Special Purpose Entities SPEs and PublicPrivate Partnerships PPPs

1
Special Purpose Entities (SPEs)
andPublic-Private Partnerships (PPPs)

• Government Finance Division
• Statistics Department
• IMF
• June 1-12, 2009

2
Introduction

• Governments often create independent
  institutions or entities to perform certain
  functions on their behalf
• Widely used in recent years
• From a GFSM 2001 perspective, the legal framework
  of such an entity is less important than the
  economic substance of their operations
• Two types of such arrangements in this lecture
• Part I Special Purpose Entities (SPEs)
• Part II Public-private Partnerships (PPPs)

3
Part ISpecial Purpose Entities (SPEs)
4
Contents of Lecture

• Definition of SPEs
• Uses of SPEs
• SPE measurement challenges
• Sectorization of SPEs

5
Definition of SPEs(1/2)

• An SPE is an entity that is created, through the
  transfer of assets, liabilities, or rights, to
  carry out a well-specified activity or series of
  transactions
• These activities are directly related to the
  specific purpose for which it was formed
• SPEs can be in nonfinancial and financial
  corporate sector
• In public sector, SPE activities are often
  instrumental to public private partnerships, BOOT
  schemes, or joint ventures
• Securitization of assets/liabilities

6
Definition of SPEs(2/2)

• SPEs often involve three groups
• Transferor
• The entity that transfers the assets, liabilities
  or rights
• The entity that creates the SPE
• Equity could be vested in transferor and/or
  partners
• Transferee
• The newly created SPE that receives the assets,
  liabilities or rights
• Investors
• Typically provide all funding requirements for
  SPE activities through loans extended to SPE or
  securities other than shares (e.g., bonds) issued
  by SPE

7
Some Uses of SPEs

• Can be misused (e.g., to conceal involvement of
  transferor), but justifiable and legitimate
  business purposes exist for use of SPEs, such as
• Securitization of assets
• Securitization/recognition of liabilities
• Pre-funding certain payments
• Managing risks in financial entities
• Facilitating market development
• Limiting tax liabilities
• Gaining efficiency

8
SPE Measurement Challenges

• Existing financial and economic analytical tools
  do not always capture the financial and economic
  activities of SPEs sufficiently due to
• Lack of disclosure transparency
• What about off-balance sheet assets
  liabilities?
• Poorly performing assets may be hidden
• Establishment of layers of accountabilities
• Who are participants in SPE, and how are risks,
  rewards, and control divided among all
  participants?
• Thus, legal framework does not always reflect
  economic substance of SPEs operations

9
Treatment of SPEs in Macroeconomic Statistics

• Make sure it is securitization
• Securitization can only occur when an existing
  asset is sold
• A future stream of revenue is not recognized as
  an asset, and is treated as borrowing by the
  creator of the SPE (i.e, NOT securitization)
• Treat SPEs (other than future streams of revenue)
  similar to all other entities in macroeconomic
  statistics regarding
• Sectorization
• Recording of flows and stocks

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Sectorization of SPEs in GFSM 2001 (1/3)
No
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Sectorization of SPEs in GFSM 2001 (and other
macroeconomic statistics) (2/3)

• For a nonresident institutional unit that
  performs fiscal (or quasi-fiscal) activities on
  behalf of government
• Record all flows between general government
  sector and the nonresident SPE
• If no flows occurred between general government
  and SPE, impute flows between the general
  government sector and the SPE
• Other nonresident SPEs
• Part of Rest of World

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Sectorization of SPEs(3/3)

• To determine control, use indicators of control
• Ownership of majority of voting rights
• Control of board or other governing body
• Control of appointment and removal of key
  personnel
• Control of key committees of entity
• Golden shares and options
• Regulation so tight that it amounts to control
• Control by a dominant customer (e.g., government)
• Controls attached to borrowing from government
• Other controls associated with entitys
  constitution and rules
• Totality of indicators ? judgmental in nature
• Also see Risk Transfer later in PPP lecture

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Part IIPublic-Private Partnerships(PPPs)
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Contents of Lecture

• Definition of PPPs (or service concession
  arrangements)
• Reasons for establishing PPPs
• Fiscal risks of PPPs
• Risk transfer, leasing, and ownership
• Managing and reporting fiscal risks of PPPs
• Recording of PPPs in accounting standards and
  GFSM 2001

15
Definition of PPPs(1/4)

• Public sector contracts to purchase quality
  services on a long-term basisprincipally
  involving the construction of new infrastructure
  to provide such services. (UK Government)
• Contract between a public sector
  institution/municipality and a private party, in
  which the private party assumes substantial
  financial, technical and operational risk in the
  design, financing, building and operation of a
  project. (South African Treasury)

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Definition of PPPs (2/4)

• The IMF definition of PPPs
• Arrangements where the private sector supplies
  infrastructure assets and services that
  traditionally have been provided by the
  government.
• Main characteristics
• Private execution and financing of public
  investment
• An emphasis on investment and service provision
  by private sector
• Risk transfer from government to private sector
• Classic scheme Design-Build-Finance-Operate
  (DBFO)

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Definition of PPPs (3/4)

• PPPs have been used as an alternative to public
  procurement in different sectors
• Education (e.g., schools, museums, libraries)
• Health (e.g., hospitals and clinics)
• Water (e.g., sanitation plants, irrigation
  systems, pipelines)
• Public administration (e.g., courts, police
  stations, and prisons)
• Transport (e.g., roads, bridges, tunnels,
  railways, airports, ports)
• PPPs provide services to the government or
  directly to consumers

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Definition of PPPs (4/4)
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Uses of PPPs

