PPPs underwrite the lifestyles of the 5% Club

PPPs & the '5% Club'

There are other ways, argues ACTU President, Sharan Burrow

There are other ways

By Sharan Burrow

What is this 5 per cent Club? It's the collection of institutional investors, lawyers, accountants, merchant bankers and other private sector service providers, who take what could be a public sector infrastructure project and turn it into a private sector commercial venture, in order to both provide the infrastructure and make a quid.

This private venture bids for a contract being let by the state. If successful, the venture raises the necessary finance from the nation's capital markets to fund the project.

When private infrastructure providers go to private capital markets for finance, the bulk of the funds raised comes from institutional investors, and not directly from mums and dads. Institutional investors seek a minimum risk adjusted return.

For private equity in private companies, that minimum return is what is achieved for listed equities plus 5 per cent. For private equity in infrastructure projects, that return is the long term bond rate plus 5 per cent.

Add to that the margin on debt financing, and a list of fees as long as the list of wines on offer at Dan Murphy's, and one begins to get a feel for what the 5 per cent Club does when the private sector gets involved in public infrastructure.

Public-private infrastructure projects are 'win-win' situations for government and the 5 per cent Club. Governments keep the spending off-budget, even though they can do the projects themselves at close to the long term bond rate (being the cost to governments of borrowing funds).

This is a curious thing in an age of alleged economic rationality. The virtue of appearing to deliver 'small government' is seen to exceed that of obtaining the facility for the community at the best price, and with the highest standards of corporate governance and public accountability.

The 5 per cent Club pockets the 5 per cent premium, plus all the management-advisory fees and executive style salaries, so that its members can live in the life-styles to which they have become accustomed, since privatisations and private funding of public infrastructure created the 5 per cent Club in the 1980s.

And the fees that support such life styles from private sector infrastructure provision are substantial. There are legal fees, due diligence fees, a wide range of technical, financial and other advisory fees, success fees for winning a project, underwriting fees for fund raising, performance fees for exceeding the expected returns of 5 per cent Club members, and ongoing management fees for a variety of services provided through the life of the project.

This is all before we get into the list of fees and penalty payments that arise, should a dispute occur between the public and private sector, such as that at Victoria's Seal Rocks, over the terms and conditions of contract performance. It is also before the fees and public sector top up subsidies funded by taxpayers when commercial or political realities require it. For example:

• the $118 million paid by the Victorian government to cover electricity price increases with the move to full competition;
• the $105 million paid to public transport operators Connex, National Express and Yarra Trams;
• the $65 million paid to ticket machine operator Onelink.

The inevitable consequence of paying an excessive risk premium, and this legacy of a cascading series of fees, penalty payments, litigation costs and public subsidies (almost all of which were not included in the cost-benefit equation in past studies purporting to show PPPs as the lowest cost option), will be a substantial increase in the future cost of regulating PPPs.

This raises a further issue. If the public sector is to regulate PPPs, it will be essential that the public sector retain key personel with the technical competence to conduct the appropriate assessments on tenders and proposals. Someone responsible to government must be able to distinguish the wheat from the chaff and to advise accordingly.

In earlier times, these same public sector people were responsible for planning public infrastructure projects, and organising finance and letting construction contracts to private firms. No government relying on PPPs to deliver infrastructure can responsibly divest its public sector of the capacity to make the necessary project and contract assessments.

In my judgement, given the current debate on corporate governance, the additional regulatory costs are likely to dwarf the post September 11 surge in insurance premiums.

As ever, it will be the taxpayer that foots the bill for all of this. Though risk transfer is often said to be at the heart of PPPs, the fact is that the Club gets its risk premium and its elaborate set of fees, whether it's a relativity risk free project like a toll road, or a higher risk investment like public transport, where the private provider is likely to be bailed out by government if worst comes to worst.

Whatever the PPP contractual provisions stipulate, at the end of the political day the risk stops with the public purse, because governments simply cannot or will not abdicate their obligations to their constituents.

There are of course other ways, and I am encouraged by the wide ranging public and private discussions now occurring over some of these alternatives.

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