Private Finance Initiative - Treasury Contents

Written evidence submitted by Meridiam Infrastructure


Meridiam is a leading long term PPP or PFI infrastructure investment fund in Europe and North America with a highly experienced team focusing on greenfield PPP projects in the transportation, social and environmental sectors. Meridiam firmly believes that PPP is the most effective form of procurement for £100 million+ single or grouped infrastructure projects due to the significant effects of whole life costing providing enhanced long term service provision to the public.

PPP is now being utilized around the world as an efficient tool for service provision allowing transfer of significant risk to the private sector.

There have been concerns that PPP contracts are inappropriately expensive, and that private sector providers have been making excessive profits from investing in PPP projects. Meridiam believes strongly that PPP is the most effective form of procurement however it does recognize that PPP procurement in the UK can and should be improved.

What are the strengths and weaknesses of the different public procurement methods?

1.  The main strength of PPP is that it delivers projects on time and on budget through fixed contractual arrangements agreed at the outset. The PPP contractor takes responsibility for the construction and the maintenance of the projects and so eliminates the need for new spending to meet unexpected demands.

2.  It used to be the norm in the public sector (see a number of Ministry of Defence projects for example) that constantly changing specifications not only delayed any construction but greatly inflated the cost. And in the past the public sector often had to meet unexpected maintenance costs as the fabric of buildings deteriorated and resources were depleted through wear and tear.

3.  Before PPP was introduced infrastructure development in the UK lagged behind other European countries. There are now more PPP infrastructure projects in the UK than in any other country. Without access to PPP funding the new build of hospitals, schools and other infrastructure projects would not have been possible. Its success is reflected in the number of countries now adopting it. Meridiam believes that it will be difficult for the UK to meet its National Infrastructure Plan targets of expenditure of £200 billion on infrastructure without PPP as it is a well supported and effective route for mobilising private sector capital.

4.  The PPP process can be improved. Too often it begins before the 'clients' have a clear idea of what they want to achieve, and bidding processes have been far too long, some projects taking two to three years to come to fruition. Protracted negotiations can cause high costs to all amid indecision about final outcomes. Understandably individual purchasers within the public sector often do not have the procurement expertise—we believe the UK should look at the Canadian model which has central procurement bodies on a province by province basis.

5.  Long term approaches are the most effective but need real up front agreement between public and private sector. Meridiam supports partnerships between the public and private sectors together with sharing of risk and return. This is particularly the case in respect of refinancing, establishing ceilings for returns together with sharing of upside benefits on a balanced basis.

6.  Changes in policy and technology cause strain and are invariably costly. Projects that prove the best value for money are those clearly defined from the outset, least subject to interference from the procuring authorities, and funded over the long term on fixed rates.

7.  It is however recognised that the public sector requires flexibility as policy changes—Meridiam believes that such changes are better incorporated through formula incorporated under the overall umbrella of long term contracts rather than shortening the overall horizon of PPP contracts. For example, if the public sector wished to incorporate a "de-scoping" of service provision that resulted in lower cost then the availability payment could be decreased taking into account the overall costs of the PPP.

8.  Traditional procurement allows for direct control and management of contracts, competitive processes, lowest cost Government funding, potential to reach the lowest price for a defined asset, comfort in obtaining control of design. We would argue that the strengths are outweighed by the weaknesses of no long term maintenance, no protection from claims or cost over-runs, the need to dedicate from day one public budgetary resources to finance the totality of the project's costs upfront, interface risk assumed by the Government, directly incurred management costs.

9.  Several projects using the traditional procurement route have experienced significant cost over-runs and delays, In the UK, the following projects: Millenium Dome, Jubilee Line and Wembley Stadium. Elsewhere in Europe: major projects such as the Stade de France, the Spanish high speed line rail programme or the construction part of the Dutch high speed line rail programme. It is not always easy to prove that a PPP route would have been more successful but the L2 project in Marseille (France) is an interesting example: due to numerous delays, notably caused by difficulties in providing budgetary resources to the project in a timely manner, the project, initiated before World War II, has experienced significant cost overruns and redesign, eventually leading the French Government to decide to implement it as a PPP.

10.  PPPs have provided strong value for money, consistently delivering high quality outcomes on-time and on-budget. Indeed the performance of PPPs has been so impressive that over 20 OECD countries use PPP procurement.

11.  The whole-life costing is a key component: it considers what maintenance will be required over the PPP contract as well as the cost of the asset. Usually under traditional procurement only the building cost was considered and no funding for the running costs allocated at the outset of the project.

12.  PPP procurement incorporates dedicated and focused private sector operational management allowing the public sector to focus on such areas as policy and regulation.

