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Public-Private Partnerships (PPPs) have spread across the globe and caused a paradigm shift in many governments in the last two decades. Private sector financing, design, construction and operation of infrastructure and private sector involvement in public services provision have emerged as one of the most important models used by governments to close the infrastructure gap or satisfy the social service needs. PPPs are delivering new and refurbished roads, bridges, tunnels, water systems, airports, schools, hospitals, social housing, prisons and a range of social services in Western industrialised nations.
In line with the globalisation trend, emerging economies from other parts of the world are either following the PPP approach or observing its development with interest. Governments in the developing world, which are confronted by even greater needs in infrastructure and public services, are now learning the potential of PPPs in the provision of infrastructure assets and delivery of services (Deloitte, 2006). For instance Asia, where most of the emerging economies are located [i] , needs some US$3 trillion over the next ten years to keep up with the growing demand for infrastructure (Asian Development Bank, 2006). Rapid industrialisation and urbanisation have put a serious strain on Asian cities, which are set to swell by nearly half a billion people in the next 20 years. For many of these countries, including Malaysia, investing public funds in infrastructure will not be enough. The governments must bring in private investment to help them meet these enormous needs, hence the attractiveness of PPPs. The Malaysia government decided to adopt this approach when the Rt Hon Abdullah Badawi took over the Prime Minister's post from his long-serving predecessor. His successor, the Rt Hon Najib Tun Razak, intensified it.
According to the Malaysian government, the country's PPP will be based on the British model. Britain and Australia are world leaders in PPPs. Their experiences may offer many learning opportunities for the late-comers. For instance, Handley-Schachler and Gao (2003) listed UK successes and failures of PPPs that could provide lessons for the emerging economies and highlighted the need for technical assistance in those countries. Regan (2006) highlighted Australian's involvement and contributions to the Public Private Partnerships in the Asia-Pacific region. On the other hand, some PPPs challenges encountered by emerging economies are rather unique (e.g. Forsyth, 2005) and require novel solutions.
Indeed, Malaysia has to face dilemmas in PPP due to the tension between its unique social, economic or political agendas, and the universal or underlying principles of PPP. This chapter demonstrates this by looking at a particular form of PPP which is being promoted in Malaysia, i.e. the Private Finance Initiative or PFI.
The Global Diffusion of Private Finance Initiative (PFI)
PFI is a relatively new but well-established model of PPP. The model has been widely adopted in the West before coming to Malaysia. PFI was invented in Australia in the 1990s, but it has been implemented most actively in the UK in the last two decades. There are 920 signed PFI projects in the UK (as of 2010), comprising new and refurbished schools, hospitals, roads, bridges, tunnels, water systems, waste incinerators, airports, social housing, prisons and a range of social services across the UK. The total capital value of PFI contracts signed by 2010 was £55bn. But the overall bill for the contracts is more than £262bn, i.e. the government has been committed to future spending of £262bn in the next 50 years (over the life of the signed contracts) -- with the peak bills due in 2017-18. There is a fresh catalogue of further projects valued at £11bn (capital costs only) - currently under negotiation.
Education and Healthcare and hospitals are the two largest clusters of public services that have adopted PFI. Nearly 100 education PFI deals valued at GBP3.5 billion have been signed in the UK. The largest deal was the Glasgow Schools Project, worth GBP 225 million (in capital asset alone), which involves a 30-year contract between the government and a consortium (3Ed) to build 11 new PFI schools and convert 18 existing schools into PFI schools around Glasgow, the largest city of Scotland. In healthcare, 85 percent of major UK National Health Service (NHS) projects have come under the PFI scheme. There have been 130 PFI hospital projects compared to only 12 publicly funded hospital projects. Contract terms are generally 30 to 35 years.
Portugal has launched a US$37 billion PPP to build 31 hospitals by 2014, where the contract covers not only the conventional PFI (design, construction, financing, maintenance, and operation of the facilities) but also hospital management and some clinical services. PFI have also been adopted in many other countries including Canada, US, France, Italy and Spain.
PFI was first proposed in the Ninth Malaysia Plan (2006-2010) by former Prime Minister Abdullah Badawi but most of the projects were never carried out or completed due to his short tenure. His successor Najib Tun Razak has promised to accelerate the implementation of the 9MP projects besides launching the new ones. 52 PFI projects worth some RM63bil (GBP16bil) have been identified under the Tenth Malaysia Plan (2011-2015) and was announced by Najib in June 2010, including seven highway projects, two coal-fired power plants and six UiTM campuses. The total PFI projects targeted for the five-year period are worth RM200bil. To achieve the target, the government plans to invest at least RM20bil to facilitate private investment. PFI is given such a boost as it is one of the major strategies to achieve the private sector-led Economic Transformation Programme (ETP)(2010-2020).
