Contingent liabilities arise in well-designed PPP project because there are some risks that government is best placed to bear. Which risks these are should be defined throughout project structuring (see Section 3.3: Structuring PPP Projects) Box 3.6: Contingent Liabilities Under PPP Projects describes some types of contingent liability that governments may accept under PPP contracts.
| Box 3.6: Contingent Liabilities Under PPP Projects Contingent liabilities are payment commitments whose occurrence, timing and magnitude depend on some uncertain future event, outside the control of government. Contingent liabilities under PPP contracts can include: • Guarantees on particular risk variables-an agreement to compensate the private party for loss in revenue should a particular risk variable deviate from a contractually specified level. The associated risk is thereby shared between the government and the private party. For example, this could include guarantees on demand remaining above a specified level; or on exchange rates remaining within a certain range • Compensation clauses-for example, a commitment to compensate the private party for damage or loss due to certain, specified, uninsurable force majeure events • Termination payment commitments-a commitment to pay an agreed amount, should the contract be terminated due to default by the public or private party-the amount may depend on the circumstances of default • Debt guarantees or other credit enhancements-a commitment to repay part or all of the debt used to finance a project. The guarantee could cover a specific risk or event. Guarantees are used to provide more security to a lender that a loan will be repaid. For more on types of payment commitments, see Module 2 of this Reference Guide, Section 4: Public Financial Management for PPPs. The EPEC note on State Guarantees in PPPs [#82, Section 2] provides further detail on the different types of guarantees that governments may offer to PPP projects. |
Assessing the cost of contingent liabilities is more difficult than for direct liabilities, since the need for, timing, and value of payments are uncertain. Broadly speaking, there are two possible approaches, as described in the Infrastructure Australia guidance note for calculating the PSC [#14, pages 84-109]:
• Scenario analysis-scenario analysis involves making assumptions for the outcome of any events or variables that affect the value of the contingent liability, and calculating the cost given those assumptions. For example, this could include working out the cost to government in a "worst case" scenario, such as default by the private party at various points in the contract. It could also include calculating the cost of a guarantee on a particular variable-say, demand-for different levels of demand outturns
• Probabilistic analysis-an alternative approach is to use a formula to define how the variables that affect the value of the contingent liability will behave, and use a combination of mathematics and computer modeling to calculate the resultant costs. This enables analysts to estimate the distribution of possible costs, and calculate measures such as the median (most likely) cost, the mean (average) cost, and different percentiles (for example, the value within which the cost is likely to lie 90 percent of the time) However, to produce useful results it requires a lot of information on the underlying risk variables.
Scenario analysis is the simpler form of risk analysis, and gives a sense of the range of possible outcomes, but not their likelihood. In practice most governments use scenario analysis, if anything, to assess the possible cost of contingent liabilities. A probabilistic approach requires more input data, and complex statistical analysis. In practice, only a few governments have used probabilistic analysis to assess a few types of contingent liabilities.
Irwin's book on government guarantees [#161] also provides a comprehensive discussion of why and how governments accept contingent liabilities under PPP projects by providing guarantees, and how the value of these guarantees can be calculated. The following resources provide more guidance and example of how particular countries approach this problem:
• Colombia's Ministry of Finance has defined its approach to (i) assessing the financial and economic implications of contingent liabilities, (ii) accounting, budgeting and assessing the fiscal implications of contingent liabilities, and (iii) identifying, classifying, quantifying and managing contingent liabilities. This approach is set out in a presentation on "management of contingent liabilities" [#53]
• In Chile, the Ministry of Finance has developed a sophisticated model for valuing minimum revenue and exchange rate guarantees to PPPs. This valuation is updated on an on-going basis for all PPP projects, and reported in an annual report on contingent liabilities [#45]. The report includes a brief description of the techniques used in Chile to analyze and value guarantees extended to PPP projects. Irwin and Mokdad's paper on managing contingent liabilities from PPP projects [#162, Appendix 1] also describes the Chilean methodology in more detail
• Peru's Finance Ministry has also published a methodology for valuing contingent liabilities under PPPs-available on the Ministry's website section on managing contingent liabilities [#200]
Defining and publishing a methodology for valuing contingent liabilities from PPPs is only part of the solution-implementing such methodologies in practice can be demanding. Governments may need to strike a balance between building capacity in risk analysis, and adopting sufficiently straightforward and simple approaches to this assessment that can be implemented in practice.
