Monday, August 26, 2019Canada's Leading Online Business Magazine

P3s a Growing Necessity For Canadian Business

Cover_Feature_949964217

The Economic Impact of Massive Infrastructure Projects

Why the U.S. Has Not Embraced The P3 Model

Financing Structure

Public–private partnerships (PPP) have grown considerably in Canada over the years, but it was a 2009 commitment from the federal government that further solidified the growth model as a sustainable option within the Canadian business landscape. Specifically, it was Finance Minister Jim Flaherty who established PPP Canada, a Crown corporation with a mandate of promoting greater uptake of private-public partnerships. PPP Canada comes equipped with a small fund, enabling it to invest in projects by taking up to 25 per cent of capital costs.

Quite simply, PPP – or P3 – describes a government service or private business venture which is funded and operated through a partnership of government and one or more private-sector enterprises. The chosen private entity provides a public service or project on the knowledge it – and any private partners – will be responsible for the lion’s share of the financial responsibility as well as any technical and operational risks that may leap forward along the way.

In some types of P3s, the cost of using the service is assumed exclusively by the users of the service and not the taxpayer. With a private finance initiative, capital investment is made by the private sector on the weakness of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government. Government contributions to a P3 may also be in-kind, such as the transfer of existing assets; maybe it’s the land to construct the project.

Typically, a public sector consortium forms a company called a “special purpose vehicle” (SPV) to develop, build, maintain and operate the asset for the contracted period. In cases where the government has invested in the project, it is typically (but not always) allotted an equity share in the SPV. The consortium is usually made up of a building contractor, a maintenance company and bank lenders. It is the SPV that signs the contract with the government and with subcontractors to build the facility and then maintain it. A typical PPP example would be a hospital financed and constructed by a private developer and then leased to the regional or municipal hospital authority. The private developer then acts as landlord, providing housekeeping and other non-medical services while the hospital itself provides medical services.

Origins of the P3 Model

Due to government concerns over skyrocketing public debt accumulated over many decades, added pressure was constantly being placed on politicians to find a stronger solution to keeping spending in line while also continuing to develop much-needed civic infrastructure. The likelihood of having the private sector absorb all the responsibility was not feasible, and so alternate models began to take shape in the mid to late 1980s. However, it wasn’t until the early 1990s when some individual one-off deals began to take hold. The key is always maintaining a balance where both public and private feel they have a say in the project’s development. It can be a fragile arrangement and requires constant attention.

It’s fair to say the Canadian model is somewhat molded in the spirit of the one created in the United Kingdom, where Conservative Prime Minister John Major’s government introduced the private finance initiative (PFI) in 1992, encouraging public–private partnerships. By 1997, the Labour government of Tony Blair expanded the PFI initiative, but many changes to the programs resulted in their running vastly over budget, leaving a bad taste in the mouths of many soured British businesspeople.

During the past two decades more than 1,400 P3 deals were signed in the European Union, representing an estimated capital value of about $415 billion. Since the global financial crisis that began in 2008, it’s been estimated P3 deals have fallen more than 40 per cent in Canada.

Public-private partnerships provide a unique perspective on the need for close collaboration and networking within public and private management. The progression of P3s in both theory and practical terms is a consequence of a new structure brought on forth in large-part because of financial necessity. To ensure success requires a tremendous amount of coordination, cooperation, organization and flexibility. Not always easy to achieve, but when it can, the savings are monumental.

CCPPP

The Canadian Council for Public-Private Partnerships is a national not-for-profit, non-partisan, member-based organization with broad representation from across the public and private sectors. Its mission is to promote innovative approaches to infrastructure development and service delivery through public-private partnerships with all levels of government.

“Over the past 20 years, CCPPP has played an important role in advancing public-private partnerships as an innovative approach to infrastructure development and I am honoured to work with the Council, championing P3s across Canada,” Alberta Premier Alison Redford stated at the council’s annual conference in Toronto, called The Power in Partnership.

In an exclusive interview with The Canadian Business Journal, Mark Romoff, President and CEO of The Canadian Council for Public-Private Partnerships, provided some excellent insight as to what this business model is all about. The CCPPP is now in its 20th year, having originated in 1993 due to the recognition of the importance of infrastructure and its development as an economic driver.

“Some of the original impetus was big infrastructure deficits and challenging financial situations not dissimilar from those of today,” Romoff tells us. “There was a group that began to think more seriously about this and looked around the world with respect to how other entities confront the same sort of issues. The notion of public-private partnerships really began in the UK and Australia.”

