3.2 In developing PFI the Government recognised that, in order to bring the experience and capability of the private sector fully to bear and deliver the required outcomes, the private sector contractor needs to be tasked with managing those risks that it is best placed to manage and given the right incentives to do so. Box 3.1 summarises some of the benefits of having funds at risk in enhancing these incentives.
| Box 3.1: The benefits of private finance In a PPP structure the private sector bears the risks allocated to it under a contract with the public sector. Payments it receives are dependent on the management of those risks and therefore its performance under that contract. The inclusion of private finance in PPP delivery structures has brought key benefits to the public sector. These include: • Improved whole-of-life risk allocation and management - the public sector has benefited directly from lenders and equity providers' detailed analysis, allocation and management of project risks on a whole-of-life basis. With payments linked to performance over the project life, the private sector must consider costs over the life of the asset, or at least the contract length, rather than just during the design and construction phase. Investment returns are dependent on the private sector's ability to control and manage risk effectively throughout the contract period. • Greater focus on due diligence - the inclusion of debt funding has significantly enhanced the review of delivery solutions and contract structures. As debt is exposed to potential loss from default on delivery by the contractor, but has its return effectively capped at the repayment of principal and interest charges, it is incentivised to ensure disciplined risk allocation. Debt providers are therefore likely to take a firm view in dealing with problems revealed by due diligence reports. • Better integration of design, construction and operational skills - with public sector payment for the service linked to performance, and the private sector being responsible for the costs of delivery, the return on private sector equity investment in a project is dependent on its ability to manage the interface between the different components of the solution and control costs over the long term. This has resulted in better long-term integration of service components, while maintaining desired outputs specified at the outset. Source: The value of PFI: Hanging in the balance (sheet)?, PricewaterhouseCoopers LLP, 2008 |