• Particularly well-suited for economic
  infrastructure, less so for social infrastructure
  because
• High economic rates of return of sound projects,
  that address clear bottlenecks, are attractive to
  private sector
• Services are directly provided to final users, so
  user charges are more feasible and even desirable
• Economic infrastructure projects have a more
  developed market for bundling construction with
  services than social infrastructure projects

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Reasons for Establishing PPPs(1/4)

• Increase efficiency
• Benefit from private sector expertise
• Improve timely delivery of quality services
• Infrastructure for free
• Tempting particularly for cash strapped
  governments trying to meet fiscal targets

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Reasons for Establishing PPPs (2/4)

• However, PPPs can be risky from a fiscal
  perspective
• Move spending off budget and can create (explicit
  and implicit) contingent liabilities for
  government
• Potentially threaten integrity of budget process
  and undermine efforts to safeguard macroeconomic
  stability
• Perhaps more difficult to achieve fiscal
  discipline and good governance with PPPs

22
Reasons for Establishing PPPs(3/4)

• Right Approach PPPs should provide better value
  for money
• Responsibility for designing, building,
  financing, and operating (DBFO) an asset lies
  with private sector
• Private sector provides service with higher
  efficiency
• Efficiency gains need to make up for higher cost
  of private capital, fixed cost of administering
  PPPs, and lack of flexibility in long-term
  contracts

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Reasons for Establishing PPPs(4/4)

• Wrong Approach PPPs allow investments to be
  recorded off budget
• PPPs can circumvent fiscal constraints (e.g.,
  formal rules) for infrastructure investment
• PPPs can, but should not, be used to solely
• bypass expenditure controls
• delay borrowing
• move public investment off budget
• move debt off the government balance sheet
• Government can be left bearing most of the risk
  involved, facing potentially large fiscal costs
  over the medium term

24
Fiscal Risks of PPPs

• PPPs entail a variety of risks
• Construction risk, financial risk, demand risk,
  availability risk, political risk, natural
  disasters
• Who should bear the risk?
• Public and private sector have certain advantages
  relative to the other in managing specific risks,
  e.g.,
• Private sector construction risk
• Public sector political risk
• Appropriate level of risk transfer depends on
  each project and country
• Adequate risk sharing is essential to achieve
  value for money!

25
Risk Transfer, Leasing, and Ownership(1/2)

• Risk transfer from government to private sector
  has significant influence on whether PPP is more
  efficient and cost-effective alternative to
  public investment and government provision of
  services
• Have to assess risk transfer and ownership by
  looking at
• Risks in owning asset
• Risks in operating asset

26
Risk Transfer, Leasing, and Ownership(2/2)

• Leasing
• PPPs can be set up as operating leases, unusual
  to take form of a financial lease
• But, from GFS and fiscal risk point of view, we
  look at economic owner of asset by asking who
  bears the ultimate risk or most of the risks
  associated with ownership
• If government, then impute a financial lease
  through which government acquires the asset
• Often difficult to assess risk transfer
• Full disclosure essential, but even then it may
  be problematic to assess risk transfer

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Managing and Reporting Fiscal Risks(1/4)

• Currently, significant scope to strengthen the
  environment for PPPs to mitigate fiscal risks,
  focusing on four areas
• Good projects
• Good laws
• Good institutions
• Good accounting and reporting

28
Managing and Reporting Fiscal Risks(2/4)

• Good projects
• Systematic 2-step investment process
• Choose right projects (strategy, prioritize)
• Do PPPs for the right reasons (value for money,
  include in medium-term budget framework)
• Good laws
• Legal framework for PPPs
• Introduce a clear and consistent PPP law or
  harmonize existing laws to provide consistent
  legal framework
• Integrate PPP proposals and guarantees with
  budget cycle
• Clarify roles and responsibilities

29
Managing and Reporting Fiscal Risks(3/4)

• Good institutions
• Management and oversight framework
• Clarify institutional roles and responsibilities
• Introduce a central PPP unit
• Implement a gateway process overseen by
  Ministry of Finance to authorize PPPs at each
  stage of project life cycle
• Strengthen technical capacities throughout
  government institutions handling PPPs

30
Managing and Reporting Fiscal Risks(4/4)

• Good fiscal accounting and reporting
• Problems!
• PPPs are chosen to move public investment off
  budget and debt off government balance sheet
• Government still bears considerable risk and
  potentially faces large fiscal costs
• General accounting and reporting standards for
  PPPs are still to be developed
• Proper accounting and reporting of the fiscal
  implications of PPPs is essential to prevent
  their misuse, and to make increased efficiency
  their main motivation

31
Recording of PPPs in Accounting Standards and
GFSM 2001 (1/2)

• Topic was extensively discussed in review of
  SNA93
• Not yet reached a final outcome (as of May 2007)
• But, already agreed to
• Look at each PPP contract to determine recording
• Follow the outcome of international accounting
  standards in recording of PPPs
• In the mean time, we have fairly straight forward
  existing accounting and GFSM 2001 reporting
  standards for
• Operating contracts concessions and operating
  leases financial leases and the transfer of PPP
  assets to government

32
Recording of PPPs in Accounting Standards and
GFSM 2001 (2/2)

• Accounting for risk transfer
• Eurostat Classify PPPs as in the private sector
  if private partner bears most construction risk,
  and either most availability risk or most demand
  risk.
• IMF Should look at all risks to determine who
  bears ultimate risk to determine control
• If government controls, then PPP assets are
  government assets
• IPSAS Not yet determined. Leaning towards the
  notion of who controls asset (Consistent with
  SNA)
• If government controls, then PPP assets are
  government assets

33
IMF Operational Approach to Managing and
Reporting Fiscal Risks

• Aims to mitigate potential moral hazard
• Emphasis on comprehensive disclosure of known and
  potential future costs of PPPs for public
  finances
• Incorporation of costs into Debt Sustainability
  Analysis and medium-term budget framework