13.  PPP projects involve long term risk transfer from the public to the private sector and incorporate a whole series of costs beyond funding. They include bidding, delays, development costs, land acquisition, lack of income from the outset in greenfield projects, contingencies for construction risk/delay and operational risk, management costs and contingencies for risk sharing with the public sector.

14.  Under PPP, subcontractors may be replaced for poor performance or bankruptcy without any cost to the public sector. Under traditional procurement the costs of such replacements usually impacted on the public sector purse after long and protracted negotiations which also resulted in delays in the project.

15.  All these factors are potential risks to the private sector and therefore add a premium to the government risk free rate. And because the risks are priced from the outset and are reflected in the contract it is not appropriate just to focus on the funding cost when comparing traditional and PPP procurement.

16.  There have been concerns that PPP projects are inappropriately expensive and that private sector providers have been making excessive projects from investing in PPP projects. Sometimes this may be due to a lack of understanding of the PPP methodology. Individual items purchased under a PPP contract are rarely priced in the same way as items in a supermarket so it is not sensible to compare costs of individual items. Items purchased under a PPP contract should be considered as part of the total package of cost including the pricing of the risks above and the cost of outsourced management of these risks.

17.  The capital structure of a PPP project contains both debt and equity (on around an 85:15 to 90:10 ratio). Equity, the repayment of which is not guaranteed, is required to act as a buffer for risks. And while it is more expensive because of the uncertainty that surrounds it, without equity funders would require guarantees from the government, as is the case in the 'forfaiting' model for infrastructure procurement in Germany.

18.  The direct comparison between actual cost of funding for Government and for PPP SPVs is therefore unfair at best and disingenuous at worst as it does not take into the different allocation of risks in the two situations.

If PFI debt had been on-balance sheet rather than off-balance sheet would PFI projects have been used as much? How should PFI deals be accounted for?

19.  Accounting for PPP projects off-balance sheet was a stimulus for more projects to be undertaken when there was an apparent lack of funds for the creation of new infrastructure, and many countries, not only the UK, aimed to remain within the Maastricht rules. With the changes in the accounting methods used, and the fact that many countries are entirely in breach of Maastricht rules in 2011, this question really just has historical interest now. The much closer scrutiny of government balance sheets mean that off balance sheet contingencies are more often being included in total indebtedness, and that reasons for doing PPP procurement are now to gain efficiency in delivery rather than some apparent benefit in getting round rules that are not longer apparently relevant.

20.  Of the 22 countries surveyed at the annual OECD PPP meeting in April 2010, 20 countries are using PPP and only four said PPP would be more attractive if the debt was not on the balance sheet. Indeed in a number of countries, until recently less financially constrained, such as the Netherlands, Denmark, Finland and Norway PPP was explored and is being utilized as a long term delivery method.

How far can risk really be transferred from the public to the private sector?

21.  Construction risk is transferred in PPP projects from the public sector to the private sector. Fixed price, date certain contracts are the norm with no facility to make new claims on the public sector purse if unforeseen difficulties arise. There are a number of examples where major construction problems have arisen but a facility has been delivered for public use such as the A13 PPP road project, Dudley Hospital and the Croydon Tramlink. Even if a project has to be cancelled due to construction failure, due to the financial structure with private sector equity and debt being drawn down to pay for construction and there being no payment until the end of construction this mean that there will be no public sector payment for failure. Where public sector grants are involved, such payments are usually made only when construction milestones are reached.

22.  Maintenance contractors, if they are incompetent, can be also be terminated at no cost to the public sector as the risk relationship is not between the public sector and that contractor, but between the public sector and the PPP SPV and it is the SPV that will face payment deductions in the event of poor maintenance performance.

23.  Equity risk is transferred—investors who put money into PPP SPVs as providers of equity are not protected in relation to their return or indeed the security of their investment. Debt risk is not transferred as comprehensively as debt funders have more access to potential public sector compensation due to contracted termination payments.

24.  Bidding cost and development risk have largely been transferred to the private sector as consortia winning for projects rarely have a stipend to cover their lost costs if they are unsuccessful and such costs end up on company balance sheets. A majority of the funding, and liquidity risks have been transferred to the private sector.It is appropriate to consider whether the cost of transferring risks to the private sector is appropriate to their benefit. There are a series of shared risks such as insurance, archaeological risk, certain environmental risks that have partially been transferred to the private sector at a cost and consideration should be given to whether this cost indeed presents the best value for money for PPP procurement.

