An important aspect of the assessment of value for money is consideration of the sustainability of the private sector entity's bid, having regard for the risks it is willing to accept for the bid price offered. Even where the risk has been transferred, there can remain a residual risk that the public sector may have to step-in in the event the private sector contractor experiences difficulties in meeting its obligations. This is because, where the provision of public services or goods is involved, private financing does not equate to contracting out ultimate responsibility for their delivery. In this respect, the NSW Auditor-General has commented:
…I think quite often the risk assessment that takes place may assume that the private sector entity continues to operate and can continue to honour its obligations under the arrangement for risks that arise. Whether or not there is a contractual obligation for the private sector party to continue to meet obligations is one thing, but in reality, many of these projects become perceived by the public as a public sector project, as a government project. If the private sector entity were, for example, to become bankrupt, go into receivership or otherwise default, the risk will quite often fall for public policy reasons or revert to the Government. 59
Whether it is regarded as a gap in accountability or not, there does not appear to be sufficient attention given to minimising, or at least ameliorating the initial, and sometimes ongoing, impact of a bankruptcy or other cessation of service by a private sector provider or the immediate clients and/or the general public. This should preferably be decided when the initial outsourcing/ partnership arrangements are being determined and/or, at the latest, at the time of the contract negotiations, so that both parties can address the issue and be aware of what action would be taken and who is responsible and accountable.
The NSW Public Accounts Committee has similarly reported that:
Governments sometimes also use PPPs to divest themselves of risk and instead transfer it to the private sector. But often the private partners in these cases run into trouble. Governments, being sensitive to community expectations, renegotiate these deals at considerable expense and re-assume the risk. In these cases they would have been better off not to enter into a PPP in the first place.60
An example of such a circumstance arose in Victoria in regard to the Latrobe Regional Hospital, for which a private sector consortium had been awarded a contract utilising the build, own and operate (BOO) model of private sector involvement. The new hospital commenced operations in September 1998. Under the terms of the agreement, the consortium was required to provide services to specified quality standards. In return for services delivered, the State paid the consortium a service charge comprising a service component and an allocated facilities component.61 The Victorian Auditor-General's Office, which had examined this PPP, reported that the overall arrangements as structured, effectively transferred a significant proportion of the financial risk to the private sector.62
Within a year of commencing the operations, the consortium began making representations to the relevant Department that the hospital had been incurring substantial operating losses.63 The Auditor-General reported that, by July 2000, the Department had concluded that, as a result of financial problems stemming from the low original bid (which was materially below the public sector comparator established for the tender process) and the inability of the private sector consortium to make the efficiency gains upon which the bid price was predicated, it was only a matter of time before the State would need to consider either the renegotiation of the contract or manage the collapse of the arrangement.64 Ultimately, the step-in provisions set out in the agreement were exercised and the hospital's operations were transferred to the public sector, with the private sector consortium required to pay the State around $2 million, representing net assets and liabilities assumed from the consortium.65 The Auditor-General concluded that:
Although the contractual arrangements for the privatisation of the Latrobe Regional Hospital were successful in transferring financial risk to the private sector, the social responsibilities of the State meant that any threat to public health and safety or hospital service provision could not be allowed to occur. In this case, the State stepped in when it appeared that a risk to the provision of on-going hospital services was developing. The final outcome was that [the private sector consortium] was able to avoid the full financial risk obligations embodied under the contractual arrangements.66
The recent research paper on PPPs by the Department of the Parliamentary Library noted another example in which the State found the need to exercise step-in rights:
In practice, the allocation of risk has not always been appropriate, and the government has had to assume risks that were initially transferred to the private party. An example is the Sydney airport rail link, which the NSW Government took over after the company that built and operated the link failed to meet scheduled payments to creditors.67
The implications for accountability arising from such circumstances highlight the need for public sector entities to ensure that a PPP arrangement includes a) adequate step-in provisions and b) appropriate governance arrangements that give the public sector entity sufficient capacity to monitor the private entity's ongoing financial viability and plan for orderly take-over to ensure continued service to the public. Lessons in this regard have been similarly noted by the NAO in respect to the use the UK Private Financing Initiative (PFI).
