Finally, the regulator can apply economic and financial models as a basis for decision-making. The objective of these models is to quantify, in a transparent manner, the impact of the regulatory decisions adopted.111 They are basically "improved" financial models designed to provide a rigorous analytical tool which allows regulators to deal uniformly with the respective forecasts. They calculate the internal rate of return (the same as a financial model), and for that purpose they take into account all the contractual restrictions imposed on the operators, the economic behavior of the agents involved and, also, they allow the regulator to analyze the social aspects of the service provision. They also allow the simulation of the consequences that would result from changes in the policies or behaviors, for the different players (users, operators, government). The governance advantage of using such kind of models is that the PPP partners can predict ex ante the behavior of the regulator, increasing trust between both sides and a sense of fairness and transparency.
Regardless of the degree of detail that these model show, they all follow a similar structure. They are built from an initial database (that summarizes the physical and financial performance of the firm, and which includes most of the accounting information frequently gathered by the operator), an identification of the regulatory instruments (for example, tariff structure, service quality levels, timing and type of investment, etc.) and some economic parameters (such as demographic characteristics of the operation area, economic indicators that define demand, efficiency levels, etc.)
Then, these models are based on explicit determinations about the expected impact resulting from the reaction of the main players (users and operators) to regulatory instruments. This is accomplished through the explicit modeling of the functional relationships (behavior functions) existing between the consumption level and the instruments. The determination of these reactions defines the financial equilibrium of the operator.
A particular form of economic financial model used in PPPs is the Public Sector Comparator112 (PSC). Victoria Partnership defines it in the following terms: "The PSC estimates the hypothetical risk-adjusted cost if a project were to be financed, owned and implemented by government. The PSC is developed in accordance with the required output specification; the proposed risk allocation reflected in the contract released with the Project Brief, and is based on the most efficient form and means of government delivery."113
It is worth mentioning that even the best regulatory models are necessarily simplifications of the interactions that they represent. The quality of the model depends on the soundness of the assumptions. In turn, the robustness of these assumptions depends on the quality of the available information. It is essential that these models be based on a solid process of information gathering about each of the key decision-making indicators.
This is why in recent years in the UK the use of the PSC has evolved focusing on the efficient use of available databases for cost estimations and more simple in house developed models.
Eventually, the permanent application of all these instruments results in the reduction of the information asymmetry inherent to the regulatory process, the formation of a solid database as well as agiler and more reliable regulatory processes.
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111 For a further discussion, see Estache, Antonio, Rodriguez Pardina, Martin A., Sember, German and Rodríguez, José María, "An Introduction to Financial and Economic Modeling for Utility Regulators" (March 2003). World Bank Policy Research Working Paper No. 3001.
112 The use and the critics and problems associated to the PSC are discussed in Annex P
113 PSC a Technical Note - Partnership Victoria