PPP - Paper 2 - privatisation and early private sector financing

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Public Private Partnerships (PPPs)

The private finance initiative ("PFI" and now more widely known as "PPP"s), is a mechanism by which Governments are able to meet and deliver their respective public service obligations, through the procurement of facilities and services from the private sector. Outside the United States of America, particularly during the 1940s and 1950s, the supply of services such as electricity, water, gas, medical services, transport (including roads, ports and airports) schools, prisons and the like, were perceived to be the responsibility of the public state sector. This was not wholly inconsistent with the view that the means of production should be owned by the State. However, a change occurred when two administrations namely, those of President Reagan and of Prime Minister Thatcher, came to the conclusion that inflation did not have to be endemic in the economy. The consequences of that joint approach has now rippled round the world but, in effect, what it requires is that nations should "live within their means". One of the ways of achieving this is to limit state borrowings to a percentage of gross domestic product. This has formed a key driver towards European Monetary Union and the requirements of the Maastricht Treaty.

As a result, Governments can no longer borrow money without also considering the potential impact on the State/Public Sector Borrowing Requirement. However, PPPs are not simply a way of moving debt off the public sector balance sheet and, for example, in the UK some 60% of PPP transactions still appear as a public sector liability.

Privatisations and Early Private Sector Financing

It the early 1980s, the UK faced the fact that a number of utilities (such as water and telecommunications) required very substantial investment. Privatisation offered three benefits:

if the Government was lucky, it would receive a (capital) payment for the assets which were being transferred to the private sector;

any debt required to fund badly needed repairs and renewals, as well as expansion, would be private sector debt, i.e. would not fall on the State/Public Sector Borrowing Requirement; and

going forward, the State would receive taxes from the new "profit making" organisations.

In the 1980s, the English and French Governments agreed on the construction of the Channel Tunnel. Although this project was purportedly a purely private sector project with two concession companies (one English, the other French), the revenue stream for the project, was secured, to a certain extent by a usage charge for 50% of the capacity of the tunnel payable by SNCF (the French Railway Authority) and by British Rail Board (the British Railway Authority) and a minimum amount was guaranteed, effectively, until 2006. In fact, when CMS Cameron McKenna was advising the UK Government on the Channel Tunnel Rail Link Project (i.e. the high speed link between St Pancras railway Station in London and the UK entrance to the tunnel, the issue of the BR obligation became important, because the subsidiary of BR, which had the responsibility for operating the trains, was being privatised.

Elsewhere in the world, independent power production was becoming important and the output from the power station was being purchased, often by a State-owned utility company. The early contracts were "take-or-pay" contracts, which caused a distortion with the relevant existing system. What a system operator required, was plant which mirrored the other (State-owned) power stations attached to the system. Accordingly, the concept of a "capacity charge" (i.e. payment for the station being available) and an "energy charge" (i.e. a payment made when the station was actually despatched), whenever it was instructed to generate electricity), was created. In addition, the system operator would require certain ancillary services such as re-active energy, spinning reserve and the like and provision was made for that as well. Thus, instead of the power station being owned by the public sector and the borrowing for the power station being a State/Public Sector Borrowing Requirement, the public sector paid for a service, i.e. for the availability of capacity and, when despatched, for the energy supplied. From the state's point of view, if the plant did not work, then the state did not pay and if the plant was available, but not to the requisite levels, then the state only paid a contractually agreed proportion. This removed from the public sector, the construction risk and the operational risk, as well as the maintenance risk. However, the risks were not totally eliminated. To the extent that the generating plant was required to meet demand (particularly in areas where the margins between capacity and demand were narrow) if the power station was not available, then there would be a macro-economic effect on the country as a whole and a micro-economic on those who required energy.

The Development of PPPs in the UK

In the UK, the concept of using private sector finance for infrastructure was applied in relation to two toll river crossings: (i) Dartford Thurrock (across the River Thames); and (ii) Second Severn (linking England and Wales). In each of these cases, the public sector made available to the private sector the already existing river crossings which were tolled (i.e. income generating) during the construction period of the new additional river crossing. The private sector designed, built and financed the new additional river crossings and maintained and operated both crossings during the concession period. Rather than granting fixed concession periods, the concession period would terminate when, effectively, the concession company had recouped the capital cost of the project, i.e. repaid debt (together with interest) and repaid the equity on the debt and dividends on the equity. The Government contribution towards the project was the existing river crossing for which it may have received a capital sum or, alternatively, a capital sum and a promise to pay what was, in effect, a subordinated loan. In addition, because certain consents needed to be obtained before the new structures could be constructed and, this was done through a new Act of Parliament, the Government assumed certain responsibilities in relation to obtaining the relevant consents at Parliamentary level. This, as it were, was the beginning of a partnership (although not in the legal sense) between the public sector and the private sector where each had to perform certain obligations and duties to enable the project to be successful.