What is PFI?
For the public sector, PFI is a procurement method which secures private funding for the development of public infrastructure, together with the provision of associated services such as facility management and maintenance. For the private sector, PFI is a business model to deliver infrastructure and related ancillary services on behalf of the public sector, in return for a long-term and secured revenue, usually in the form of unitary payment or on a "no service no fee" performance basis.
The uniqueness of PFI compared to other forms of public project financing is that it focuses on whole-of-life costing and full consideration of risks. The key for successful PFI is an optimal risk allocation between the public and private sectors - any risk should be allocated to the party which can manage it most effectively. In general, PFI aims to use the innovative skills and abilities of the private sector in a way that is most likely to deliver value for money and improved public services.
Figure 1 shows the comparison between conventional public procurement, PFI and privatization
Figure 1: Comparison of Conventional Public Procurement, PFI and Privatization
Funding via public budget.
Funding via private investment without explicit public sector guarantee.
Funding via private investment without implicit or explicit public sector guarantee.
Immediate impact on public sector financial position.
Impact on public budget spreads over the duration of the concession.
No impact on the level of public sector expenditure.
Risks are entirely borne by public sector.
Risks are allocated to parties which can manage them most efficiently.
Risks are entirely borne by the private sector.
Relationship between public sector and private contractor is short term.
Relationship between public sector and private contractor is long term.
Relationship between public sector and private contractor is long term.
Extensive public sector involvement at all stages of project life.
Public sector's involvement is through enforcement of pre-agreed KPIs.
Government acts as regulator.
Private sector acts as contractor or sub-contractor only.
Private sector plays major role through all stages of project.
Private sector plays major role through all stages of project.
Applicable for projects with low commercial viability or require full public sector control.
Applicable for projects which are commercially viable where public sector is the main purchaser.
Applicable for projects with high commercial viability where public sector is not the main purchaser.
(Adapted from 3PU guidelines)
The Malaysian Dilemma with PFI
PFI has been controversial as a preferred government option for the development of public infrastructure and services. It has presented many challenges for even the most mature PFI players i.e. Britain (e.g Gaffney and Pollock, 1997; Froud, 2003; Shaoul, 2005) and Australia (e.g. Johnston Gudergan, 2007; English, 2007). In the UK, for instances, examples of the more recent challenges include transparency (hood et al. 2006), value-for-money (Coulson, 2008). accountability (Asenova and Back, 2009) and stakeholder management (Foo et al., 2011). Claiming as a follower of the British PFI model, Malaysia is not exempted from those challenges. Furthermore it has to face additional dilemmas for part of the underlying philosophy and some of the standard operations of the British/International PFI framework pose challenges to the local unique social, economic and political agendas.
The key feature of typical PFI schemes is significant risk transfer from the public sector to the private sector. The case for PFI is that it illustrates the endeavour of the public sector to achieve a proper sharing of the project risks and rewards. The public sector does not act as an ultimate project guarantor against any latent losses. (Erridge and McIlroy, 2002) Unlike traditional procurement, PFI-based procurement puts an emphasis on the provision of service rather than the provision of a facility and which places higher level of responsibility on the private sector over an extended period of time (TTF, 1997; HM Treasury, 2000). This allows the private sector to utilise efficiencies arising from long-term asset management as well as giving it incentives to introduce innovative solutions.
The transfer of risk in PFI projects involves two elements. Firstly, the payment mechanism is subject to availability and performance of the facility. Secondly, the contractual terms identify the party responsible for each particular risk. One major tool for achieving VFM in PFIs lies in the mechanism for efficient transfer, allocation and management of project risk, whereby the implicit presumption is that the private sector is better equipped to manage the main types of project risks.
In the UK, the Private Finance Panel (PFP) (1995) classifies risks into these categories: (1) Design and construction risk: the possibility for design and construction faults, cost and time overruns, which are common in large-scale construction projects (2) Commissioning and operating risk - maintenance and life-cycle issues which occur during the commissioning and operating phases.(3) Demand/ volume/usage risk - the uncertainty that the project is economically viable and will attract sufficient number of customers/users. (4) Residual value risk - the uncertainty about the value of the asset at the end of the concession period.(5) Technology / obsolescence risk - where new or unproven technology fail or become outdated (6) Regulation and legislative risk - the introduction of new legislation that affect the cost or usage (7) Disposal risk - the cost of some project-related assets can deflate. (8) External financing risk - the inability of the project company to raise capital or changes in interest rates occurring during long negotiation periods (Allen, 2001). Typical PFI contracts usually contain a risk matrix that spells out the percentage of distribution of the risks to the public and private sectors, and the nominal prices for the risks.
