2.2.2 Prepare the detailed design of the PPP arrangement 
Guidance 28, 29
All aspects of the PPP arrangement (e.g. responsibilities, risk allocation, payment mechanism) need to be developed in greater detail, with the ultimate goal of producing the draft PPP contract. It is advisable to deal with this in sub-steps rather than try to draft a full PPP contract right away. This simplifies the internal review process. It is better to focus the initial internal discussion and approval on the broad commercial aspects of project design rather than on detailed legal terms.
• The first step might be to prepare a document outlining the principal commercial terms ("heads of terms") Once the heads of terms have been internally approved, the Authority should progressively develop and refine the different topics Guidance 30 Certain aspects (e.g. payment mechanism) might first require the advisers to prepare discussion notes presenting and assessing various alternatives.
• The risk allocation of the PPP arrangement will be further developed with the help of advisers and the results checked against prevailing market conditions. Preliminary risk matrices or registers will have been used in the feasibility phase They will be further refined in this phase. Guidance 31
• The assessment of demand risks is essential in PPP projects. The allocation of demand risk is done through the payment mechanism in the PPP contract, which may seek to transfer some, all or none of the demand risk to the private sector (see an example of this in Box 2 and Box 3).
• The financial model of the expected PPP9 (sometimes called a "shadow bid" model) is prepared initially by the Authority and its advisers for use in the feasibility analysis. In this phase, the shadow bid model should be further developed and refined and it should be used to examine alternative risk allocations and payment mechanisms.
Box 2 • Traffic revenue risk allocation |
Forecasting traffic demand is crucial in transport PPPs since traffic influences both project costs (through capital and maintenance expenditures) and project revenues, especially if direct user charges, such as tolls, are the main source of cash flow for the PPP Company. An accurate estimation of the future level and composition of traffic volumes is, however, a difficult task as: • traffic forecasts tend to overestimate actual traffic levels (the so-called "optimism bias") • inflated traffic forecasts may be linked to traffic modelling flaws but also to strategic decisions of PPP consortia when they bid Traffic forecasts commissioned by the lending banks, for example, are less prone to traffic optimism bias. Given such uncertainty, the allocation of traffic revenue risk is a key decision in the design of a transport PPP contract and the payment mechanism (see Box 3). There are several options for allocating traffic revenue risk. • at one end is the conventional toll road, where revenues derive from toll payments and, thus, the PPP Company (and its lenders) are exposed to full traffic revenue risk; • at the other end lies the "availability-based" option, where the PPP Company receives fixed periodic payments from the Authority as long as the road is available for use. In this case, the PPP Company bears little or no traffic revenue risk; and • in between, there are several options designed to share the traffic revenue risk, such as: • revenue-sharing bands: lower and upper thresholds for sharing traffic revenue risk between the PPP Company and the Authority if traffic is outside the thresholds; • flexible-term contracts: the PPP contract will end when the PPP Company has received a certain amount of revenue from users (e.g. the "least present value of revenue" approach implemented in Chile) • financial re-balancing: provisions to change the economic balance of the PPP contract if traffic is much lower/higher than planned or at set regular intervals. Recent practice in transport projects has seen the use of a mixed payment mechanism consisting of an availability payment (intended to cover operating expenses and debt service) and a direct user charge (e.g. toll) that provides the equity return. |
_________________________________________________________________________________
9 Note that this model is not the same financial model that a bidder will prepare and submit with its proposal.