RENEGOTIATION OF PPP CONTRACTS: Evidence, Typology and Tendencies Gypsy Curse?
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1 RENEGOTIATION OF PPP CONTRACTS: Evidence, Typology and Tendencies Gypsy Curse? Jose Luis Guasch Former Head of the World Bank Global Expert Group on PPP Professor Emeritus of Economics, University of California, San Diego Senior Adviser, The Growth Dialogue, George Washington University, Washington DC Symposium on Public Procurement, Belgrade, Serbia September
2 Initial Reflexions A renegociatión of a PPP contract implies a change in the initial contractual conditions, not to be confused por example with a change in the tariff adjustment mechanisms as defined in the contract There are indeed valid reasons to renegotiate PPP contracts and some incidence is to be expected as a result of a number of things, such as incompleteness of the contract, the long duration of the contract/project, the likelihood of unforeseen events with significant economic/financial impact, the likelihood of changes in priorities by conceding governments and so on. Yet the observed high incidence of renegotiations is a serious concern, a source for criticism and for the questioning of the effectiveness of PPP programs. It appears to indicate an abuse of the instrument and its use for (to a large extent) opportunistic reasons rather form well founded contractual ones Definitional Semantics: PPP vs Concessions 2
3 Salient Features A very significant number of PPP have been renegotiated shortly after the contracts have been signed. These renegotiations occur frequently in a short period of time after financial close (or even before). And often the same contract is renegotiated several times. The problem is especially acute in some sectors, notably transport and water and sanitation and beginning to appear in social sectors. Most of renegotiations are initiated by private sector operators and to a lesser extent by the Government. Very few canceled/abandoned concessions/ppp Yet the system is evolving, but converging to what? 3
4 What is a Renegotiation? A renegotiation is a modifications of the contract not foreseen in it i) Mainly by a change in the risk assignment matrix or of its extent ii) By a change in the scope of the project-so called complementary contracts, additionality of investment/works etc (but even then it depends whether it was foreseen and guided in the contract, ) iii) By other changes (derived) on the contract conditions (such as duratión/term, schedule and timing of investment, investment levels, tariff structure, service levels, performance indicators, etc)* iv) By clarifying or corrective changes in the contract-often of reduced impact Clarification: Compensations to operator for the occurrence of specific events are not renegotiations, when it is specified in the contract. They do add to the costs of the contract, and do have adverse fiscal consequences. And they do generate conflicts on two accounts: On assessing the causality of the eventwho is responsible and on determining the proper level of compensation
5 Renegociatión, most often linked or triggered by: i) Additions or changes in the scope of the Project usually originated (but not always) by the Government, ii) Shortfalls in demand/revenues iii) Rent seeking opportunities iv) Political oportunities iii) Aggressive bids or mistakes in the bids Aggressive bids, intended to win the project, but with the objective to subsequently renegotiate better terms (positive returns) Aggressive bid defined when, net profits do not cover return to capital from day one R = PQ-OC-T-D<rK 5
6 What do we mean by contract renegotiation? Renegotiation is when: i) a change in the risk matrix assignment and / or in the conditions of the contract, or ii) A change in compensation iii) a change in project scope (if this was not regulated in the contract). Renegotiation is not when: Examples Reduce the level of services (airports, from IATA A to B). Defer or advance investments for several years. Extension of the contract term. Reduction guarantees (financial bonds) Increase the guarantee of the government (to pay lenders). Delays in the reduction of tariffs (tolls), or levels Reduce the thresholds of the economic equilibrium of the contract, etc. Government requests new investments. Reduction of fees for the government. Avoid bankruptcy of the operator. Changes on the contract scope, etc. Tariffs are adjusted with a formula set it in the contract or indexed by inflation. Triggers are activated and consequences implemented. Payments to operator as established and regulated in the contract, etc.
