By Chongo Sombo Mulenga (MCIArb)
APMG International’s PPP Guide distinguishes the concepts of financing and funding. Under the guide, financing pertains to the up – front capital required to meet the costs of constructing infrastructure. The primary sources of financing for traditionally procured infrastructure are treasury surpluses or public borrowing. As PPPs are notoriously recognized as an avenue for private sector involvement in the development of public infrastructure, debt and equity are the main sources of financing for privately financed infrastructure projects.
Funding within the context of PPPs refers to the source of money required to meet payment obligations (such as debt service obligations as well as operation and maintenance costs) and provide the private partner with a satisfactory return on its investment. In order to appreciate the sources of funding in PPPs, it is cardinal to
note that while financing is required for the development or construction of infrastructure, funding is generally a post – construction concept as it pertains to operational infrastructure.
On this understanding, the funding or payment mechanisms of PPPs are generally categorized as “User – Pays” or “Government – Pays”. In User – Pays PPPs, funding is sourced from user fees charged by the private entity for the use of the project infrastructure whereas in Government – Pays PPPs, funding is typically sourced from taxes and other public revenue streams.
Payment Mechanisms
The concept of payment mechanisms sets PPP projects apart from traditionally procured infrastructure projects and the choice between the Government – Pays mechanism and the User – Pays mechanism, or possibly even a hybrid of the two, is largely dependent upon the functions of the private party as well as the overall structure and specifics of the project. However, in any instance, the private party’s remuneration is dependent upon performance of contractual obligations as service delivery is the bedrock of PPP arrangements.
User Pays
PPPs that are solely funded by user charges are known as User-Pays PPPs. Under the User – Pays payment mechanism, the private entity generates revenue by collecting fees from users of the project infrastructure for the services provided through such infrastructure. Illustratively, this payment mechanism is common in PPPs for the development of road infrastructure whereby road users are charged toll fees for utilizing roads constructed or rehabilitated by the private party. It is through the collection of tolls fees over the tenure of the concession, which generally averages around 20 to 30 years, that the private party is able to make a return on its investment.
Many governments tend to be swayed towards User – Pays PPPs on account of the neutral budgetary effects of these projects. Beyond this, it is believed that User – Pays PPPs yield social benefits that accrue to the general populace without limitation to the actual users of project infrastructure. PPPs have great propensity to encourage and facilitate economic activity in surrounding areas and subsequently enhance the value of real estate in those regions. As property values rise, there might be a need for upward adjustments in property taxes, resulting in increased revenue for the government. This additional revenue can be channeled towards financing public initiatives and investments, benefiting the broader population beyond just the users of the project infrastructure.
Government Pays
Under this payment mechanism, the government is the only source of revenue for the private party to recoup its investment along with returns thereon. Government – Pays PPPs are very common in sectors in which public policy directs service delivery without user charges. Social infrastructure projects such as prisons, hospitals and schools are often anchored on the Government – Pays payment mechanism. This mechanism effectively allocates demand risk to the public sector, ensuring that the private entity’s revenue remains unaffected by fluctuations in demand for the public infrastructure or social service, irrespective of whether user fees are collected by the public authority.
Generally, payments from the government are dependent upon the availability of the asset or services in accordance with contractually agreed terms. In PPP arrangements whose revenue regime is premised on government payments, the importance of linking remuneration to performance cannot be overemphasized. The
private entity is incentivized to satisfy performance requirements by increasing its remuneration as it nears optimum performance levels. Conversely, penalties for poor performance, such as termination, serve as a deterrent. Ultimately, the agreement should be fashioned in a manner that makes it more beneficial for the private party to
excel in the performance of its obligations rather than risk termination of the project on account of underperformance.
Hybrid Payment Mechanism
There is a third payment mechanism which is essentially a blend of the User – Pays and Government – Pays mechanisms. A classic example of the application of the hybrid payment mechanism is with regard to economic infrastructure such as roads without tolls. Typically, the hybrid payment mechanism comes into play in
circumstances where:
-User-generated revenues are insufficient to ensure the project’s financial viability; and/or
-The project’s financial structure is highly sensitive to demand and price fluctuations.
In this model, the government may intervene by providing direct financial support to the project company in order to ensure commercial feasibility of the PPP project. The public sector may provide grants to the private party during the construction phase of the project, termed as “co – financing”. Alternatively, during the operational phase, the public sector may make supplemental payments to the private entity in order to lower the cost for users.
Conclusion
The User Pays payment mechanism seemingly feeds the narrative that PPPs facilitate infrastructure development and social service delivery without imposing costs on the public sector. However, this perception is rebutted by the Government Pays and Hybrid payment mechanisms which recognize that the need for infrastructure development and social service delivery may not always generate private sector appetite from a purely commercial standpoint. In such cases, the public sector might need to take up financial responsibility in order to encourage private sector participation and enhance the commercial viability of projects. This demonstrates that while PPPs aim for private sector engagement, there are instances where public investment becomes crucial to ensure the success and
viability of these initiatives.
Resources
-https://ppp-certification.com/ppp-certification-guide/7-how-private-finance-ppp-project-financed-where-money-pay-construction#_ftn72
-https://ppp-certification.com/ppp-certification-guide/51-revenue-regime-and-payment-mechanism
-https://ppp.worldbank.org/public-private-partnership/ppp-contract-types-and-terminology
-https://investmentpolicy.unctad.org/pages/27/what-are-ppps
DISCLAIMER: Any views or opinions expressed in this article belong solely to the author and do not represent those of people, institutions or organizations that the author may or may not be associated with in a professional or personal capacity, unless explicitly stated. Any views or opinions are not intended to malign any religion, ethnic group, club, organization, company or individual. All content provided in this article is for informational purposes only and is not intended as a substitute for professional advice. Therefore, while the author strives to ensure that the information in this article is complete and accurate, the author assumes no responsibility for any errors or inaccuracies. All liability with respect to actions taken or not taken on the premise of this article are hereby expressly
disclaimed.
Any image(s) used in connection with this article are not the property of the author and may be subject to copyrights held by the originator.