“The interesting thing is that Canada looked at those two models and adapted them for the Canadian environment,” Romoff continues. “Over the years there have been significant changes to the approaches taken by those countries to make our model a bit more efficient and responsive to the Canadian reality.

Today, Canada’s approach to the P3 model is recognized internationally as the best in class.”

The key aspect of any organization such as the CCPPP is to continue to observe and learn what concepts within the model work and what doesn’t.

“One of the rules of the Council is to keep an eye on what’s happening internationally in this space in order to ensure that if there are lessons to be learned we want to bring them home if they are adaptable to the Canadian environment and we’ve been very successful doing that.”

The P3 approach in Canada is one that continues to evolve and Romoff believes will get better with every contract written. The CCPPP now has 182 projects that are at various stages of growth and completion, with about 90-plus already in operation. The rest are either under construction or at the procurement stage. It’s a significant piece of the infrastructure pie in the country.

“The value of those projects that have already gone to full operation, or at least where funding has been finalized, is now in excess of $60 billion,” Romoff pronounces.

From Romoff’s candid perspective, an important thing to remember is that P3s are not a panacea – so not every infrastructure project should go down that specifically structured path. There is an overriding need to ensure the idea makes sense and drives all the benefits of such a setup.

“When it’s not the appropriate approach then you’re best to look at traditional procurement or other models,” he says. “That’s why Canada has such a strong track record.”

While there is no figure set in stone, Romoff believes that for a P3 partnership to work, it would likely need to have a threshold value of at least $50 million for it to be a worthwhile project for all parties involved. But he notes not all projects fall into that higher-end category; but there are still ways to make the process work.

“The schools in Alberta were bundled, so what you’re seeing is that where projects might not be substantive enough in their own right, you can bundle a few of them in order to give the overall package enough substance that it becomes attractive to the private sector to want to bid it.”

Healthcare and transportation typically lead the way in P3 partnerships, but noticeable gains have been made in several other sectors, not the least of which would be municipalities.

“For new players in the space there is a need to educate yourself, so we are hoping to jump-start that process by developing a guide, which has been distributed with 1,200 copies sent out across Canada.”

The P3 model continues to assert itself as a growing business option, and yet there remains a tremendously large untapped market that has yet to be reached for a variety of reasons.

“I would say no more than 20 per cent of all infrastructure development in Canada has been pursued using the public-private partnership approach,” Romoff reveals.

Despite that seemingly low percentage, he believes there is great potential to grow the model, which will be driven by the enormous economic benefits. Finance Minister Flaherty was one of the keynote speakers at the CCPPP conference last year, outlining the current situation from the federal government’s perspective in front of some 1,500 delegates.

“The reality is that governments are cash short,” Flaherty told the audience straight out. “The good news is that the balance sheets of corporations in Canada are very strong and are awash in cash. The P3 approach is an essential part of our government’s future plans; at the federal level, we intend to do more P3s.”

Timelines

There’s also no such thing as a typical timeline for the complete execution of a P3 project, quite simply because each one comes with its own set of parameters, including the individual partners involved in the project, the complexity and size of the venture and the budgets, etc. that all influence the pace at which the plan comes together. Romoff notes there are definite phases each P3 will go through en route to completing the project, regardless of size and scope. However, it’s fair to say this model does take a longer period of time in most cases than would traditional procurement because of the need to coordinate so many different players together and have them working as one. It’s not as difficult as herding cats – but can require a good deal of patience for those spearheading the overall project.

“You want to make sure you build in all the safeguards to ensure that when you sign the deal you’ve got a contract that is going to get you the outcomes you want,” Romoff says.

“If you decide you want to do it, you then have to test the marketplace to ensure interest,” Romoff notes. “That’s what this ‘expression of interest’ or ‘request for qualifications’ proposal stage is all about. This stage will tell you if anyone out there is interested or not. In Canada there has been very strong interest in this approach and usually you get five or six consortia that express interest.”

Recently the overall marketplace has become much more competitive. With most substantive projects it wouldn’t be uncommon to receive eight or nine consortia expressing interest according to Romoff. These consortia are made up of private-sector players such as the developers, design architects, construction companies and law firms that act on their behalf as well as those involved from the financial community. These teams form and express interest and then at that point the public-sector entity, whether it’s a provincial government or the federal government, will review all the consortia expressing interest and typically bring the list down to the best three preferred proponents in what is a very competitive process.