For example, the private financing deal for the construction of the Channel Tunnel Rail Link and operation of the UK arm of the Eurostar international train service had to be restructured after it became clear that overly optimistic forecasts for the operating performance of Eurostar UK had scuppered the private sector partner's efforts to raise all the money it needed from private investors to build the Link.68 In an audit of that PPP, the NAO found that, under the original deal, the responsible Department decided not to demand all of the information it was entitled to under the contract with the private sector partner.69 This decision hampered the Department's ability to monitor progress and at the same time denied the external financiers, at the early stages of the project, the opportunity to bring private sector financial disciplines to the deal. NAO found that, in the restructured deal, the Department now has considerable influence on the way the whole project is being managed and is actively monitoring the performance of the private sector partner and the other parties to the project.70
There is no doubt that risk transfer has been seen as a major driver for the UK PFI.71 More broadly, the PFI was introduced to harness private sector management and expertise in the delivery of public services.72 For example, in 1997, National Air Traffic Services Ltd (NATS), the company owned by the Civil Aviation Authority which was responsible for air traffic control in the UK, estimated that it required some £100 million of further capital investment every year for the next decade to increase air traffic control capacity to meet future traffic growth. But NATS could not be sure of getting this money: it competed with the rest of the public sector for finance. The UK Department of Transport had concerns over whether NATS could manage such a large investment programme efficiently. The Department and the UK Treasury concluded that the solution to this problem was to adopt a PPP for NATS which provided:
● above all, for standards of safety and national security to be at least maintained, in particular by separating service provision from safety regulation;
● an injection of private sector money and improved project management skills;
● for NATS to benefit from greater freedom to invest and to improve its services free of public sector constraints; and
● that, in achieving these prime objectives, the interests of the taxpayer should be safeguarded.73
In a recent report, the NAO highlighted that the corporate governance arrangements put in place for the NATS PPP, in order to provide for ongoing protection of the public interest, appeared to be working.
The PPP involved transferring part ownership of the company responsible for air traffic control from the regulator, the Civil Aviation Authority, to a consortium of airlines, which was given operational control and a 46 percent share of the company.74 In designing the PPP, the UK Department of Transport had to incorporate controls over the business to protect safety, national security and the public interest, without taking operational control of the business away from the Strategic Partner. The Department and its advisers addressed these needs mainly through arrangements for corporate governance of the Company, laid down in a Strategic Partnership Agreement, and through the provisions of the Company's licence to provide air traffic services. A key feature of the PPP is the role of three 'Partnership Directors' nominated by government. Their function is:
● to exercise their independent commercial judgement on issues of strategy, performance, resources and standards of conduct; and
● to seek to ensure that the Board, as the principal decision-making forum in the Company, functions effectively and transparently.75
In particular, their duty is to protect the taxpayer's financial interest in the company, and to ensure that the company retains its capability to operate without undue reliance on the consortium.76
In practice, achieving transparency and accountability is a major challenge for good governance in an outsourced environment, not least in the nature and extent of risks involved. The public sector must act in the public interest and, in common with the private sector, avoid apparent personal conflicts of interest to the maximum extent possible while being prepared to openly explain decisions - that is, accept overall responsibility for decisions. In short, such a focus on accountability encourages measurement of performance in a practical operational manner that makes sense to those involved. 77 That does not occur by accident or default. It requires sound leadership and direction.
It has to be admitted that the public sector often does not operate with complete clarity as to the extent of a public sector employee's, officer's, CEO's, and/or board member's accountability for implicit or explicit action that may affect the citizen. While reforms are raising public sector awareness of, say, legal accountability (just as in the private sector) the innate complexities of public accountability do not lend themselves to easily providing complete clarity of requirements. Indeed, ongoing reforms promote individual discretion, judgement and initiative. Nevertheless, there is a public expectation of personal responsibility and accountability that has to be met.
The UK PFI has also demonstrated the governance complexities that can arise as governments move further into the PPP experience. Initially, a Treasury Taskforce provided UK public sector entities with specialist skills and experience to assist in developing PPP projects. That role has now been taken up by Partnerships UK.
Partnerships UK is not an adviser. It acts as a PPP developer, working in partnership with public bodies. Public bodies which previously would have used the Treasury Taskforce may now enter into a development partnership agreement with Partnerships UK. The latter works with the Government in the development of PPP policy and contract standardisation; helps with project evaluation and implementation; and supports PPPs in difficulty. Partnership UK's financial targets are set to fulfil its public sector mission while permitting a fair return on capital. Its returns are linked to the success of the PPP. It helps to fund the costs of development and procurement, and intends to provide finance for PPPs where this will achieve better value for money for the private sector.
As a private sector company, with the Government holding a substantial minority stake, Partnerships UK is itself a PPP, having completed a capital raising exercise in March 2001. It is a joint venture with the public sector owning a minority interest and the private sector owning a majority. A majority of board members come from the private sector. The public sector is represented by two non-executive directors appointed by HM Treasury. The wider public interest is represented through an Advisory Council made up of the principal public sector stakeholders. In a real sense, it is another player in the accountability drain with dual responsibilities and accountabilities which is not conducive to Parliamentary confidence about just who is to be held accountable for what and on what basis.