Risk transfer is the government's key justification for PPPs because without substantial risk taking by the private sector they would not be worth undertaking. The importance of risk transfer is reflected in the evaluations of VFM that take place in the pre-contractual stage. Before a PPP scheme can be approved, it must be demonstrated that the deal will save money when compared to the publicly financed alternative.
The Public Sector Comparator ('PSC') is the technical construct[17] developed to test whether privately financed arrangements provide superior VFM to traditional bundled procurement methods. A PSC calculates the net present cost of the hypothetical[18] public provision of the infrastructure and the services. It is expressed as a single net present cost amount against which bids are compared and involves four elements:
• The raw PSC that determines the cost of the public procurement option, including estimated net capital and operating costs over project life.
• The cost of transferable risks that are often a key determinant of VFM and are frequently updated to allow for variations in risk allocations as negotiations proceed prior to contract signing.
• The financial and non-financial cost of risk retained by the government, including that of performance failure.
• A competitive neutrality adjustment, essentially involving the application of the National Competition Policy in order to remove any net competitive advantage of the public option (such as non-tax status) relative to the private option.
The PSC has been criticised on numerous grounds, including that it is sensitive to a number of assumptions necessary for its calculation and that the discount rate methodology is faulty because the real issue is uncertainty and not risk, which renders calculations problematic. Also, the length of contracts (sometimes up to 40 years) may render financial calculations and assumptions about costs, discount rates and risk allocation incomplete, resulting in inappropriate bases on which to draw conclusions about the viability of proceeding with the PPP option. Moreover, some argue that more emphasis needs to be given to non-financial elements in a longer-term evaluation.[19] Others have also noted that the PSC may not take into account indirect government costs, such as ongoing monitoring costs, and, in the case of Sydney's Cross City Tunnel, the costs of associated road works.[20]
The centrality of risk allocation and anticipated VFM to justify taking the PPP service delivery option, together with reservations about VFM calculations, suggest that verifying their achievement is a likely focus of post-contractual oversight arrangements. Changes in risk transfer and risk premiums favourable to consortia crystallised in the operating stage should be compensated by reductions in the stream of payments to private consortia if VFM is to be achieved as anticipated.[21]