(a)        Availability or Demand     

Accommodation projects often apply to government-provided services that do not generate any income or relate to subsidised services that would not pay for the accommodation cost, e.g. state-run schools and hospitals, buildings for government departments, police, army, etc. A few projects do generate income and take demand risk: e.g. student accommodation projects in developed markets.

In an emerging market context, if the project is to be paid through subsidies/availability payments, the government party needs to be able to assure the concessionaire that it will be able to stand behind the payments due. A central government letter of support or guarantee may be required, or else the project may need to bear the cost of a suitable political risk insurance / non-payment guarantee.

(b)        Output Specification and Payment Mechanism    

Assuming performance is measured on availability, what is being measured? How much of the specification is based on outputs (e.g. desired functional outcomes such as safety, temperature, availability of systems) as opposed to inputs (e.g. requirements to deliver specific services). How is the availability payment calculated, and how much of it is at risk? How is performance monitored and how are deductions levied? How subjective are the requirements and is there a risk of abuse?

If the project is not subject to demand risk, then the government must take a closer look at the project outputs to ensure that it receives value for money for the availability fee paid. Payment mechanisms can become complex, but the government should always bear in mind that these mechanisms need to be operable by the end users. This may be a new discipline for some public servants (such as school estates managers) and it will be necessary for the contract managers to be given adequate training to explain how a PPP contract is intended to work, and what tools are available within the contract framework to measure performance. Ideally the contract requirements should be as objective as possible, but this is not always achievable and a level of subjectivity may be present. Where the government party has control of monthly payments, it may be very easy in practical terms to withhold payment until such time as the government is satisfied that proper performance is provided, but since cashflow is critical for thinly-capitalised concessionaires, we have seen this unilateral right of withholding be subject to abuse, for commercially driven reasons.

(c)        Interface with users/visitors/vandalism

To what extent can performance be affected by interaction with facility users and visitors? How open to the public is the facility? To what extent should the risk of damage and interference be shared between the concessionaire and government? How does this interface with project insurances?

User damage is a perennial risk in some accommodation contracts. Schools, in particular, have a reputation for being subject to accidental damage risk during the day and vandalism risk out of hours, when out of use. A practical mitigant to vandalism risk is to keep the buildings occupied at more times, for example by encouraging out-of-hours use for social clubs, which can also generate a source of revenue.

(d)        Risk of termination / Compensation on termination

What level of poor performance merits a default termination of the project? Can this be measured objectively? How should the concessionaire be compensated on a default termination?

Where there are detailed performance mechanisms with penalties attached, it is typical for the concession agreement to provide that these mechanisms will be the sole remedy of the government for damages for poor performance. This ensures that the parties are rigorous when setting the performance mechanism and avoids a double jeopardy risk, whereby the government may be tempted to ignore the penalty regime and sue for general damages. Where this mechanism applies, it would be appropriate to use a suitable threshold of deductions incurred as a trigger for termination (e.g. 25% of payment lost to deductions over a three month period), because this type of trigger is objective and easily understood by both parties.

On a default termination, the shareholders can expect to lose their equity; lenders will wish to receive their outstanding senior debt, but on many projects this may not be guaranteed.

(e)        Management of services costs     

What services are being provided under the project? A distinction is often made between “hard service” costs (maintenance and renewal) vs “soft service” costs (cleaning, catering, grounds maintenance, security); the latter are more exposed to changes in labour rates. How can this risk be managed efficiently over the project term?

Labour rates have often been seen as more volatile, so a simple CPI inflation ratchet in the payment provisions may not be sufficient to cover the risk of increased staff payments. In some projects this risk is shared by requiring the concessionaire to benchmark any proposed cost increases against other projects in the market, or if necessary conduct a full market testing exercise to establish the prevailing cost. This leaves the government party exposed to price increases, but avoids the needs for the private sector to price for this risk.

(f)         Design review      

How much design detail is ready at bid selection phase? How can the government ensure that it has adequate control over the finalisation of the design to meet functional requirements and/or aesthetic requirements? Can the concessionaire proceed at risk if disputes arise on design adequacy?

A design review procedure is commonly adopted – the concessionaire submits its detailed design as it is developed during the project and the government checks it is compatible with the end-user requirements. This is particularly useful for projects with a high level of interaction with the government staff, such as hospitals and schools, and where operational efficiency will be key. That said, the concessionaire will likely have a tight construction programme, so any delay in receipt of approval to proceed (whether because of a dispute or otherwise) may create severe difficulties. For this reason concessionaires commonly request a right to proceed at risk pending resolution of the dispute (and for the dispute itself to be referred to a fast track dispute resolution procedure).

(g)        Employee/ Pension issues

Does the service involve the transfer of existing staff? Are the staff unionised and/or do they have expectations of certain conditions as government staff? Is there a concern about creating a “two-tier” workforce for the same services? Are pension contributions properly funded at transfer?

Accommodation projects typically involve transfer of existing staff from government employment. Since they may continue to have the benefit of government terms and conditions (as negotiated by public sector employee unions), there may be a political sensitivity if the workers still feel part of the original public sector provision, and the concessionaire has freedom to diverge from the original terms and conditions. The unions may want to avoid a “two-tier” public sector workforce arising; the risk for the concessionaire with a “single-tier” workforce is that the unions may negotiate a pay increase on the non-concessioned projects and create an expectation that the concessionaire’s transferred employees should have an increase as well. This may not be allowed for in the concessionaire’s financial model.

(h)        Energy use           

Power will be a major component of project operating costs. How will the project allocate energy consumption and tariff risk between the parties?

Typically the concessionaire would take consumption risk – based on the anticipated energy use for the buildings calculated at design stage – whereas the government party would take tariff risk. Some adjustments may be necessary over time if usage changes materially within the buildings, for reasons beyond the concessionaire’s control.

(i)         Commercial use   

To what extent can the facilities also be used for commercial purposes? To what extent is it fair to have this revenue cross-subsidise the service fee and if so how should it be shared?

As mentioned above, out-of-hours usage of facilities – such as in schools – can be a useful way of generating additional revenue while also performing a useful social function. In some projects, the concessionaire is asked to bid a level of minimum income it expects to make and this will be netted off the availability fee for the benefit of the government. Typically any excess income will then be subject to a sharing mechanism with the government, e.g. 50:50, after any necessary costs of opening/closing/cleaning have been covered.

(j)         Refinancing

To what extent has the government shared in interest rate risk through the setting of the availability payment? What happens when interest rates can be improved, how will the benefits be shared?

Since the government will wish to have a fixed availability fee, it may be necessary for the concessionaire to ensure that its lenders obtain a suitable interest rate swap to ensure that the financing costs are stable enough to be covered by a fixed fee from the government. Since the swap price will usually not be known until the moment of financial close, it has been common for government parties to share in the risk that the swap price diverges from the rate assumed at bid submission (otherwise the project may be unbankable for the concessionaire). If this is the case, it would be reasonable for the government party to share in some of the upside if the project can be refinanced at a cheaper rate. Many projects therefore contain a provision that requires the concessionaire to notify the government whenever a refinancing occurs, or any material change to the financing documents that generates an equity upside. It is common for 50% of the upside to be required to be shared with government.