“You get it down to three and then they put together a firm proposal and so an RFP goes out to those three bidders and that process then results in the final selection of the preferred proponent,” Romoff states. “Because of the way we’ve introduced efficiencies into the process, the timeline is really quick and usually less than 90 days. The UK can take up to a year for just that process alone.”

In terms of timelines, Romoff says there has been little in the way of frustration from any of the players involved in the P3 process regarding any setbacks or having the process getting bogged down in bureaucratic red tape.

“The Canadian approach sets the standard and attracts all the international players,” Romoff responds. “They and our own domestic industry like the process because it’s competitive, it’s fair, it’s transparent and there’s a continuing dialogue between the public-sector agencies and potential bidders that provides a comfort level for everyone. Infrastructure development takes time. You can’t make a decision on Monday and hope to have a shovel in the ground on Friday; everyone understands that.”

Transportation and Healthcare

The two principle sectors of P3 activity in Canada have historically been transportation and healthcare. When it comes to the former it most often relates to the building of roads, highways, bridges and urban transit systems.

“In British Columbia you’ve got The Sea to Sky Highway, which was built in time for the Olympics and takes you up to Whistler,” Romoff notes. “This is a section of Highway 99 running from Horseshoe Bay to Pemberton. There’s the Golden Ears Bridge and the SkyTrain or the Canada Line, which takes you from the airport in Vancouver to downtown – all built as public-private partnerships. In Quebec, the A20 and the A30, two major highways, were built as public-private partnerships. In Alberta there is a series of four ring roads in Edmonton. The 407, just outside Toronto was also built in a public-private partnership and the Confederation Bridge out in PEI.”

Romoff also tells us there are two more huge P3 projects coming up on the horizon. One is a federal deal with a bridge being built across the St. Lawrence River in Montreal. The estimated cost could reach $5 billion.

The second major transportation project that has been approved is in Windsor and is officially known as the Detroit River International Crossing. Recently there’s been a movement to have it named the New International Trade Crossing (NITC). Of note, this project will be the first bi-national public-private partnership project between Canada and the U.S. although it begs the question as to how much of a partnership is involved with Ontario and Canada footing the entire bill for Michigan and the U.S.

Despite the fact Michigan is not committing any funds to the project, state governor Rick Snyder is 100 per cent behind the project.

(Editor’s note: For more information on the DRIC, further detail is contained in the adjoining feature).

Along with transportation, healthcare is the co-leader of P3s here in Canada, and is likely to remain that way for the foreseeable future. Essentially, it’s a long-term contract running anywhere from 10 to 30 years between a public-sector authority and one or more private sector companies operating as a separately-defined legal entity.

The government can provide purchasing power, while outlining a set of standards for an efficient and reliable health system. From the private sector, those participating receive payment for services rendered while at the same time assuming most, if not all, substantial financial, technical and operational risks. The risk taking is worthwhile due to the potential of shared cost savings, thus leading to greater profitability.

As with each sector of a P3 relationship, the private entity is made up of any combination of participants who have an interest in assisting, assuming of course they also have proven core competencies that bring value to the project.

“Since 2004 we’ve built about 50 hospitals in Canada as public-private partnerships,” Romoff relates.

Additionally, active movement on P3s has been generating momentum in the education sector, and especially in Alberta. The province has built – or is in the process of building – about 80 schools.

“They’ve done them in bundles; about 20 at a time,” Romoff explains. “It’s been a very successful program for them.”

The P3 model lends itself to a number of interesting sectors and has made a huge impact on the Canadian scene. That said it seems other provinces have been lagging behind in this regard.

“It’s less about lagging and more about a little bit of visionary thinking in Alberta,” Romoff responds. “Other provinces had thought initially about the education sector but what’s happened in Alberta is having an impact on the others.”

The diversity of the model is quite fascinating. On the one hand, there may be colossal projects such as hospitals and urban transit systems but it’s also water systems or wastewater systems. It may be a courthouse, such as the one built in Durham Region in southern Ontario. The Ottawa Light Rail Transit System is a P3 along with a number of other urban transit systems across the country. The Canadian Securities Establishment in Ottawa, our national intelligence monitoring facility, which Romoff says underlines just how powerful the model can be.

“That’s a very special project, because clearly it’s a sensitive file and so if that kind of facility lends itself to a public-private partnership, then there’s something about this idea that makes sense.”

