2.16 The appropriate calibration of the payment mechanism (i.e. the assignment of numbers and related formula to contractual requirements) is key to achieving value for money, risk transfer, workability and success of the commercial aspects of the project. Good calibration leads directly to a good operational client/contractor relationship and is a key legacy of a good procurement team.
2.17 There are a range of payment mechanism models across different PPP sectors. Summaries of some of the common models can be found in SoPC4 which can be accessed at www.hm-treasury.gov.uk/documents/public_private_partnerships/ppp_index.cfm. Research has indicated that across all of these models, there is a need to test the payment mechanism in advance of actual service delivery and understand exactly (relative to the economics of the project):
o what the financial impact of various levels of non-performance or unavailability will be. These must be sufficient to incentivise good performance but not so high that they encourage "risk pricing" by contractors or affect the bankability of the project. They need to be well balanced across all areas of performance so as not to introduce perverse incentives or unintended consequences. For example, that the failure to clean a store cupboard results in whole service unavailability; and
o how these impact contractually, generally through the accumulation of some form of failure or penalty points. In practice, it is sub-contractors partnering with the SPV who are responsible for the service provision and therefore for service failures and deductions. Therefore, significant deductions or penalty points can lead to for example, replacement of a sub-contractor and warning notice/default provisions. These should be realistic in relation to anticipated performance levels and not introduce any "hair triggers" which would make it impossible for a contractor, or their funders, to step in and improve performance prior to their contract being terminated.
2.18 Research indicates that the most effective way to understand these areas is to develop a fully calibrated working model of the payment mechanism which reflects the project being delivered. This will have to incorporate both accommodation and service areas for modelling availability and performance requirements and where applicable, include weighting and allocating financial values or percentages to these.
2.19 The majority of PPP sectors already have a standardised payment mechanism, within their standard contracts, reflecting the specific objectives of the payment mechanism within that particular sector. During the preparation of the Invitation to Participate in Dialogue and in the dialogue period, the payment mechanism and related drafting should be considered carefully including the calibration aspects. There is typically a direct nexus to the work that public sector client teams do in analysing and configuring, then pricing accommodation/facility and service requirements. The importance of certain areas of the facilities, and/or services to be delivered and their financial values ultimately drive how they are treated in calibration modelling.
2.20 Whilst standardised calibration models are required within sectors, population of these models and assignment of values and weightings must always be project specific.
2.21 Best practice is to complete a draft calibration exercise based on the public sector designs and release these to Bidders, potentially along with the associated calibration models, as part of the ITPD and tender documentation. This will allow bidders to tender on a common basis. Under the competitive dialogue process, the calibration model should be refined with the bidders during the dialogue process and finalised prior to the appointment of a Preferred Bidder.
2.22 The key parties and their roles in developing the payment mechanism are noted below:
o The Procuring Authority - development of the payment mechanism in conjunction with their sector specific payment mechanism model and advice from their advisers. They are responsible for authorising the output and services specifications which define accommodation requirements, layouts and required service standards and response periods. They will identify the prioritised areas and services and ensure that their importance is highlighted to bidders and recognised within the payment mechanism.
o The Advisers -
• Technical Advisers - will assist the Procuring Authority in the production of the sample project layout and the weighting of the relative importance of services and areas. The adviser must be able to impart knowledge of operational payment mechanisms and how the Authority's requirements can be reflected within the model with appropriate weightings or values assigned. Technical advisers will also provide guidance on contractor performance across a range of likely performance/availability levels which can then be analysed against resulting financial implications. In turn these levels of performance (e.g. excellent, good, mediocre, poor) will be able to inform the level at which warning notices and termination triggers should be set. The performance data, ideally drawn from comparable operational projects in the form of "number of failures per month" for different levels of performance, is critical to the calibration process. (Access to such information should be an evaluation point when appointing technical advisers.) They will also advise on the appropriate rectification periods to be included within the services specification
• Financial advisers - will typically model the payment calibration model on an interactive spreadsheet. This will reflect the areas of layout of the proposed project. The outputs of this model will be used to assess the level of deductions attributable to each service failure and the commercial implications of these. This will initially be based upon the forecast unitary charge for the project. The model should be developed at an early stage and shared with the private sector at appropriate phases of the procurement process in order that all parties understand the implication of the payment mechanism model. The calibration model will be updated to reflect the facilities to be provided by the Preferred Bidder and will play a key role in finalisation of the payment mechanism.
• Legal Advisers - will liaise with other advisers to ensure the financial elements of the standard contract drafting reflect the results of the calibration work and will populate the payment mechanism schedules and contract accordingly. It is recommended that, in conjunction with other advisers, they provide a range of worked examples of deductions linking the legal drafting to the financial impact resulting from the model.
2.23 The purpose of developing a calibration model in support of a payment mechanism is to ensure that the resulting financial and contractual incentives/deductions are appropriate, fair and enforceable. Whilst ensuring that the contractor is strongly enough incentivised to perform, it will also provide assurance to both public and private sector interests that the risk profile to payments is ultimately bankable. There needs to be suitable protections against hair trigger scenarios and rapid loss payment.
2.24 The bespoke nature of projects needs to be reflected in calibration development. It is important to Bidders to understand which services an individual Procuring Authority prioritises and why. In this way they can ensure that their service proposals can be tailored for that individual project.
2.25 Specific areas of the calibration which have caused problems in the past, and should be considered during the procurement process, include:
o the need for clarity regarding the rectification periods and penalties attaching to temporary and permanent rectification to ensure that service failures are fully addressed on a permanent basis. For example, if deductions only apply to temporary rectification periods - there is no incentive to implement a permanent resolution of a problem. If they can only be applied once a permanent rectification is achieved, there is no incentive for the temporary rectification to be completed.
o the extent of variable and volume related payments (for example, energy) requires careful consideration when developing calibration i.e. how are they weighted across the project and do they form part of the unitary charge upon which the initial calibration elements are based?
o Energy - the link between the technical requirement for energy efficiency and the payments to be made for use of energy should be clearly understood with both parties.
o Interim services - these need to be clearly defined. A separate services specification and rectification period may be applied, especially in refurbishment projects.
2.26 It is expected that the payment mechanism calibration model will be maintained over the operational stage of the contract. It can be used to test the results of the performance reports. It is recommended that contracts contain provisions that allow parties to review and undertake minor recalibration of output specifications on an annual basis. The calibration model will be used to assess the impact of such changes.