped amount to the SPV. to the expiry of the PPP contract. This difference is not material to the In return, the government agency analysis that follows. The SPV uses this finance (and the agreed to pay a capital contribution capital contributions it receives during the construction phase, The SPV also enters into an from the government agency and monthly service payments Operation and Maintenance (O&M) under the PPP contract) to pay the during the operation phase. contract under which it subcontracts monthly progress payments due The government agency was also its obligation to operate and to the D&C Joint Venture under the responsible for providing access to maintain the rail system to an D&C contract. site during the construction phase, Operator. The Operator either and a lease or licence of the project performs the maintenance activities When construction is completed site during the operations phase. itself, if it has the capability to do so, and operations commence, the SPV or it subcontracts these activities receives monthly service payments The SPV enters into a fixed to the rolling stock and systems from the government agency under price Design and Construct supplier and perhaps one or more the PPP contract, which it uses to: (D&C) contract, under which it members of the D&C Joint Venture. subcontracts its obligation to • pay the fee payable to its design and construct the rail system The SPV raises the finance it needs Operator for the provision of (including the rolling stock) to to fulfil its contractual obligations by the operation and maintenance an unincorporated joint venture entering into: services under the O&M contract; 6 WWW.DLAPIPER.COM • meet its interest and principal According to the Full Business Case default or insolvency if failing to repayment obligations to the for the Canberra light rail project,1 do so would reduce the value of Debt Financiers under the the PPP model was considered to their existing investment or loan. Loan Facility Agreement; and provide the best value for money The additional resources provided outcome because of: by investors or financiers may be • if surplus funds exist after making sufficient to solve the problem, in the above payments, distribute • the heightened degree of risk which event government is shielded the surplus to the Equity transfer and cost certainty it from the risk. It is only when the Investors as a return on their offered over other delivery investors or financiers are unable equity investment.