When the concept of Public/Private Partnerships (P3) first seriously emerged on the Ontario landscape during the early 1990s, it was viewed as a way to leverage private sector capital for otherwise unaffordable initiatives. Some 10 to 15 years later, the Ontario government again faces deficits, but now the pent-up demands for infrastructure and service improvements are overwhelming. Once again, partnerships are being touted for their potential — and with an additional decade of experience to draw on, that potential has been increasingly validated. In the U.K., mainland Europe, Australia, New Zealand and many other jurisdictions, public/private partnerships are used in virtually every sector. Consequently, a significant body of knowledge is now available for Canadian governments to draw upon.

One of the U.K.’s leading experts on the subject is Deloitte partner Frank Wilson, who chairs the firm’s Global Public Sector Group and leads the local and regional Consulting practice in the U.K. The following is an excerpt of a conversation between a member of Deloitte’s Canadian Public Sector practice and Frank Wilson.

Frank, could you describe the nature of partnership activities in the U.K.?
Frank Wilson: There are two kinds of government-initiated partnership programs in the U.K.: the Private Finance Initiative (PFI) that pertains to the finance and development of capital or infrastructure projects, and Public/Private Partnerships (P3), which are service related or what historically has been referred to as “service outsourcing.” Of the two, PFI is more firmly entrenched in the U.K., where literally hundreds of projects have now been undertaken across government, totaling in excess of £52 billion. PFI was initiated by the previous Conservative administration, and when the Blair Labour Government was elected, it saw the advantages and extended the program. So the PFI program in the U.K. has become  “politically neutral.”

What kinds of projects are being financed by PFI?
Wilson: There are a wide variety of capital infrastructure projects. Mainstream government departments are the biggest PFI users in the U.K. — the Department of Social Security undertook a single PFI transaction approaching £2 billion. The Ministry of Defense has built helicopter and frigate fleets, tanks, and barracks using this approach. There also is a lot of activity in higher education — the building of universities, colleges and student accommodation. Another major segment is local and regional government, where the projects are across the spectrum: new schools, social care facilities for the elderly, roads, street lighting and waste disposal.

We increasingly are seeing PFI projects on a large scale. In the early days, for instance, we were doing stand-alone primary schools, and these were very ineffective in terms of cost. Now, the projects tend to be very large indeed, between 10 and 30 schools at once, or a combination of schools, libraries and community facilities at multiple locations as part of one contracting process. So the size and complexity of PFI projects has grown considerably over the past decade.

Is there a central approval process for these projects?
Wilson: In local government, an amount of funding is allocated each year to support PFI-credited projects. These credits are awarded through a competitive process between local governments, the result of which is a commitment of central government funding in support of their infrastructure initiative. This process provides an incentive for local governments to bring forward PFI-type projects to qualify for the available government funding for these public/private ventures.

At higher levels of government, any public sector organization looking to invest in projects of a sizeable nature must test viable options for funding it. Therefore, the PFI approach must always be compared with a traditional procurement models to determine prospective cost savings, and an outline business case must be submitted to government for approval.

What is driving this level of public/private activity? Why has private involvement in public service financing and delivery been so well accepted in the U.K.?
Wilson: It’s been largely a question of necessity. Successive governments have not provided the public funding necessary to refurbish or replace public assets. PFIs have enabled schools and roads to be repaired or replaced and hospitals to be upgraded and built. The public focus is on results, not on the method.

Our participation in the European Union has also been a major consideration; in particular because of the EU’s stipulations around public sector borrowing limits. Now we have the magic wand to put these projects off balance sheet, and manage the cost over 25 years. From an accounting practice and management perspective PFIs have also helped the public sector take a “whole life cost” approach in planning and developing new infrastructure.

Another driver is the opportunity to improve government efficiency by bringing private sector skills in design, construction, facilities management and contract management to bear on a public sector in need of innovation in these areas. Recent U.K. studies have shown that where the public sector procures such projects in a traditional manner, the propensity for time and cost overruns is significantly greater than when the private sector provides the solution.

Finally, there is the issue of “PFI credits” at the local government level that motivate municipal leaders to find projects that fit the allocation criteria for central government financing.

With respect to P3s, how are multi-vendor projects managed?
Wilson: This is a relatively new, innovative approach to traditional service outsourcing. For example, a government may be looking to bundle eight required services individually. In the “bundled” P3 approach, the preferred bid might only score highest on five of the eight. Their competitors may be better on the remaining three, but the consortium offering the best value on most of the requested service areas will be the winner. The public sector client needs to recognize, therefore, that it may not be procuring the best individual solution, rather the one that results in the best “overall“ deal.

