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Lessons the Middle East can learn from the UK’s PFI/PF2 model

April 2019  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2019 Issue


As demand for public infrastructure increases in the Middle East, so too has the appetite for public-private partnership (PPP) projects in the region.

In the wake of increasing debate around the feasibility of PPP projects in the UK, following the collapse of high profile UK contractor Carillion and subsequent shelving of the UK PFI/PF2 model, the Middle East market must consider what lessons can be learnt from these events in order to strengthen its own PPP models.

This article looks at a number of key deficiencies in the UK PFI/PF2 model, highlighted by the UK government in the wake of the Carillion collapse, and examines how the Middle East market could use these lessons to ensure the robustness of the Middle East PPP model.

Legal framework

One of the key criticisms of the UK’s PFI/PF2 model was that the legal framework was considered to be inflexible and overly complex and it was difficult to assess on an ongoing basis if value for money was being achieved.

Having a suitable legal framework which provides a clear, flexible and transparent set of rules that both private and public parties trust is critical for the success of PPP projects.

Private sector participants should be confident that they contract as equals and will not be subject to arbitrary changes to the conditions of the project agreements, including revocation of property rights.

A legitimate and effective appeals process is also a crucial element of the legal framework. Clear and predictable rules should be in place to resolve disagreements between public and private parties.

Additionally, ensuring that the legal framework adopted is sufficiently flexible to enable the relevant PPP framework to evolve over time is an important factor in its success, particularly as PPP projects evolve in the region from simple utility based projects into more complicated social infrastructure, such as schooling and hospital projects. Ensuring that sufficient flexibility in the model has been factored in is also integral to ensuring projects are efficiently run and not unduly hindered by bureaucratic process.

While a number of Middle East countries have implemented their own PPP legislation, countries which are currently developing their PPP frameworks, such as Saudi Arabia, could significantly enhance their private sector participation laws by ensuring that the attributes set out above have been adequately taken into consideration. A sound legal framework is key to attracting the right participants and ensuring value for money is easily demonstrable.

Procurement

Developers often complain about the aggressive procurement time frame for PPP projects in the Middle East, which are typically expected to reach financial close between 12-18 months (depending on the size and complexity of the project) from the release of the RFP. This is significantly shorter than under the UK model which has a significantly longer average procurement time frame of somewhere between 30-35 months.

While a 30-35 month procurement time frame may be considered excessive, a more balanced approach may need to be adopted. Providing bidders and procurers with a less aggressive procurement time frame would assist both sides to achieve better value for money by providing the procurer sufficient time to properly evaluate the merits of each bid submitted (not just the lowest price) and providing both sides with a better opportunity to develop and refine the preferred bidders proposal prior to contract award.

Diversity of bidders

Under the UK PFI/PF2 model, all key government procurement activities (subject to certain thresholds), including PPP projects, were required to be published in the Official Journal of the European Union ensuring an equal playing field for all EU companies wishing to participate.

Similarly, legislation in Egypt and the proposed Saudi private sector participation law also allows foreign and national bidders equal access to PPP projects. In addition, there are no specifications in either piece of law requiring government bodies to hold an ownership stake in the project.

Although there is no obligation in the Dubai PPP Legislation for the government to take a stake in the project, the project company is required to be a UAE company. This requirement brings the PPP project within the ambit of the UAE Companies Law, which requires companies incorporated in the UAE to be majority (51 percent) owned by a UAE national. This type of requirement places some burden on international entities wishing to participate in PPP projects and could potentially have a negative financial impact, as developers need to factor the cost of additional structuring and governance requirements, made necessary as a result of local ownership requirements, into the overall project price.

Moreover, by limiting access to projects to specific classes of bidders, it increases the risk of overexposure to a small number of contractors and could deter more experienced bidders from other jurisdictions from becoming involved with a project. This could pose a serious risk to the sustainability and future of the market.

Value for money

The process by which a PPP project is assessed as providing value for money should be the underpinning consideration for contract award. While entering into design, construction and long-term operation and maintenance contracts should create an incentive for the bidder to design and build an asset with low lifecycle maintenance and operating costs, the emerging trend in the Middle East seems to place more focus on price of the bid rather than the solution. Given some of the lower tariffs that have been proposed recently in the region, questions have emerged as to the sustainably of delivering projects at this price. Lessons should be learned from the collapse of Carillion and its consequences, including the procurer’s ability to bring projects in-house or to redeploy them back into the market.

Ability of procurers to bring projects in-house

The ability of procurers to bring a project in-house in circumstances where the project is either underperforming or where expected service payments no longer represented value for money, were identified as key areas of concern by the UK government and were key factors in its decision not to continue with its PF2 programme for future infrastructure projects.

While Middle East concession contracts will typically provide the procurer with a right – but not an obligation – to take back control of the project where the project is underperforming, it does not necessarily address the issue of whether there is an in-house capability to actually perform the relevant services once control of the project has been assumed by the procurer. This is not, however, something that can easily be addressed in the concession contract and is something that governments should consider as part of their value for money assessment, particularly when faced with tariff prices that seem too good to be true.

The issue of whether a project still represents value for money is a trickier issue. The Middle East model tries to address this issue by limiting the project company’s ability to claim increased costs and change in law relief, by including thresholds that have to be met either annually or in aggregate before the procurer is required to cover the cost of such increases. However, this issue could be further and more comprehensively addressed in Middle East models by including benchmarking obligations, which require the project company in the later years of the project to benchmark its costs against the market with an ability to re-baseline costs where the contract no longer represents market, ensuring operating costs remain competitive for the life and type of the asset. This type of provision could conceivably also increase the overall project price if, for example, the cost of labour and spare parts have increased significantly during that period, but such increase in any case should not have an impact on value for money given that any such increase would represent market value.

Conclusion

As indicated above, the Middle East would benefit from looking carefully at the factors contributing to the failure of the UK government’s PFI/PF2 model and seek to use the lessons learnt to improve and strengthen its own models in the region.

 

Joanne Emerson Taqi is head of the Bahrain office, and Kristian Perussich is a senior associate, at Norton Rose Fulbright (Middle East) LLP. Ms Taqi can be contacted on +973 16 500 214 or by email: joanne.emersontaqi@nortonrosefulbright.com.

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