Reforming PPP in Infrastructure. Lessons from Chilean Experience

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Solomon Parrish
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1 Reforming PPP in Infrastructure Lessons from Chilean Experience

2 Index: I. Advantages of long term contracts for Public Works Concession II. Contract Renegotiation III. Problems with Public Works Concession IV. Water and Sewage Sector V. Port sector VI. What Explain High Incidence of renegotiation VII Institutional Reform VIII Conclusions

3 I. Advantages of long term Concessions Concessions with user charges Facilitate and create flexibility for the development of projects where users have willingness to pay for services; Allows increasing investment in infrastructure and releasing public funds for social needs when net additional resources are brought to the sector and it is possible to apply only with this mechanism of financing; Rationalize the use of infrastructure promoting efficient user charges; Create market discipline if allocation of risks are properly designed (commercial risks should be born by the firms). Reduce natural monopoly costs and information monopoly creating competition for the right to provide the services;

4 I. Advantages of Public Works Concessions and Concessions with differed payments by the government Facilitate establishing specific level of service standards that can be easily monitored; Allows addressing anti maintenance bias of Public Work Ministries; Allows technology modernization through FDI; Foster Public sector modernization focusing the role of the state (Increase labor productivity. Improvement of service efficiency in ports, airports, hospitals, prisons);. Facilitate the trade off between investment and operational cost; Create incentives for capital market reform;

5 II. Renegotiation of Contract and Arbitration amendments ( ) Amount % of Add % of Cost Original I. Investm Overrun Original Investment % 16,5% Additional Invest 2800 Cost Overrun 1420 Additional Expendit 1380 Total Expenditure % Defined by: Arbitration 231 9,2% Conciliation 220 6,9% Mutual Agreement ,9%

6 III. Problems in the Implementation of Long Term Concessions Subsidies committed for future years are not counted as public debt. Political pressure to speed up investment end up with poorly prepared projects, significant environmental and social conflicts and huge cost overrun, which are used by private participant for very high claims;. Minimum traffic guarantees have reduced market discipline. High hold up risk, encourage force renegotiation and eventually rent seeking, Renegotiation lends the possibility of channeling significant future subsidies surpassing budget constrains (70% transferred to next government.) Ambiguity on concessionaires compensations rights for unforeseen events (reestablishment of economic equilibrium). Lack of monitoring of service commitments

7 III. Problems in the Implementation of Long Term Concessions Dispute resolution schemes have generated excessive litigation, with a bias in favor of Concessionaires. Extensive renegotiation increases cost overruns, and affect the incentives in bidding processes( bid low and you will manage to rearrange the contract down the road). Adverse selection effect on quality of future bidders. Private initiative prone to rent seeking and inefficiency. Also information asymmetries affect process and increases cost. Current fiscal accounting of PPP generates bias in choosing investment mechanism. Tendency to build white elephants, and structuring non competitive bidding, forcing the merger of construction with operation. Inappropriate award schemes. (Least Present Value as an exception)

8 IV. Water, Sewage and Waste water treatment Privatization Experience In 1997 approval of private participation. Hybrid approach initially British model of full privatization of regional companies with limits to horizontal integration( yardstick comp). Latter long term contracts with price cap regulation base on model of efficient company. Transfer of ownership or full management of water rights. Extension in coverage in water treatment from 9% in 1997 to 95% in Further increase in productivity, and efficiency and water and sewage coverage. Problems with extension of services outside area of concession. Still need to tighten price cap regulation to transfer benefit to consumers of higher productivity. Need to improve regulation (expert committee for dispute resolution, information requirement, obligation of expansion outside area of concession) Not clear if medium term consessions(10-15 years) with end value of assets could have been better. Strong Monopoly of Information. End point problem (Intangible and physical assets)

9 V. Ports Single Operator Concessions Experience Breaking of national State port company in city port authorities. Concession of Single operators berth inside public ports with limits to vertical and horizontal integration Investment developed, technological improvement, huge increase in transfer speed, significant improvement in productivity. Bidding process establishes price caps. Competition among ports and operators in each macro zone Strong lobby against limitation to vertical and horizontal integration Government will call for bids for new container terminals, keeping restrictions to vertical and horizontal integration key factor for new jump in efficiency.

10 V. What explain the high incidence of renegotiation in public works Concessions Common practice in public works Adverse selection: companies that bid low and adjust payment after allocation. High hold up risk Poorly prepared projects Incentives for increasing investment outside the budget and cost benefit analysis framework. Ambiguity regarding responsibilities for unforeseen events create incentives for litigation Dispute resolution equity arbitration promote litigation High risk of collusion on conciliation schemes Lack of Transparency and check and balances on contract adjustment. In Water, Port and airport sector little litigation and renegotiation. What they have in common.? Check and balances and transparency

11 VI. Institutional Reform: the way forward Get financial implication right. Investment done committing the payment of future subsidies is equal to government debt. Cost benefit analysis is as important as in public Investment (Private Initiatives creates significant pressure.) Create a Policy board with independent experts and government Ministers for: defining policies on concessions, specific concession project and contract approval. Create a Technical semi autonomous Agency for Advising State institutions granting concessions (decentralization of capacity for granting concessions, avoid the single agency approach) Check and balance between Agency, board and granting State institution.

12 VI. Institutional Reform: the way forward Focus on performance base contracts Create an independent regulator for overseen and enforcement of contracts with focus on fulfilling explicit commitments in terms of quality of services and technical standards. The independent regulator also assess fulfillment of contract renegotiation clause for additional works. Create a permanent independent Dispute Board for pre judicial dispute resolution mechanism as a means of conciliation. Change to arbitration criteria ruling according with law, bidding documents and contract. Avoid equity arbitration. Strengthen mechanism for choosing arbitration tribunal.

13 VII. New Rules for reducing Opportunism, renegotiation and risk of hold up Initiation of concession with right of way secured Legal assurance of compensation only when the principal(state) changes factors affecting directly the project which were unforeseen at the time of handing in the proposal. Harmonization of complex projects through prequalification. Reduce the procedure and time for solving cases of serious non compliance. Limits to the possibility of stopping construction through legal resources..

14 VII. New Rules for reducing Opportunism, renegotiation and risk of hold up Renegotiation rules within the law. Force bidding of construction for new projects when in operation. Limits to new works during investment phase Call option with compensation during construction if there are significant changes in projects. Call option in the last 40% of the concession with full compensation. Mandatory preparation of environmental assessment by State.

15 VIII. Overall Conclusions of PPP in Infrastructure Whenever competition have been promoted the results has been significantly improved (face to face or for the field ). Level Playing field critical for innovation and keeping transparency and low cost. Reduce renegotiation in long term contracts by establishing rules in the law and check and balance by independent regulatory Agency. Separate granting agency from central advisory unit linked to Finance. Modified arbitration procedure to a two stage process. Focus on performance based contracts Eliminate ambiguity of unforeseen events adjustments Force LPV schemes whenever demand is inelastic to quality of service. A new agenda for reform is needed to promote competition, reduce regulatory capture, enhance accountability, check and balances and transparency. Significant increases in Efficiency and a level playing field could emerge from new wave of reform

Contract Renegotiation: Chilean Case David Duarte Arancibia Budget Office Ministry of Finance of Chile Paris, France March,

Contract Renegotiation: Chilean Case David Duarte Arancibia Budget Office Ministry of Finance of Chile dduarte@dipres.gov.cl Paris, France March, 2009 Agenda Chilean PPP System Current regulation Some