7 Why Renegotiation is an important issue? Implications Eliminate the competitive effect of the auction including transparency: questioning the credibility of the model/program Voids value for money analysis. Outcomes usually adverse to users, government and welfare overall Asymmetric information and lack of transparency of bilateral negotiations and skills of public sector to renegotiate the contract: Distortion in public tender, in that the most likely winner is not the most efficient operator but the most expert/qualified in renegotiations Decreases the benefits/advantages of PPP and the welfare of users, and usually it has a fiscal impact by increasing liabilities to the government Confirms rational expectations of operators While some can be efficient, many of them are opportunistic Contrast with PPP adjudicated trough non-competitive biddind, trough bilateral negotiations
8 Costs associated with disputes, conflicts and renegotiations are: Time and financial resources: to address and resolve the conflict. Social and Political: Since conflicts tend to be highly visible and have great coverage of the media, leading to disenchantment of citizens, the PPP model tends to lose credibility and public support, and it may weaken or kill the program. Financial/Fiscal: Often the results of the negotiation have a fiscal cost to the government. Economic and Social: Users tend to be adversely affected by the results of conflicts, particularly renegotiations (in terms of reduced access, higher or lower prices and delays in service quality) On average, those costs range from 2 to 30% of investment Overall pricing of uncertainty on that account is around 2-4 percentage points of cost of capital
9 Data Sample Based mainly in Latin America PPP/Concessions Original Sample 1000 concessions New added 589 concessions (Peru, Mexico, Colombia, Brazil, Uruguay, Chile, Central America, Dominican Republic, CA) Complemented as needed (mainly explicative, cualitative, corroborative) with samples from countries in other regions 9
10 Incidence of Renegotiation of PPP Contract PPP in (Broad) Infrastructure and its Evolution-1990 a 2014 Period Period Period All Sectors 42% 68% 43% Electricity 10% 41% 30% Transport 55% 81% 54% Water and Sanitation 75% 76% 60% Other sectors: social et al 42% 33% Source: Guasch (2004) updated
11 Renegociations in Peru: Period All sectors: 69% Transport: 84% Average number of renegotiations per Concession/PPP: 2.3 Originated by: Private Sector: 61% Public Sector: 36% 11
12 Not an Exclusivity of Emerging Countries: Renegotiations also take place in Developed Countries 12
13 Region / country Sector % of renegotiated contracts source Total 68% Latin America and Caribbean Electricity 41% Transport 78% Water 92% Guasch 2004 (2012) US Highways 40% Engel Fischer & Galetovic 2011 France Highways 50% Atthias and Saussier 2007 Parking 73% Beuve et al 2013 UK All sectors 55% NAO 2001 Table 1: Percentage of renegotiated contracts by region and sector. Source: Estache, Antonio and Stéphane Saussier, "Public- Private Partnerships and Efficiency: A Short Assessment", CESifo DICE Report 12 (3), 2014,
14 Tendencies 14
15 Observations on the Evolution of Incidence : I Explicatives- from learning and testing ( ) to (in)maturity allowed ( ) to a corrective reaccion ( ) Repeated Renegociations same project, Renegociaciones happens quite quickly from PPP adjudication (many even before financial closing) Very small number of cancellations, some increase, 15
16 Observations on the Evolution of Incidence : II Rapid increase on the incidence of renegotiation in second period, falling in the last period Much faster the time lapse for renegotiation request form about 1 year to 3 months financial closing issues and other Increases in the incidence of repeated renegotiations of same contract, average number of times 4.1 and 2.8 (without Colombia which is an outlier, more than 20 times!!!) Small increase in the number of cancelled concessions 16
17 Observations on the Evolution of Incidence : III Some hope and signs of sanity in latter period, numbers appear to be improving Due to a number of things, among them that a number of countries have taken measures to control dissuade renegotiations request (more on this later) Driven by bachlashes, fiscal concerns and the mingling of the usual suspects 17
