Australian governments have encouraged PPP bids from consortia that can provide the complete package of services required for the project, including financing, construction, maintenance and operations or service provision. In doing so, governments are not able to cherry-pick the best components from competing bids. The bidder that offers the best service solution may be rejected in favour of another bidder who offers the best overall value for money because it has a cheaper financing solution.
It is possible government could achieve better value for money by unbundling the PPP, and separately tendering one or more of the construction, maintenance or financing packages after it has appointed its preferred private sector partner for the project. Unbundling would also be welcomed by contractors, as it would avoid the need for them to form themselves into consortia before they can bid for the package of works they are interested in.
However, unbundling a PPP is not without its own difficulties. For instance, it requires government to accept interface risk between the various packages. Moreover, if the owners and service providers are appointed ahead of the lenders, the rigour which the lenders bring to the assessment of project risks does not occur until after the owners and service providers have been appointed. The lenders may identify risks which have been inadequately assessed or allocated, resulting in the reopening of proposed commercial terms.
Perhaps this risk could be addressed by requiring a portion of the debt to be fully underwritten at the time the owners are appointed, with a separate debt funding competition for the balance of the debt to follow. But the underwriting financiers would need to be recompensed for their additional effort. Lack of debt financier engagement during the bid development phase has been one downside of separate debt funding competitions in the UK.
Similarly, proposals to have an equity funding competition after the appointment of a preferred bidder will discourage equity investors from incurring the expense of developing a proposal to that point, as the return they receive through a forced sale of a portion of the equity may not provide an adequate return on the bid development costs which they have risked.
For many potential PPPs, the downsides of separately tendering the construction, maintenance or financing packages will often outweigh the potential advantages. But there could be other reasons that justify a more unbundled approach, such as the need for greater flexibility during the operation phase.
One area where we have seen unbundling on recent Australian PPP projects is in the construction works, with packages of construction work which might otherwise have been included in the PPP have instead been delivered under separate publicly funded contracts. Recent examples include:
• the Sydney Metro Northwest, where the design and construction of the tunnel and underground station boxes was let under one contract; the design and construction of the viaduct and above ground station platforms was let under a second contract; and the design and construction of the trains, rail systems, station fit-out and the operation and maintenance of the entire system was let as a PPP under a third contract;
• the Melbourne Metro, where:
- the tunnelling work, underground stations, station fit-out, mechanical and electrical systems and specific operations and maintenance services for this infrastructure are being delivered under an availability based PPP;
- the works at the eastern and western portals will be performed under a second alliance contract; and
- the rail systems will be designed, installed and commissioned under a third alliance contract.
The advantages of separating works into separate contracts include:
• construction can commence more quickly: by separating certain civil works from the PPP works, government can award contracts and commence construction activities earlier than would have be the case if all works are included in a single PPP contract;
• better value for money: separating risky work from the less risky work, and delivering the risky work under an alliance contract, can deliver a better value for money outcome for government by avoiding the need for pricing contingencies in respect of risks that may or may not occur;
• more operator focussed PPP consortia: the high value of design and construction works, relative to the value of the operation and maintenance activities, in a PPP contract often results in the D&C contractors having significant influence within bidding consortia. Removing significant civil works from a PPP contract can help to even things up, resulting in bidding consortia that are more operations focussed, which is often what government is seeking; and
• market capacity: by publicly funding the design and construction of certain works, the value of the works that need to be privately financed can be reduced. This can be an important consideration if the overall project value would otherwise be such that the finance market might not have sufficient capacity to fully underwrite finance for, say, 3 separate bids.
However, this approach also creates risks that need to be carefully managed. In particular:
• caps on liability: contractors will typically cap their liability under a contract by reference to the contract price. If the value of the works under a particular contract is quite small relative to the value of the project as a whole, the maximum potential liability of the contractor for late or defective performance of works that are critical to the overall success of the project might not be sufficient to make any privately financed components of the project 'bankable'. It was for this reason that TfNSW needed to accept liability to its Sydney Metro Northwest PPP contractor for late or defective work by TfNSW's tunnelling or viaduct contractors;
• interface risk: it creates interface risks that government needs to manage. For example, if an asset is designed and constructed by one contractor, but then operated and maintained by another, the operator/maintainer will want warranties in relation to the design and construction of the asset. While it may be possible for government to transfer to the operator/maintainer the warranties given by the D&C contractor, it will often be necessary for the government to accept liability to the operator/maintainer for any defects in the work performed by the D&C contractor;
• design development risk: the design for the separate works will often not be finalised at the time the PPP contract is awarded. The separate contractor will usually be entitled to make changes to the design as it is developed, so long as the design still meets the performance requirements for the relevant works. These permitted design changes can, however, have a significant impact of the costs at the PPP contractor will incur in fulfilling its obligations with respect to the PPP works.