Are there particular kinds of risk which are particularly appropriate for transfer through PFI deals or particular projects which are suited for PFI

25.  PPP can ensure that a wide variety of risks may be transferred but cost and experience are key. There is no point in the private sector taking on a risk and making a huge contingency in their pricing to take account of the effects of that risk or being unable to cope with such a risk that would cause the collapse of the company running the PPP. PPP risk transfer needs to look closely at whether risks being transferred are at the right cost. All the risks we say are transferable may be done so at a cost that still meets a government private sector comparator under competitive conditions.

26.  Partial user paid risk in PPP projects can be transferred where there is existing income from an existing route (Nottingham Tram), public sector revenue support (Limerick Tunnel), where an extension is involved (A5 Germany), where user risk relates to block movements (Tours-Bordeaux High Speed Rail), where there are limited alternative routes or to ease heavy congestion (Texas motorways). Existing revenue makes the prospect more palatable for investors and Meridiam (all Meridiam projects in brackets) believes this risk can be fully transferred as part of a user paid PPP project.

27.  The benefits of using the PPP procurement focus relate to the creation of long term and stable assets that are the results of long term planning, and technology based PPP projects do not exhibit these features. Meridiam believes that IT projects are not really appropriate for PPP treatment as they tend to require a series of technology upgrades and long term corporate guarantees.

28.  Best suited are road and rail construction projects, bridges, tunnels, urban and high speed travel, energy, social accommodation and environmental projects such as wastewater and waste management that can be created as part of a long term and agreed partnership between public and private sectors.

29.  Size is another criterion—given the development costs of PPP projects unless a project has a particular mass, of say £100 million or more, then the costs of around £1-2 million per project can be disproportionate to the long term benefits gain from whole life costing.

What State guarantees are explicit or implicit in PFI deals?

30.  The state has always tried to avoid having explicit guarantees in PPP deals where the aim was to present PPP transactions as being off balance sheet.

31.  Certain countries such as France do use explicit state guarantees in PPP projects. In France the "cession Dailly" is used, which is a financial mechanism enabling lenders to bypass the project company to get direct payment by the public authority as soon as the asset construction is considered to have fulfilled the public authority's requirements. It is Meridiam's conviction that such mechanisms, may create misalignment of interests and therefore reduce the economic rationale of the use of a PPP. There are no such mechanisms in the UK.

32.  Some state guarantees may be implicit in that if there is a project with a compensation on termination structure, if there is project failure then the state will pay amounts agreed under such compensation but there are a lot of stages that need to be gone through before payment is made—it is never an on demand guarantee from the state. If the project is strategic and falls into difficulty then the state will be likely to repurchase the project to ensure that it keeps working and will effectively 'buy' the capital value of the project from the banks.

33.  PPP project creditworthiness relies on the credit of public authorities, which under availability schemes remunerate the private partner in exchange for performance. Investors expect the public authority to respect its financial commitments as soon as the private partner meets the predefined performance requirements.

In what circumstances are PFI deals suitable for delivery of services

34.  Meridiam's vision of any PPP is that it is linked to the delivery of services, the underlying infrastructure asset being only a way to reach the objective in terms of service provided to the public. The essence of PPP, compared with the traditional procurement route, is notably to put the idea of service and performance at the core of the infrastructure project.

35.  Nevertheless, the rationale of PPP deals for a "service only scheme", ie without the existence of an underlying infrastructure asset, may prove not obvious and appears close to already existing "outsourcing".


36.  Meridiam Infrastructure is an infrastructure fund manager focused solely on public private partnership equity investment in the transport, social and environment sectors. Based in Luxembourg with offices in Paris, New York and Toronto, the fund manages assets of c €1.5 billion and invests in countries that are members of the EU, OECD in Europe and North America.

37.  Meridiam acts as a bidder and developer of PPP infrastructure projects from the first bid stage, as investor and operational manager, and invests with no divestment for a period of 25 years. By the end of 2011 it will have invested in 17 projects in nine countries, including the UK, with an average investment per project of £40 million.

38.  Meridiam's investors are mainly state and municipal pension funds, insurance companies and development institutions (EIB and the Development Bank of Japan) from member countries of the OECD. Meridiam looks for stable returns for its investors over the 25 year life of the fund with annual cash yields of around 5% rising to 10%-15% in the latter years of the fund.

39.  The Meridiam infrastructure team is highly experienced, bringing together international engineers, ex-government officials, project financiers and project operators each of whom have 10 to 20 years' background in procurement in the public and private sectors. They have experience of different procurement approaches and are convinced that PPP is the most efficient and cost effective procurement vehicle in the long run.

40.  PPP is used interchangeably in this note with PFI as Meridiam believes there is really no difference between the two descriptions in the segments where Meridiam operates.

April 2011

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Prepared 10 August 2011