18 Typology Renegotiation - By drivers of the renegotiations - By entity requesting renegotiation 18
19 Renegotiations by Type/Cause: Evolution-1990 to 2014 Period Period Period Agresive Bids 14% 22% 10% Demand Problems 30% 40% 24% Additional Works 23% 32% 10% Expropiation of land and rights of way 15% 20% 19% Financing Issues/ Bankability of Projects 9% 15% 11% Political 11% 18% 9% Corrective/Errors 5% 8% 9% 19 Source: Guasch (2004) updated 2014
20 Typology of Renegotiations: Originated by Government Oportunistic (polítical) Change in priorities Originated by private sector Oportunistics (rent seeking) Shock Originated by both 20 Ambiguous
21 Renegotiation by Originateur and Evolution-1990 a 2014 Period Period Period Originated by Private Sector Originated by Government Originated by both 52% 60% 43% 26% 30% 21% 19% 8% 18% Ambiguous 3% 2% 18% Source: Guasch (2004) updated
22 Mean Time to Renegociation Mean Time to First Renegotiation Mean Time to First Renegotiacion All sectors years Electricity years Transport years Water and Sanitation years Social Sectors 0.7years 22 Source: Guasch (2004) updated 2014
23 Low Incidence of Canceled PPP Period Total PPP Projects in Infrastructure Canceled Percentaje , Compositión 19 Toll Roads 9 Energy 7 Water and Sanitation 8 Telecom % Per sector 5,8 % 1.9% 3,5 % 0.3% Compositión Toll Roads Energy Water and Sanitation Telecom 3.5 % Per sector 23 Source: Harris (2002) WB and updated 2012
24 What are the outcomes of the renegotiation process? On average, terms of contract improve for private operator/investors Eficiency and Value for Money generally decrease Users are generally adversely affected Adverse fiscal impact that includes increases in certan and contingent liabilities for Government 24
25 Common Outcomes of the Renegotiation Process Percentage of renegotiated concession contracts with that outcome Delays on Investment Obligations Targets 69% Acceleration of Investment Obligations 18% Tariff Increases 62% Tariff Decreases 19% Increase in the number of cost components 59% with automatic pass-through to tariff increases Extension of Concession Period 38% Reduction of Investment Obligations 62% Adjustment of canon-annual fee paid by operator to government Favorable to operator Unfavorable to operator Changes in the Asset-Capital Base Favorable to Operator Unfavorable to Operator Source: Guasch (2004) Updated % 17% 46% 22%
26 Three Countries Case Renegotiations in CHILE (contratos complementarios), COLOMBIA (otro si) and PERÚ (naked contracts)
27 Summary Statistics of the Sample by Country,
28 Númber of renegotiations per concesión per year per country
29 Characteristics of the Renegotiation per contract,
30 Aditional Cost to the Government in relation to the initial value (investment) in the contract ( %)
31 Fiscal Costs of the Renegotiations in Chile and Colombia Constant millions dólares as of dicember 2009
32 INDIA: Recent Experience Around 2005, they did not foresee the need or concern about renegotiations there Today 70% of the PPP (300 in roads) are requestingrenegotiation of contracts (many described as aggressive bids) Asking increases in grants (viability gap fund), increases in tariffs, delays or reductions on investments. Increases of term, transfer risks to Gov etc
33 Measures to address Renegotiations For Aggressive Bids For Demand Problems For Complementary Contracts (additional request for investments) For Political Reasons For Financing Issues For Land and Rights Acquistion Issues Corrective issues 33
34 Plataform to control Renegociations The principles behind the platform are as follows, Preserve the value for money of the PPP project/contract. Inviolability of the Contractual/Bid Offer. When confronted with requests for renegotiation, the sacred character of the original contract/bid must be respected. And the operator should be held responsible for its offer. The financial equation of the winning offer should always be the reference point, and if the contract would be modified in the case of the renegotiation or adjustment, the outcome should be an impact of zero net present value of the benefits and risks, and without changing the allocation matrix. Compensations to the other party have to be considered to insure any extraordinary benefit. Renegotiation must not be used to correct errors in the basis for tender or excessively risky or aggressive bids.
