Pulling together

South Africa boasts enormous potential for PPP development but this will only be fulfilled if clear regulation helps to alter the current attitudes, says John Janks

The South African government has developed a regulated process for PPPs to facilitate projects which bring private parties into the performance of what are otherwise government institutional functions. This programme has effectively been used instead of more conventional privatisations, which the government does not favour.

Given the pressures on government capital funding capacities, this is an important potential way to procure a wide variety of public facilities and services that would historically have been provided by government, with the involvement of some private capital, assumption by the private sector of much of the risk and the realisation of benefits from private sector efficiencies.

Requirements for PPPs

To regulate PPPs in accordance with constitutional and statutory requirements for transparent, competitive and equitable processes at the national and provincial levels, a dedicated PPP unit has been established in the National Treasury. It has been an effective regulator at those levels; under its aegis, a standardised guideline on PPP provisions has been published. While its provisions are not suitable for PPPs in all sectors, they provide clear explanations of the principles and requirements for PPPs where they do apply and include many specimen clauses.

Binding PPP regulations are designed to ensure that PPP procurements meet the constitutional and statutory requirements, that the government’s commitment to broad-based black economic empowerment is reflected and implemented in PPPs and that the regulatory involvement is active and extensive. It has had the unfortunate side-effect of contributing to PPP bidding processes being slow and expensive. Typically, few PPPs reach financial close in less than two years. Government institutions remain unrealistic in not recognising how much project requirements change and unexpected obstacles frequently are encountered, which add to both costs and time.

Disincentives to PPP bids

The private sector sponsors and funders are now finding that the high bid preparation and negotiation costs and the long timelines required before financial close is reached are serious disincentives. As might be expected, engineering and construction companies remain the most actively interested in sponsoring PPP bids, and the design and construction parts of awarded contracts are being implemented well. Much greater difficulty is being experienced in attracting and retaining the interest of suitable sponsors and contractors to undertake operations and maintenance. This is likely to become worse in the next few years.

South Africa has announced an extensive capital investment programme for infrastructure, especially to meet the requirements of the 2010 Football World Cup, which will be held in South Africa. In principle, many of these projects would be ideally suited for implementation as PPPs. However, regulatory problems and delays will have to be eliminated or greatly reduced and bidding cost issues addressed if wholehearted private sector involvement is to be retained.

Funding facilities

Debt funding of these PPP projects to date has been provided readily by South African banks. The funding instruments and terms have been very conservative. Traditional senior debt structures on project finance principles are standard. Banks have shown little creativity in structuring other PPP funding products. More creative use of the capital markets and of securitised debt instruments could increase access to PPP funding, especially for new black investors who lack conventional credit profiles, and could markedly improve the affordability of projects. The funding of black empowerment equity continues to be a serious brake on meeting the empowerment targets.

The Development Bank of Southern Africa (DBSA) has now introduced an empowerment funding facility that is helpful. It remains very conservative and, to better balance its risk, the DBSA insists that, where the empowerment participants use this facility, the other sponsors must include the DBSA in the senior debt funding. This makes the senior debt opportunities for other lenders less attractive. The political and social imperatives for empowerment are clear and widely supported. However, better funding solutions have to be developed to enable wider participation and more effective realisation of benefits.

At the national level, the strongest PPP sector is still in the provision of office accommodation and related facilities for national departments. This combination of construction and facilities management requirements has meant that these areas have developed the greatest experience and expertise in PPPs. In the energy sector, South Africa is fast reaching the limits of its generating and transmission capacity. The sector is being restructured and PPPs will become more common. In the meantime, there is a PPP project underway that will provide new peaking generation capacity.

Boosting the health sector

At provincial level, the greatest activity is in the health sector. A number of provincial health departments are using PPPs to have new facilities built, or existing facilities upgraded and extended. PPPs are also proving excellent vehicles to co-locate private health facilities in public hospital precincts, with the private sector operators taking on facilities management and other responsibilities in the public sections of those precincts as well. The most prominent provincial PPP currently is the Gautrain project, which covers the design, construction, operation and maintenance of a rapid rail link that will join Pretoria, Johannesburg and Johannesburg International Airport. Negotiations with the preferred bidder are well advanced and the financial close is expected very soon. This will be an interesting test of a number of the regulatory aspects of PPPs.

There is already litigation by some communities, which object to the process used to determine the route of this service. The bid process has taken much longer than was envisaged originally, while initial government cost estimates appear to have been significantly underestimated. This highlights an area of some concern to the private sector participants in PPPs. Very often, government capital and operating cost models seem based on unrealistically low assumptions and estimates. When bids fall outside these estimates, mistrust is fuelled, delays follow, and the relationships that should be partnerships become adversarial and difficult.

A broad new area of PPPs is about to open up with the introduction of enabling legislation at the municipal level. However, the regulatory scheme that has been adopted at this level is even more complex and potentially confusing than that at provincial and national levels. This will inevitably mean greater costs, longer delays and more unhappiness. Many government institutions find the PPP process confusing and intimidating and there are indications that local authorities will hesitate to use PPPs because of process uncertainty and fears of over-regulation, high bid costs and long delays. The greatest needs for delivery of services are at the local authority level, but there is a real danger that the regulatory difficulties will so inhibit municipal PPPs that the sector will not develop significantly.

There is a strong base on which South African PPPs can grow, but the sector must solve the regulatory difficulties and improve trust between public and private stakeholders if it is to grow as it could.

John Janks is a partner at White & Case