VI EUROSAI Training Event:
Seminar on “BETTER AUDITING OF PUBLIC AIDS AND SUBSIDIES”

Prague, 6-8 November 2006

PAPER 3

In this Paper you will find background information on Public Private Partnerships (PPPs) and on auditing of PPPs. 
Generally on Public Private Partnerships
Introduction to Public Private Partnerships
The role of private sector in financing and operating of some parts of public infrastructure has increased greatly in the past decade. PPPs are no longer new contractual forms but are used in more and different ways in public management. There is a shift from ministerial direct management to private contractors in construction of public assets and service delivery: ministries are becoming more specialised in setting up contractual relationships and monitoring implementation, leaving to contractors the direct management, exploitation and in some cases also the funding of activities. 

Government outsourcing is a common feature. However, more and more private producers are now being used in direct provision of goods and services in areas where traditionally the government was the only provider, such as health and defence investments, correction facilities and welfare-services. Also, what earlier was only outsourcing of construction (especially transport and utility infrastructure), the service component now gets more important. An example of industries that already in the past were penetrated by the private sector, but the importance is even more visible nowadays, are culture or sports. The use of market-type mechanisms can improve efficiency and be a way to improve the provision of goods and services by governments. 

PPPs refer to the private sector designing, building, maintaining, operating and financing infrastructure assets traditionally provided by the public sector. PPPs can also involve the private sector purchasing already existing infrastructure assets and redeveloping them. Public-private partnerships bring a single private sector entity to undertake to provide public infrastructure assets for their “whole-of-life”, generally 20-30 years.

PPPs and other similar types of public/private finance projects have proven their usefulness as may be seen on the examples of countries with most experience, such as the United Kingdom, Ireland, the Netherlands, the Scandinavian countries, Portugal, Spain, France, Canada, Australia, New Zealand, Japan, Chile or Republic of South Africa.  

Increasingly in Europe the use of market-type mechanisms by the public sector can improve the efficiency and effectiveness of public spending depending on the specific instrument utilised (PPPs, concessions, vouchers, etc). This raises many questions concerning the economic need for PPPs. 

•	Is there an economic need for PPPs or can other measures, such as concessions or vouchers be used to increase the effectiveness in public spending?
•	How can Governments obtain better efficiency and effectiveness in public spending, utilising mechanisms as PPPs?
•	Is a public sector comparator a necessary element when conducting PPPs?
•	How should PPPs be audited?

It can also be a way of increasing investments if budget resources are scarce, as they in most cases moves the actual payments for investments to future years. In either of these cases, private sector experience, efficiency and early supply of financial resources must overweight possible contingent liabilities and risks for the government. In this respect a public sector comparators could be a tool to compare net current value of proposed private solution against the in-house cost for government of delivering public services or assets.

The Importance of a PPP Law
Most OECD countries, if not all, have a system of laws and regulations related to public procurement and contracts. As for private participation in public infrastructure and service delivery, a variety of instruments like guidelines, standards, codes of conduct or laws are applied. 

Rules for PPP contracts differ between countries. As PPPs usually cover more complex issues than regular procurement and design-build contracts, a special law, or instructions can be useful, for the government to reap the benefits of PPPs. 

The needs for a special PPP law differs and depends on to what extent PPPs are used. At the same time as a law can be useful, special features of PPPs might demand certain flexibility and allow for different practices depending on the type of project (some projects are very special and off a one-time nature and in those cases a case-by-case approach might be the best option). What needs to be evaluated is whether there is a trade off between detailed regulation and the need for flexibility and if so, what could be recommended for countries going down the PPP-path? It is important to consider having, a mandatory framework integrated by laws and regulations in this field and to decide what aspects should be regulated (economic, financial, management, monitoring etc.), how detailed shall rules or legislation be or how to define rules while at the same time keeping flexibility?

The Value of a Dedicated PPP Unit
Governments’ capacity to ensure good PPP design and contract execution is a main issue. Key aspects such as ensuring government skills to develop PPP contract standards and appropriate risk sharing solutions can be improved when a dedicated PPP unit is available. Important issues to consider, such as the organisation, resources allocated and the specific role of this unit are subjects for discussion in this session. 

PPP contracts involve features more advanced than traditional contracts where a private producer builds, or designs and builds, an asset for the government. Depending on the goods and service that a PPP involves, more features have to be handled, for example: who will carry different types of risks (both current and potential), how to define and measure output and quality, and in the case of long contracts, how to renegotiate contracts. Setting up contracts that take these aspects into account is difficult, especially since the private sector partner might have an information advantage in some stages of the process. 

Government skills, as for any other agent, increase with experience in the area and good practice. As PPPs can be complicated, they require that the government has solid skills not only in tendering procedures, with legal and management aspects, but also with the actual functioning of assets, maintenance and service delivery. Knowledge and skills by government units involved in PPPs are essential to formulate adequate contractual frameworks that allow for the public sector to reap benefits of using PPPs compared to traditional in house production. Whether this technical and legal knowledge is owned by one special unit in the government or several units within line ministries or agencies depends on country specific institutional set up and the scale of the use of PPPs. 