There are disadvantages, in the UK, in relation to toll roads, as space tends to be available for construction at a premium. It was not practicable to always have a toll road. In addition, the general application of tolls on motorways and trunk roads would be politically difficult to manage. Accordingly, the concept of a shadow toll was developed whereby the private sector undertook the design, build, financing and maintenance of a road or stretch of road and received from Government payment based upon usage. Therefore, although the Government was securing at the end of the contract a road which had not previously existed or, alternatively, an upgraded road, if, during the lifetime of the contract, the lanes of the road were not available for a period of time, then, as payment was based on availability, the Government did not have to pay. This has now been adapted so that, particularly in local authority schemes, payment is made for availability and a portion of payment relates to shadow tolls. This is being further developed to incorporate congestion management charges so as to incentivise the private sector to maintain traffic flows (speed and capacity) at above certain stipulated levels.


PPPs change the way the public sector manages its business. In effect, it purchases a service either for its own use (e.g. Information Technology) or for use by the public (e.g. roads).

However, the challenge is to form long-term contracts (e.g. 20 years); but the issue is how do you write a contract for a concept? The public sector requires the private sector to deliver a service which is for the benefit of members of the public. The public sector needs to recognise that it has to set up a management system to work alongside the private sector.

A case study of what can go wrong relates to the Benefits Payment Card Project. There is a very helpful publication by the National Audit Office of the United Kingdom on the cancellation of the Benefits Payment Card Project. E-mail enquiries can be directed to [email protected] and the website address is www.nao.gov.uk.


The term "partnership" does not mean partnership in the anglo-saxon legal sense. Nevertheless, PPPs require a particular aspect of partnering. There are a number of views as to where the expression "partnering" came from but certainly the first real rise in the United Kingdom of partnering was in the oil and gas industry. It was an attempt to get away from the old adversarial position with regard to "Owner" and "Contractor" but also to see whether, by combining resources, it would be possible to become more efficient and thereby reduce the costs of oil exploitation.

It is arguable that the concept (but not the name) has existed in Japan for some considerable period. The author remembers drafting a contract for a Japanese service provider and discussing the question of professional indemnity insurance to be taken out by the designer. The service provider indicated that, as far as it was concerned, it had chosen the designer, based upon its knowledge and, therefore, it would take the risk if the designer did not achieve that which it was meant to achieve. On the same project, the main contract/sub-contract in fact became a team contract. In addition, the author sat at a table with the three members of team contractors and was instructed to answer questions by any of the contractors freely and fairly. Based upon his comments, commercial terms were agreed at the table and then instructions were given for the author to write the contract. That stage has not yet been reached in many parts of the world.

The concept of partnering in the construction industry is that the owner and the contractor become, as it were, a team and the project management team has individuals from the various parties involved. There is an agreed target sum and each of the parties (including the owner) charge actual cost. If the actual cost is less than the target sum, then there is a sharing of the benefit and if the target cost is exceeded by the actual sum, then there is a sharing of the burden. This is not necessarily on a 50:50 basis and, in reality, it is unlikely that the contractor will take uncapped liability in respect of the downside. Quite often what happens is that there is an underlying contract or series of contracts based upon more traditional relationships between owner and the contractor(s) but certain provisions (e.g. liquidated damages and claims) are suspended whilst the alliance/partnering agreement is in effect. The alliance/partnering agreement can be terminated by any party on notice because alliancing/partnering only works whilst there is a good relationship between the parties. If the relationship becomes adversarial, then the problem may be overcome by removing one or two individuals but if the problem is systemic, then the default position is to revert to the original contractual relationship.

It is quite hard to do that in relation to PPPs, as an adversarial arrangement will not lead to a successful long-term contract. Indeed, the UK Treasury Task Force Guidelines on the standardisation of PFI contracts provided, at paragraph 1.2.3, "The partnering arrangement can work well to address certain issues which arise in IT deals but only if it exists within a sound contractual framework. The Project is likely to lead to difficulties if partnering is invoked as a reason for avoiding the task specified from the outset in the relationship between the Authority and the Contractor and what the initial deliverables are." These guidelines have now been superseded by the standardisation of BFI contracts issued by the Office of Government Commerce and the quote now appears at paragraph 1.2.3 of Part II.

The guidance goes on to say "Failure to set these parameters will undoubtedly make the Project more risky (usually for both parties) they also deter third party investors (whose involvement might improve the value for money options available to the authority). This is because any financier being distanced from day to day involvement in the progress of the Project, has to be satisfied, not only with the feasibility of particular solutions, but also that the project risks are specified with sufficient clarity and allocated correctly".