The question for PFIs in Malaysia is whether genuine risk transfer is achievable. This is a reminiscent of the experience of the previous privatisation era which was filled with the challenges of political patronage and rent-seeking (Jomo, 1997; Tan, 2008). Lucrative projects were awarded to government-linked companies (GLCs) or individuals closely associated with segments of the political leadership, who bore no or little risks. The expansion of highway construction has seen the private companies reaping high profits as the demand/usage risks are eliminated by the closure of alternative roads. The introduction of independent power producers (IPPs) resulted in unequal power purchasing agreements (PPAs) where the public (through the state-owned national electricity company Tenaga Nasional Berhad) guaranteed the minimum purchase of electricity at high prices. The privatisation of water treatment in Selangor involved 20-25 year concession agreements to allow private companies sell treated water at a set price to the state Water Supply Department (PUAS) which distributed this water to consumers). As a result, while the private companies made annual profits between US$10 million and US$47 million in 2001, PUAS faced annual deficits of around US$100 million (Hall et al 2004). In many projects, the private companies also bore minimum financial risks through substantial state support such as soft loans, tax breaks credit guarantees and even the transfer of public assets to generate cash flow for the former. For example, In the North-South Expressway (NSE) project which began in 1987, the transfer of 335km of public highway from the government to the concessionaire, United Engineers Malaysia (UEM), allowed the latter to start earning toll revenue while it was completing the remainder of the road (Tan, 2008).
The above examples show that the PFI requirement for genuine risk transfer may become a challenge for Malaysia. There has been a deep-rooted culture for lopsided risk distribution as the public sector (and the people) has tolerated a long period of disadvantaged deals and the major concessionaries are used to profiting from risk-free deals. Rigorous review and significant transfer of risks may drive the major concessionaries away from PFI projects and put the entire initiative and related-programmes (e.g. ETP) at risk. Although risk matrices are being introduced to Malaysian PFIs, it remains to be seen if their patterns of risk distribution will divert from their British counterparts. Even if the contractual patterns of risk distribution are similar, either project parties may hold assumptions or implicit guarantee which may defeat a genuine transfer of risk, for example, that the government will bail out the private sector should any high-impact risks materialise.
A key for the feasibility of PFI projects is the availability of private finance. The proponents of the PFI in the UK argued that, under the existing financial regime, the level of investment desired by the government would be unsustainable without private capital. For example, in the NHS from 1997 to 2001 there had been 20 signed hospital projects, while before 1997 there was one hospital delivered every seven years and it was taking ten years to complete the planning process alone (Stone, 2001).
PFI projects are financed by the private sector partners. Private companies, which usually comprise of a building contractor, a bank and a facility management company, set up the project legal entity called the special purpose vehicle (SPV) or consortium (See Figure 2). The SPV bids for deals and signs PFI agreements with the public sector which is know as the client. SPV members are also known as sponsors because they usually provide the 'seed equity capital' and thus 'own' the project during the concession period (Merna and Smith, 1999). The SPV is a firm in its own right, distinct from the mother organisations of its members. Apart from small amounts of sponsors' equity (10-15%), capital requirements of PFI projects are usually met through some form of project loan. In addition to traditional bank loans, other financing methods used in PFIs include the bond market, mezzanine finance, lease finance and mortgage finance. The bank as one of the SPV members usually provide or help arrange for the above (e.g. syndicated loan). At the climate of PFI trend in the UK, most commercial banks in London (such as HSBC, Lloyds, HBOS and RBS) and several foreign banks find PFI as an attractive form of investment.
Figure 2: Typical set-up of a PFI scheme in the UK (note the role of banks as financier). (Source: Beenhakker, 1997)
Figure 3: Typical set-up of a PFI scheme in Malaysia (note the role of EPF as financier). (Source: Netto, 2006 cited in Takim et al. 2009)
The situation is Malaysia is rather different. Local commercial banks are still relatively inexperienced and sceptical in providing project financing for PFI projects. Only government-linked banks, such as Bank Pembangunan, have entered the PFI market. In order to facilitate the implementation of PFIs, under the Ninth Malaysia Plan, the Ministry of Finance Malaysia has acquired a substantial amount of funds to facilitate the first wave of PFI implementation in Malaysia (Jayaselan and Tan, 2006). The PFI Sdn Bhd, a specific government body set up by the Ministry of Finance to administer the Malaysia PFI procurement process, will borrow money from The Employee Provident Fund (EPF) to finance selected projects. EPF has agreed to invest RM 20billion in terms of loan to facilitate PFI projects. Investment from EPF will be channelled via PFI Sdn. Bhd to the construction contractors and facility operators (see figure 2). Subsequently, in the tenth Malaysia Plan, a RM20bil facilitation fund is set up by the government to help kick start crucial projects. At least RM15bil will be given to the private sector in the form of grant (3PU, 2010). It is thus clear that in both Malaysia Plans, the financing for PFI will come from public coffers (EPF, facilitation funds or the government-linked banks) rather than from commercial banks. This is a unique Malaysian solution to the unavailability of private finance in the so-called Private Finance Initiative.