Accountability and Evaluation Issues and PPPs
Accountability mechanisms aim at reinforcing efficiency and effectiveness in complex contractual partnership relations between the public and private sector when seeking to utilise private delivery of public services and assets. In the budget implementation process, contractual relationships are essential not only because of their actual presence and importance in legal, financial and output terms but also for other reasons, such as transparency, accountability and control. These are basic elements in ensuring efficient and effective public spending while avoiding corruption or mismanagement. 

The following can illustrate some of the issues the public sector faces when using PPPs for goods and service delivery:

•	Which control mechanisms can be used by governments to ensure efficiency and effectiveness in private delivery of public services? How to control a contractor’s output, both ex ante when choosing a contractor and during the execution phase of the contract? The use of value for money and operational audits.
•	Can ex post audit performed by the Supreme Audit Institutions or other external audit serve to prevent tendering mistakes and contract mismanagement? Who is accountable and for what? How is the responsibility shared by the government and the contractor? How are reporting requirements organised?
•	Is the accountability process effective before Parliament? Does Parliament receive adequate and timely information on contract implementation and actual outputs and outcomes? 
•	Should citizens have a role in the whole PPP process? How is transparency to citizens ensured when dealing with PPPs? In countries with a tradition of very open governments, how is the availability of information assured towards citizens when using private contractors?

PPP’s from the Public Sector’s Point of View
PPPs are getting more and more common. Some countries already have well-established programs of PPPs, while others are beginning to show interest. The variety of instruments and forms utilised need to be well understood before they are used.

Countries follow different approaches, such as PFI (Private Finance Initiative; approach followed especially in the United Kingdom), BOO (Build Own Operate), BOOT (Build Own Operate Transfer), BTO (Build Transfer Operate), DBFO (Design Build Finance Operate) etc., where the differences imply government and private partner take varied risks and responsibilities. The formulas used are somehow as varied as the areas of PPPs implementation, since the said approaches and terms are all usually considered included in the PPP concept. However the way PPP works and the gains that the government can make by using them differ.

The most common feature in this area is still construction of new infrastructure, but more and more contracts include a larger service component, such as maintenance and financing of the project. Furthermore, some countries are using PPPs for delivering public services traditionally delivered by public authorities, such as water supply, health care, housing, prisons, etc. 

PPPs from the Private Sector’s Point of View
The use of PPPs has increased the scope of private companies into an area previously out of reach for them. PPPs offer a possibility to broaden the scope of activities for the private sector. However, just as contracting for PPPs is difficult for the government, so is it for private companies. Risk issues and long term contracts makes it necessary for private partners to take into account more factors than they usually do. The private sectors view and experiences of PPPs can help countries handle this new level of complexity.

The long-term nature of these contracts, the size of projects and the capacity to be able to wait a long time for revenues and eventual profits has implications in the decision of entering into this kind of partnership. Depending on the specific projects, size of private contractor and its financial capacity are important aspects for contractors to enter in this type of partnership. Like for the public partner, clear risk sharing design is a key for the private partner to estimate any net future flow of incomes and the costs to be assumed to mitigate the risk.

Scoring Issues and Accounting for PPPs
PPPs have many faces and the reasons for PPPs differ. In economic terms, there is the aim of improving the efficiency in the use of public resources by bringing in private sector management, improve competition etc. 

Common international accounting standards are vital to promote proper accounting of the risk that is shared between the public and the private sector. Accounting rules and best practices can have a great impact on PPP design and some issues that are important are the recording and treatment of income and expenditure flows, net assets value and contingent liabilities. These issues are important both with regards to general accounting methodology, but also for treatment and accounting in government budgets, to avoid PPPs becoming just another way of moving expenditures off budget. International accounting standards for PPP are needed and currently being discussed, for example issues as the importance of risk sharing and adequate and proper risk allocation between partners, calculation of unknowns (contingent liabilities), accounting standards for PPPs (IASB, IPSASB, Eurostat, IMF) and of course auditing standards (ISA, INTOSAI).

Risk Issues for PPP
Since PPP/PFI schemes were introduced and applied, a couple of surveys, research and studies analysed differences in risk profiles between traditional public sector procurement projects and PPP/PFI projects. Some surveys confirmed assumption that risk transfer from public sector is one of the main objectives and advantages of PPP/PFI projects. Large projects generally are attendant on many kinds of risk, e.g. design and construction risk (cost and time); commission and operating risk (including maintenance); demand for volume/usage risk; residual value risk; technology obsolescence risk; regulation and legislation risk; etc. The fundamental idea of PPP is the assumption that risk transfer from public sector might be properly allocated and thereby to increase overall investment into public services. As far as the risk transfer is concerned, the receiving party has to possess both the competence to appraise risk adequately and the expertise and experience necessary to control or minimise it. The private sector companies are in a better position to manage some risks than the public sector bodies, either because they have the experience and expertise or because private consortia had greater freedom and scope to manage risks. Public sector bodies can use some specific tools for a variety of prospective plans. Usually, when preparing development programmes they work out a so called ‘public sector comparator’ to study likely costs and risks, which would have been attendant on given actions. Then they can study possibilities to transfer some risks in the PPP/PFI framework and make considerations on further development. The competence to appraise risk adequately is therefore essential.  More information may be found here.