Having estimated the cost of contingent liabilities, the government can assess whether they are affordable given fiscal constraints. For example, as described in Section 2.4.2: Controlling Aggregate Exposure to PPPs, this could include considering the implications of PPP contingent liabilities in the context of overall debt sustainability analysis, or specific limits on PPP liabilities. A few countries have introduced contingent liability funds to ring-fence and budget for these liabilities. The EPEC publication on State Guarantees in PPPs [#82] also provides a helpful overview of different approaches to managing the fiscal implications of PPP contingent liabilities.
| Key References: PPP Project Appraisal | |
| Reference | Description |
| Yescombe, E. R. (2013) Public-Private Partnerships: Principles of Policy and Finance, 2nd edition, Elsevier Science, Oxford | Chapter 5: The Public-Sector Investment Decisions describes the factors that a public authority should take into account when deciding to invest in new public infrastructure via a PPP, and how these can be assessed |
| PPP Project Appraisal Overviews | |
| Farquharson, Torres de Mästle, and Yescombe, with Encinas (2011) How to Engage with the Private Sector in Public-Private Partnerships in Emerging Markets, World Bank/PPIAF | Chapter 4: Selecting PPP Projects describes how governments can assess whether a project can and should be developed as a PPP, including considering affordability, risk allocation, value for money, and market assessments |
| European PPP Expertise Centre (2011) A Guide to Guidance: Sourcebook for PPPs (Version 2) Luxembourg | Chapter 1: Project Identification, Section 1.2: Assessment of the PPP Option describes and provides links to further references on how governments assess whether a proposed PPP is affordable, whether risks have been allocated appropriately, whether it is bankable, and will provide value for money |
| South Africa, National Treasury (2004) PPP Manual Module 4: PPP Feasibility Study, Johannesburg | Module 4: PPP Feasibility Study describes in detail the analysis required to support a business case for a PPP project. This includes needs and options analysis, project due diligence, value for money analysis, and economic valuation |
| Project Feasibility and Economic Viability Analysis | |
| Equator Principles Association Secretariat (2011) Equator Principles, Essex, UK, http://www.equator-principles.com/ | Describes the Equator Principles framework for managing the social and environmental impact of project finance investments, and provides guidance material on best practices |
| National Planning Department of Colombia (2006) Metodología general ajustada para la identificación, preparación y evaluación de proyectos de inversión, Bogotá | Pages 79-84 in the General Adjusted Methodology for the Identification, Preparation, and Evaluation of Projects provides guidelines for the Technical Feasibility Studies that should be carried out at this stage to estimate the capital, machinery, labor, materials, and other inputs required to implement the PPP project |
| Chile, Ministerio de Planificación (2006) Metodología de General de Preparación y Evaluación de Proyectos, Santiago | The General Methodology for Preparing and Evaluating Public Investment Projects provide guidance for preparing projects-identifying the problem, producing a diagnosis of the current situation, identifying possible alternatives-and evaluating projects-including cost-benefit analysis, cost-efficiency analysis |
| Perú, Ministerio de Economía y Finanzas, Pautas para la Identificación, formulación y evaluación social de proyectos de inversión pública, a nivel de perfil, Lima | The Guidelines for the Identification, Formulation, and Social Evaluation of Public Investment Projects provides guidelines for identifying public investment projects, and for carrying out detailed feasibility studies and economic viability analysis |
| Philippines, National Economic Development Authority (2005) Reference Manual on Project Development and Evaluation (Volume 1) Manila | Provides detailed guidance on feasibility and economic evaluation analysis required for all public investment projects |
| United Kingdom Her Majesty's Treasury (2011) The Green Book: Appraisal and Evaluation in Central Government, London | Provides guidance on appraisal of projects, programs and policies, by combining economic, financial, social and environmental assessments to guide analysis of the options available, along with detailed technical annexes. The Green Book is used as a guide by many other governments |
| European Commission (2009) Sourcebook 2 - Techniques & Tools: Evaluative Alternatives, Brussels | Online sourcebook covering all aspects of socio-economic evaluation as part of their Resource for the Evaluation of Socio-Economic Development. Includes sections on cost-benefit analysis and cost effectiveness analysis, in each case describing the approach, when it is used, its strengths and weaknesses, and provides a bibliography with further reading |
| Belli, Anderson, Barnum, Dixon & Tan (1998) Handbook on Economic Analysis of Investment Operations, Washington, DC: Operational Core Services Network Learning and Leadership Center | A detailed handbook, starting with an introduction to economic analysis, and going on to describe in detail how to assess economic costs and benefits. The handbook includes chapters on estimating economic benefits specific to the health, education, and transport sectors |