35 Measure being taken to address the renegotiation issue I A number of countries have taken decisions to address the issue with mixed success Mexico Peru New Law and Regulations and Process Review to the Law and Regulations,and Platform Chile New Law and Regulations and Conflict Resolution Framework Colombia Portugal India New Law and Regulations and Institutionality and Process Platform for renegotiations Normative package to guide the process
36 Measure being taken to address the renegotiation issue (II) More specifically, measures that have been taken are for example: Use and implementation of "delivery unit" to high level. Use and implementation of requirements unit (licenses, permits, rights-of-way, evaluations specific-environmental archaeological). Greater role of the PPP Unit and regulatory agency (Peru, Colombia). Disuse of clause of financial equilibrium (Chile and Peru). Platforms of renegotiations and process led by the Ministries of Finance (Mexico,Chile and Peru). Platform for efficient land expropriation and securing of rights of way (Mexico) Use of regulatory accounting (Peru and Chile). Transparency of the renegotiation process. Disclosure of information since the request, analysis, negotiations and final amendment- web information. Greater use of LPVR as the award criteria to mitigate demand risk (Chile, Colombia). Control of aggressive bids by larger performance bonds (Uruguay, Paraguay). A Freeze period for renegotiations (Colombia and Peru) A statement in the law or regulations that the risk matrix cannot be altered (Mexico). Use and composition of panels of experts (aggressive betting, renegotiation, arbitration, regulation).
37 PLATFORM 1 The contract should stipulate the renegotiations approach, criteria and process. Increase the political costs of accepting renegotiations demands, by implementing a Transparency Framework-Use of Web, publish the requests, decisions and arguments, and using the media to inform on request and decisions and rational. Establish a reputation of not being well disposed to renegotiate by cancelling PPP/concessions processes particularly from request driven by aggressive bids Use and implementation of "delivery unit" to high level to resolve impasses in the preparation of projects/contracts. Use and implementation of requirements of resolution/problem unit (licenses, permits, rights-of-way, evaluations specific-environmental archaeological etc.) Establish a freeze period for renegotiations; say no renegotiations will be considered for three to five year after contract award. Only few exceptions can be accepted (Peru and Colombia). Establish clear jurisdiction over the decision to renegotiate, at high level, such as Interministerial Committee lead by Minister of Finance (Chile and Peru). 37
38 Platform II Establish in the contract the right to evaluate and reject aggressive and reckless bids, defining the criteria and standards, including submission of financial model for those bids or additional guarantees (financial bonds). Require submission of winner financial model (Peru, Uruguay and Mexico (the latter only in social sectors PPP)) Establish that the performance bond will be adjusted upwards if the bid offer appears to be aggressive ( as measured by the difference betwenn the highest bid and the second highest and the average bid) (Paraguay and Uruguay) Establish transparent framework of conflict resolution (panel of experts and arbitration). Using proper panels of experts (which composition based on technical profile and selected at random from pool of experts) to address issues such as aggressive bidding, renegotiation requests, arbitration, regulationresetting tariff structure. Establishing a matrix of risks with detailed risks identification and allocationestablishing that modifications of the contract must not alter the risk allocation. A statement in the law or regulations that the risk matrix cannot be altered (Mexico, Peru, Uruguay). Require that to submit a bid, the proponent has to have and enclose a letter of credit from the Bank, establishing the finacing commitment and terms (Canada) 38
39 Platform III Establish that if the contract is modified, the net present value of the modifications must be zero, and preserve value for money Impose appropriate (biting) level of performance bonds: for example, at least 15% of the investment (Uruguay) Clarification and wording of key contractual clauses and biding documents. Putting in place a platform for efficient land expropriation and for the securing of rights of way (Mexico and Chile). Demanding that to award the project at least 80% of the land needed ought to have been liberated by the government (India) Structure financial support by government (certain and contingent) over time, not all at the beginning (i.e. viability gap funding) Establish guidelines for levels of compensation. 39
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