Auditing Issues and Concerns
In general, auditing PPPs is a new field of audit for most SAIs. Some countries though already have long history of implementation of PPPs and their SAIs already have experience with auditing this ever changing and emerging environment much earlier. Especially experience of the National Audit Office (SAI of United Kingdom) is valuable.

Legislative Issues
SAIs do not have same possibilities and conditions for auditing of the public/private types of cooperation. Legislative arrangements in various countries differ, as much as differs what constitutes PPPs as opposed to other types of partnership. SAIs should thus identify what is their audit remit and how this should be applied. In some cases legislation does not allow for audits of these kinds of partnerships. SAIs are encouraged to inform their parliaments about existing restrictions, and it is advisable to contact concerned private entities as well in order to explain the benefits of these types of audit.

Experience/Skills
SAIs with no experience in auditing PPPs may find these audits problematic in the beginning, as private sector is involved. Lack of professional preparedness, commercial expertise, guidelines or insufficient audit capacity may often be a limiting factor. It is therefore considered most useful to arrange trainings for auditors and seek experiences and best practice of other SAIs. Bad experience, examples of failure and what went wrong are also important to get acquainted with.
Sharing good practice and bad experiences with other public sector bodies and SAIs is therefore crucial as this helps overcome common problems.

Types of Audit Applied
Compliance, financial as well as value for money audits play an equipollent and important role in auditing PPP projects. Value for money is an important issue to be evaluated, and a range of performance measures should be applied in order to evaluate the economy, efficiency and effectiveness of each project. Achievement of value for money should be a key issue in the overall process.

Issues Related to Auditing PPPs
Auditing a PPP is a complex process that requires thorough planning before the audit itself begins. Particularly good preparation in advance preconditions that audit objectives are achieved. A number of questions should be given, as are i.a. the scope of audit or it’s objective. It may be misleading if SAIs focus their attention on narrow part of the project, such as accountancy, technical procurement or only on what went wrong.  

It is important to choose the best time for examining the project as well. Attention should be given to both stages of the project, i.e. the preparatory stage and the stage when PPP is implemented and running. In addition to that, long-term audits may be subject to re-examination where possible, ideally at regular intervals, since there is always a possibility that the SAI’s recommendations have not been implemented. A check on whether the project is still achieving it’s objectives.

Looking on the preparatory stage of a project, SAIs should ensure that alternative ways of procurement of service been considered and compared, that the PPP’s objectives and benefits have been set well, that the private body’s capabilities have been assessed well. SAIs should evaluate whether both parties of the partnership bear equal risks and whether none of the parties are disadvantaged. Budgets, cost management and project management should be reviewed. Attention should be directed on public sector comparators and whether they have been chosen well. 

Value for money is an essential part of every audit – questions on achievement of objectives, service delivery or confirmation of affordability should be always answered. Existing methodologies may not equip the auditor to assess the performance of new types of PPP. Benchmarking the quality of services is difficult when there are a few comparable projects or where the partnership’s objectives are not clear. Information for benchmarking may be gathered from other bidders or comparable projects from other states. Excluding performance issues from the audit cannot give a full picture and result. 

SAIs should take in consideration that the public sector does not always have adequate financial, legal or technical expertise to run such projects and that private bodies almost always have better resources, which puts them into advantage. 

Insufficient access to information and unwillingness of private (or public) sector to cooperate may also be an important and limiting factor. The private sector may fear commercial confidentiality; the public sector may not want to interfere with commercial freedom. 

Useful Resources
Good practice guides, recommendations, papers and audit reports may be found on the websites of the INTOSAI WGAP, national SAIs and other bodies. A brief list is given below.

•	INTOSAI WGAP website: www.nao.org.uk/intosai/wgap
Attention should be given to:
o	Guidelines on best practice for the audit of public/private finance and concessions
o	Guidelines on best practice for the audit of risk in public private partnerships (PPP)
o	Papers relating to WG’s 6th – 12th meetings (years 1999 – 2004) 

•	SAI United Kingdom: www.nao.org.uk
The National Audit Office provides an extensive list of reports, recommendations and other materials. Over 50 reports on PFI/PPP subjects have been published and are available at the above given website and are directly accessible here. 

By Radek Majer and Vaclav Perich (Supreme Audit Office, Czech Republic)
Nick Treen (SIGMA)