| Boardman, Greenberg, Vining & Weimer (2011) Cost Benefit Analysis: Concepts and Practice (4th ed.) Upper Saddle River, NJ: Prentice Hall | Comprehensive reference textbook on cost-benefit analysis issues |
| Asian Development Bank (1999) Handbook for Economic Analysis of Water Supply Projects, Manila | Provides detailed guidance on appraising water supply projects-including demand analysis and forecasting, least cost analysis, financial and economic cost-benefit analysis, and sensitivity and risk analysis |
| Hine, J. (2008) Economics of Road Investment [slides] World Bank | This presentation provides an overview of specific issues in cost-benefit analysis for road sector projects |
| Khatib, H. (2003) Economic Evaluation of Projects in the Electricity Supply Industry, Stevenage, UK: The Institution of Engineering and Technology | Chapter 7, "economic evaluation of projects" focuses on economic cost-benefit analysis. Other chapters cover financial analysis, describe how to build environmental considerations into project appraisal, and describe risk analysis |
| European Investment Bank (2005) RAILPAG: Railway Project Appraisal Guidelines. Luxembourg | Chapter 4, Financial and economic analyses. Includes guidance for the development of the financial and cost-benefit analyses and sector relevant aspects. |
| Commercial Viability Analysis | |
| Asian Development Bank (2008) PPP Handbook, Manila, Philippines | Chapter 3.5 on assessing "commercial, financial and economic" issues, includes an overview of a typical financial model of a PPP project, and how it is used to assess commercial viability |
| Farquharson, Torres de Mästle, and Yescombe, with Encinas (2011) How to Engage with the Private Sector in Public-Private Partnerships in Emerging Markets, World Bank/PPIAF | Chapter 8: Managing the Initial Interface with the Private Sector describes how to prepare and carry out a market sounding exercise |
| 4ps Public Private Partnerships Programme (2002) 4ps Guidance and Case Study, London | Provides tips and guidance on implementing market sounding , and a case study on the experience of market sounding for a hospital in the United Kingdom |
| Darrin Grimsey & Mervyn K. Lewis (2009) 'Developing a Framework for Procurement Options Analysis', in Akintoye & Beck (eds.) Policy, Finance and Management for Public-Private Partnerships, Chichester, UK: Wiley-Blackwell | Describes the advantages of market sounding and sets out a market sounding exercise for a hypothetical example hospital PPP project |
| Singapore, Ministry of Finance (2004) Public Private Partnership Handbook (Version 1) | Requires implementing agencies to conduct market sounding before pre-qualification, and describes the type of information that should be shared at this stage |
| Value for Money Analysis | |
| United Kingdom, Her Majesty's Treasury (2011) Quantitative Assessment User Guide, London; and (2011) Value for Money Quantitative Evaluation Spreadsheet, London | Provides detailed guidance and a worked example on the quantitative approach to value for money assessment-calculating the Public Sector Comparator, and comparing it to the PPP reference model, as well as an excel spreadsheet tool for carrying out the analysis |
| Darrin Grimsey & Mervyn K. Lewis (2005) Are Public Private Partnerships value for money?: Evaluating alternative approaches and comparing academic and practitioner views, Accounting Forum 29(4) 345-378 | Describes approaches to assessing value for money in PPPs, and sets out in detail the PSC approach and its pros and cons |
| Organization for Economic Cooperation and Development (2008) Public-Private Partnerships: In Pursuit of Risk Sharing and Value for Money, Paris | Chapter 3 on "the economics of Public-Private Partnership: is PPP the best alternative" describes the determinants of value for money in a PPP, and how it is typically assessed |
| World Bank (2009) Toolkit for Public Private Partnerships in Roads and Highways | Section on value for money and the PSC describes the logic behind value for money analysis, how the PSC is used, and some of its shortcomings |
| United Kingdom, Her Majesty's Treasury (2006) Value for Money Assessment Guidance, London | Describes in detail how value for money should be assessed, at three stages: assessing overall programs, particular projects, and during procurement. The guidelines take a quantitative and a qualitative approach, and include detailed checklists for the latter |
| Leigland, J. (2006) Is the public sector comparator right for developing countries? Appraising public-private projects in infrastructure. Gridlines, 4 | Summarizes common criticisms of PSC analysis, and describes whether and how using PSC analysis may make sense in developing country contexts |
| Australia, Infrastructure Australia (2008) National Public-Private Partnership Guidelines: Volume 4: Public Sector Comparator Guidance, Canberra | Provides detailed guidance on calculating the public sector comparator, and a worked example, including extracts from the excel model used |