What are the lessons from bundling services in a P3 context?
Wilson: We have learned that government ought not to bundle and outsource only those services that are poor performers, because there’s insufficient margin for the private sector to (a) make a profit or (b) do it for less cost than government already is doing it. Alternatively, outsourcing only high-performing services reduces the incentive for private sector to enter the competitive process.

The solution is to create an appropriate risk-reward balance for the private sector, based on service indicators or benchmarks to be achieved over a set period. Where the private provider has bettered the set standards, many P3 service arrangements in the U.K. also include a formula for profit sharing. Some of these P3s form joint ventures to provide services to other parties and share the profits earned.

Are governments looking for synergies in multi-service bidding?
Wilson: Now that’s an area where the U.K. market is particularly advanced.  In the case of service consortia — which may include everything from the provision of technology services to tax collection to human resource management to food services — the government avoids pre-determining the synergies, because there are no longer separate contracts to manage. With one omnibus contract, the consortium and its general contractor are left to figure out the internal economies. And with the market for P3s growing and becoming more sophisticated, the consortia tend to be stable and bid on multiple projects, so they have worked out their internal arrangements.

When the private sector takes over services, how are staff transfers normally handled? What happens to the existing agreements?
Wilson: In Europe we have legislation that specifies transfer obligations for new and existing labour. When a P3 or an outsourcing contract takes place, the provider has to take on board the existing public-sector employees on the same terms and conditions as in their pre-existing contracts. Rights of continued employment need to be maintained throughout the duration of the contract for pre-existing staff. The same terms and conditions are applicable even to new employees, and include pension obligations.

What is the normal duration of these service contracts?
Wilson: About 10 years. They will have what we call market testing after five years to make sure the rates are appropriate relative to market conditions. At that time, the contracting entity generally retains the right to re-tender, and adjustments can be made to the existing arrangement.

And in the case of the PFI agreements, what happens at the end of those contracts?
Wilson: At the end, the assets are handed back over to the public sector client, debt free and in a condition suitable for continued use, as per the contract. Or there may be an option to extend the arrangement for an additional five or 10 years.

How does government make sure that infrastructure is maintained during the life of the contract, especially in the final years?
Wilson: There are tight specifications from the project outset. If the private sector starts cutting corners, there are holdback provisions in the monthly payment mechanism plus additional remedial provisions, up to and including rights of termination.

Is there any standardizing in the way governments draft these agreements?
Wilson: Absolutely. If we’re doing our 20th project of the same type, it would be foolish to start with a blank piece of paper. A lot of institutional knowledge has been built up, and governments attempt to leverage off it. Basically, you take the most recent contract and adapt it to fit current circumstances to the extent possible.

A common perception in Canada is that the private sector often out-negotiates the public sector in partnership transactions, which raises public suspicion around these types of arrangements. Has this been an issue in the U.K.?
Wilson: Absolutely. And that’s also why the public sector needs private financial, project management, and technical advice in partnership or outsourcing projects. I had an experience last year with a PPP client who was a local government chief executive. He and his team were in a hurry to close a transaction by their year-end. We advised our client that their private partner’s forecasted rate of return was excessive under the circumstances, the result of which was a found saving of £8 million benefitting our client.

Based on the U.K. experience, how do you think partnership activities can be advanced in Canada?
Wilson: First and foremost, the advantages to government need to be clearly spelled out. The great promise in PFI/P3 projects lies in combining the policy and stakeholder management skills of the public sector with the talent for innovation, construction, design, operations and management of the private sector.

Second, there needs to be a shared understanding that the assets developed through a partnership process will have an extended life compared to traditional government procurement process. PFI-type arrangements contractually ensure that assets are functional, maintained and are paid for over the 25-year term of their agreement.

Third, it needs to be recognized that partnerships also stimulate the private sector economy with activity that may not otherwise have occurred. From the private sector’s point of view, the big benefit is the significant impact on their balance sheet, since they end up with projects that have 25-year cash flows and are backed by the public purse.

Finally, and perhaps most importantly, governments, by virtue of contractual commitments to private partners, are forced to be disciplined and make long-term commitments to lifecycle maintenance. This is an obligation the public sector has historically been unable to define and abide by, and which has led to the current poor state of public infrastructure in many countries.

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