While the solution has helped Malaysia to kick-start its first and second waves of PFIs, it represents a significant diversion from the underlying philosophy and standard procedures under the international framework. Project financiers have an important role regarding the overall risk management and the financial stability of projects. The commercial interest of SPV members requires each party fulfils their contractual obligations in the agreed time scale (Asenova, 2009). In order to minimise their own risk exposure, banks can adopt a range of strategic approaches, such as selecting consortia with reliable track record, observing an optimum contractual risk distribution, which does not permit the SPV to take unjustified risk, ensuring that the projects are well managed and finally, saving projects that are failing by taking over the project work or replacing the contractors and sub-contractors. In the case of Malaysia, without a significant presence of private-sector financier, the above goals may not be materialise.
Most PFI projects in the UK involve competitive bidding, although rare exemptions are allowed for contracts of small value, as long as compliance with EC and UK procurement rules is maintained (PFP, 1995).
As mentioned, the Value-for-money (VFM) requirement is a major criterion in the selection of PFI as the procurement method from the options available. This requirement is to be met through the use of competitive tendering process and the selection of the most cost-efficient bid, whereby special attention was to be paid to innovative solutions, additional benefits or income generation elements. Furthermore, VFM is demonstrated by comparing private sector bids with an independent, risk-adjusted public sector comparator (PSC), which describes in detail all costs to the public sector if the project were developed through traditional non-PFI means.(TTF,1998).
It is important to ensure the availability of sufficient market interest from potential private sector bidders for a genuine competition (Asenova, 2009). Throughout the stages 7-12 of the PFI process (see figure 4), the public sector clients have to maintain the competitive tension between the bidders. To facilitate bid evaluation, the public sector client usually establishes a procurement team with competence that ideally matches that of the bidders.
Figure 4: The main stages of the PFI process from the prospect of the public sector. Source: TTF (1998)
Meanwhile, the bulk of Malaysia's privatisation programmes have gone to unsolicited projects initiated by the private sector. For projects initiated by the public sector, the contracts were often awarded without any open tendering. A non-competitive selection process resulted in beneficiaries being mainly individuals or companies closely connected to the political leadership (Tan, 2008). Despite dissatisfaction of foreign investors and local business communities, the government has not made much progress with the implementation of the competitive selection process as it will affect the vested interest of politically-linked individuals and business as well as contradict some local ethnic-based affirmative action agendas.
The requirement to use competitive tendering process of PFI therefore represents a real dilemma to Malaysia. A Public Private Partnership Unit (3PU) has been set up under the Prime Minister Department in 2009 with the roles being to formulate PFI policies and guidelines, screen and evaluate PFI applications. 3PU has claimed that they will use the competitive tendering process. As of January 2011, PFI projects which are listed by 3PU as at the tendering or pre-qualification stages include the Integrated Public Transportation Terminal in Gombak, Teaching Hospital of the UIA (International Islamic University) Medical Campus in Kuantan, the Fish Landing Port in Sandakan and the UKM (The National university of Malaysia) Children Hospital in Kuala Lumpur. The evidence thus far shows that the government is prepared to embrace the universal practice of competitive tendering process but the extent of the practice remains to be seen.
Malaysia has faced dilemmas in embracing the international framework of PFI as parts of its underlying philosophy and standard operations pose challenges to the local unique social, economic and political agendas. Three examples are given in this book, i.e. the transfer of risk, funding party and bidding process. Malaysia has responded to these three challenges differently: in the first case of risk transfer it has yet to find any solutions; in the second case of funding party, it has created a unique solution which diverts from the global practice; and in the third case of bidding process, it has accepted the global practice. The cases from PFI reinforce the book's proposition that Malaysia has not been "propelled" into a global order as predicted by Giddens but has cautiously accepted a new paradigm of public-private-partnerships from the developed nations by filtering what is allowed to seep in.