Controversies

As with any business model, the P3 is not without its controversies. A common problem that often rears its ugly head in these types of projects is that private investors obtained a rate of return that was higher than the government’s bond rate, even though most or all of the income risk associated with the project was initiated by the public sector. Yes, it causes discord. However, from the other side of the coin there is also the argument for ‘high risk – high reward’.

It is certainly the case that government debt is cheaper than the debt provided to finance P3 projects, and cheaper still than the overall cost of finance for typical P3 projects, i.e. the weighted average cost of capital (WACC). A number of Australian studies of early initiatives to promote private investment in infrastructure concluded that in most cases the schemes being proposed were inferior to the standard model of public procurement based on competitively tendered construction of publicly owned assets.

One response to these negative findings was the development of formal procedures for the assessment of PPPs in which the focus was on “value for money,” rather than reductions in debt.

There has been considerable debate in Canada and the U.S. about the use of P3s in infrastructure and other public projects. In many instances special interest groups, and in particular public sector unions, have opposed the use of P3s with the primary argument being that it will create a boon for those participating from the private sector, while coming at the expense of the public sector through job losses. A response to that, however, could be it promotes greater efficiency and saves money in the long run. It is also sometimes argued that P3s should be avoided because the public sector can borrow the funds to develop a project at a lower interest rate than the private sector through private financing.

U.S. Inaction

The success of the P3 model has been well documented here in Canada, and it’s also been widely embraced by the UK, Australia, India, Russia and China despite some bumps and bruises along the way. However, noticeably absent from that list of strong economic countries is of course the United States of America. Clearly, they have yet to fully embrace the concept.

“I would say it’s a work in progress,” Romoff diplomatically states. “Historically they haven’t been a significant player in the public-private partnership space but I think you’re going to see that will change too, because the infrastructure deficit is so large in the U.S.”

In other words, the financial challenges are so significant that there has to a move afoot to look at more innovative ways to deliver on public infrastructure necessities.

“It’s a state responsibility; increasingly states are putting in place the legislation that they require to enable P3 projects to go ahead.”

Needless to say, with 50 states – all with varying types of laws and legislative processes – getting them all on board is something that will take a considerable amount of time. As with other jurisdictions, some states have very forward, progressive types of legislation that would lend itself to moving ahead with this type of model sooner than later. New York State would certainly be categorized as such where Governor Andrew Cuomo has been keenly interested in the P3 approach.

“In some cases there is legislation in place that precludes P3s,” Romoff reveals. “I think we’re seeing now is that there’s more and more interest.”

The strongest interest coming from south of the border seems to be the transportation sector, which comes as no real surprise because there’s a very obvious, transparent revenue stream.

Financing

The source of funding for these multi-billion projects most often comes from banks, private equity firms, philanthropists and pension fund managers or a combination thereof.

For more than two decades public-private partnerships have been used to finance transportation and health infrastructure. There isn’t a country in the world where healthcare is financed entirely by the government. While many citizens believe that healthcare is the responsibility of government, private capital and expertise are increasingly viewed as much-needed sources to reduce overall costs and get beyond the miles of red tape. As example, spending on healthcare among the Organisation for Economic Cooperation and Development (OECD) and BRIC nations of Brazil, Russia, India and China is expected to grow by more than 50 per cent in the decade between 2010 and 2020, amounting to a cumulative total of more than $70 trillion.

Historically, Ontario and British Columbia have led the way with P3 projects in the country. Alberta, Quebec and New Brunswick have been picking up momentum over the past five years and now Saskatchewan is coming on board with a project called SaskBuilds.

There seems to be very little current data available on what the real infrastructure deficit is here in Canada, but some time ago, The Federation of Canadian Municipalities provided a study and mentioned a deficit of $123 billion.

“You can be sure it’s far larger than that now,” Romoff states.

The federal government is in the process of assembling a long-term capital infrastructure plan. In doing that work, it’s expected the result will be a stronger and more accurate sense for what the real infrastructure deficit is here in Canada.

“There was an infrastructure report card developed recently which was less about the size of the deficit but rather what is the state of our infrastructure,” Romoff says. “There are two parts to it: the upkeep and building new infrastructure.”

According to the OECD, the worldwide deficit is expected to be $2 trillion for the next 20 years, or $40 trillion as a gross deficit. With those types of figures, shared infrastructure projects seems not only prudent but entirely essential.

“What’s encouraging on the Canadian scene is that there is greater recognition at all levels of government that infrastructure is absolutely essential to economic development,” Romoff replies. “Governments are looking at how they can address that challenge, given the current situation.”

By Angus Gillespie 

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