| Colombia, Ministerio de Hacienda y Crédito Público de Colombia (2010) Nota Técnica: Comparador Público-Privado para la selección de proyectos APP, Bogotá | Introduces the PSC methodology, explains all the analytic steps, and provides a worked example |
| Chris Shugart (2006) Quantitative Methods for the Preparation, Appraisal, and Management of PPI Projects in Sub-Saharan Africa: Final Report, Gaborone, Botswana: New Partnership for Africa's Development | Describes some methodological inconsistencies and challenges with the PSC-focusing on two related issues: which is the appropriate discount rate to use when calculating present values, and how the cost of risk should be taken into account |
| Darrin Grimsey & Mervyn K. Lewis (2004) Discount debates: Rates, risk, uncertainty and value for money in PPPs, Public Infrastructure Bulletin, 1(3) 1-5 | Describes the implications of the choice of discount rate in comparing PPP and public procurement, and the relationship between discount rates and risk allocation |
| Gray, S., Hall, J., & Pollard, G. S. (2010) The Public Private Partnership Paradox, unpublished manuscript | Provides a more theoretically-driven discussion of the choice of discount rate for evaluating PPPs, compared with public procurement projects-emphasizing the difference between discounting future cash outflows and inflows |
| Australia, Partnerships Victoria (2009) Annexure 6: Frequently asked questions and common problems in Public Sector Comparator (PSC) development, Melbourne | Lists and answers common questions on when and how the PSC should be used, and some methodological questions. Also describes some common problems in developing the PSC |
| European PPP Expertise Centre (2011) The Non-Financial Benefits of PPPs: A Review of Concepts and Methodology, Luxembourg | Describes the shortcomings of standard PSC analysis, which assesses fiscal costs but does not take into account non-financial costs and benefits. Suggests an alternative approach incorporating non-financial benefits in the PSC |
| New Zealand, National Infrastructure Unit (2009) Guidance for Public Private Partnerships in New Zealand, Auckland | Chapter 5: Procurement Options sets out the logic and analysis for assessing whether procuring a project as a PPP is likely to provide value for money. This includes a simple, quantitative cost-benefit comparison of PPP and public procurement |
| Fiscal Analysis | |
| Tim Irwin (2003) Public Money for Private Infrastructure: Deciding When to Offer Guarantees, Output-Based Subsidies, and Other Fiscal Support, World Bank Working Paper No. 10 | Section 6: Comparing the Cost of Different Instruments describes how governments can assess the cost of various types of fiscal support to PPPs-including output-based grants, in-kind grants, tax breaks, capital contributions, and guarantees |
| Organization for Economic Cooperation and Development (2008) Public-Private Partnerships: In Pursuit of Risk Sharing and Value for Money, Paris | Chapter 3 on "the economics of Public-Private Partnership: is PPP the best alternative" describes how the affordability of a PPP can be assessed |
| European PPP Expertise Centre (2011) State Guarantees in PPPs: A Guide to Better Evaluation, Design, Implementation, and Management, Luxembourg | Sets out the range of state guarantees used in PPPs-encompassing finance guarantees, and contract provisions such as revenue guarantees, or termination payments. Describes why and how they are used, how their value can be assessed, and how they can be best managed |
| Australia, Infrastructure Australia (2008) National Public-Private Partnership Guidelines: Public Sector Comparator Guidance (Vol. 4) Canberra | Section 16: Identifying, allocating, and evaluating risk describes in detail different methodologies for valuing risk (and contingent liabilities) in PPPs |
| Tim Irwin (2007) Government Guarantees: Allocating and Valuing Risk in Privately Financed Infrastructure Projects, World Bank | Comprehensively describes why and how governments accept contingent liabilities under PPP projects by providing guarantees. Describes in detail how the value of these guarantees can be calculated, with examples |
| Colombia, Ministerio de Hacienda y Crédito Público (2005) Pasivos Contingentes, Bogotá | Presentation by the Ministry of Finance of Colombia on the conceptual and legal frameworks, and methodologies used in Colombia for managing contingent liabilities |
| Chile, Ministerio de Hacienda (2010) Informe de Pasivos Contingentes 2010, Santiago | Describes the conceptual framework for assessing contingent liabilities and the government's contingent liability exposure. This includes quantitative information (maximum value and expected cost) on government guarantees to PPP projects (concessions) |
| Tim Irwin & Tanya Mokdad (2010) Managing Contingent Liabilities in Public-Private Partnerships: Practice in Australia, Chile, and South Africa, World Bank | Describes the approach in the State of Victoria, Australia, Chile, and South Africa, to approvals analysis, and reporting of contingent liabilities under PPPs. Appendix 1 describes in detail the methodology used in Chile to value revenue and exchange rate guarantees |
| Perú, Ministerio de Economía y Finanzas, Pasivos Contingentes, Lima | Presents a methodology, results, and background reports on the value of contingent liabilities under PPP projects in Peru |