Back Matter

Back Matter

M. Cangiano, Barry Anderson, Max Alier, Murray Petrie, and Richard Hemming
Published Date:
April 2006
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    Joint ventures are usually set up to exploit the commercial potential of existing government assets; franchising involves competition between private companies to be a monopoly supplier (often in a local market); and contracting out refers to the outsourcing of supply to the government. The terms franchising and contracting out are often used interchangeably.

    This may limit efficiency gains insofar as a private operator cannot tailor an asset to meet service requirements. However, in Chile, most PPP projects are tendered with detailed design and engineering studies provided by the government, with a view to promoting small firms’ participation in PPPs and thus increasing competition.

    This is the case for many PPPs in Italy and Spain. The PIDIREGAS scheme in Mexico includes PPPs between public enterprises in the electricity sector and private companies for the provision of assets and services.

    PIDIREGAS is the Spanish acronym for “long-term productive infrastructure projects with deferred impact in the recording of expenditure.” Most PIDIREGAS projects are for the provision of assets only.

    While a focus on DBFO schemes accords with common usage of the term PPP, the United Kingdom considers PPPs to encompass broad private sector involvement in government activities, including privatization and contracting out. DBFO schemes are part of the U.K. program. Accountants include PPPs under a range of schemes referred to as service concession arrangements, which also cover contracting out and franchising.

    With prisons, private construction and operation are possible. There are doubts, however, as to whether all prison services can be contracted; clearly, detention can, but this is less obviously true for rehabilitation.

    SPVs are specific to individual PPP projects and should therefore be distinguished from institutions set up to facilitate PPPs and infrastructure investment in general. The National Development Finance Agency in Ireland is an example of the latter.

    The International Financial Reporting Interpretations Committee (IFRIC) of the International Accounting Standards Board (IASB) identifies four criteria for consolidation: SPV operations are decided by the originator; the originator controls the SPV; the originator benefits most from the SPV; and the originator assumes SPV risk (IFRIC, 1999).

    While there are as yet no obvious examples of problems created by SPVs set up in connection with PPPs, SPVs have been a concern in other spheres. A recent proposal to establish an SPV to facilitate the leasing of 100 Boeing aerial refueling tankers by the United States Air Force is a case in point. The Congressional Budget Office (CBO) concluded that the SPV would, in effect, be substantially controlled by the federal government and that its transactions should therefore be reflected in the federal budget (U.S. CBO, 2003a).

    For further discussion of securitization, see Chalk (2002). While they are not connected to PPPs, securitization operations in Italy have raised questions as to their appropriate accounting treatment. In one case, the government sold real estate at a below-market price to an SPV to use as collateral in issuing bonds on its own account to pay the government. Eurostat decided that the bonds should be counted as debt and the sale of the real estate should be recorded on budget, because the risks and rewards related to ownership had not been transferred to the SPV.

    The limited use of PPPs in New Zealand may come as a surprise given that the country has been at the forefront of public sector reform. This is due to their association with privatization, which has not proved popular in New Zealand in the wake of problems in the privatized electricity sector.

    PPPs are growing especially rapidly at the subnational level. Torres and Pina (2001) report that about 30 percent of services provided by larger subnational governments in Europe are delivered through PPPs.

    European Commission (2004b) and Brenck and others (2005) provide details about PPP projects in a number of European countries.

    After the bailout of private road operators in the 1980s, road concessions are now being reconsidered as a means of addressing the poor quality of the road network in Mexico, based in part on the fact that rail concessions have been a moderate success. While urban water supply and sanitation are open to the private sector and candidates for PPPs, there has been little private investment in these areas. Beyond the energy sector, most progress has been made with respect to telecommunications, ports, and airports, but this mainly takes the form of privatization. See World Bank (2003) for more details on private infrastructure investment in Mexico.

    This has been included as part of a wider development financing strategy proposed by the Rio Group of Latin American countries. The Rio Group was set up in 1986 to enhance consultation and coordination between Latin American countries on political, economic, and social issues.

    Many useful papers are collected together in Grimsey and Lewis (2005).

    For an analysis of market and nonmarket failure, see Wolfe (1993).

    Bundling clearly places a premium on the private sector’s ability to make integrated bids for PPP contracts covering each element of a DBFO project. This being the case, an SPV with responsibility for all aspects of a PPP project can contribute to effective bid integration.

    These five main risks can be further subdivided. Detailed risk matrices, together with indications of who should bear each type of risk, are provided in South Africa and the state of Victoria, Australia.

    The government’s ability to forcibly spread risk across taxpayers, while financial markets have to be provided with an incentive to accept risk, may put the private sector at more of a disadvantage as far as large and very risky projects are concerned. The scope for the private sector to spread risk also will be somewhat limited in countries with less developed financial markets.

    The private sector may in some cases face lower borrowing costs than the government, for example, when there are serious concerns about government liquidity and/or solvency and for foreign partners of many developing country governments.

    For example, under the capital asset pricing model (CAPM), which is widely used by the private sector, the expected rate of return on an asset is defined as the risk-free rate of return plus a risk premium, and the risk premium is the product of the market risk premium and a beta coefficient which measures the covariance between the returns on that asset and market returns.

    In those cases where the government uses a discount rate that includes a market risk factor, this is usually arbitrary and low. It therefore changes the size of the bias but does not remove it. Grout (1997) concludes that the long-standing practice of using a STPR of 6 percent in the United Kingdom, which includes a risk factor, created a bias against the PFI projects. This bias should have been removed with the reduction in the STPR to 3½ percent and the requirement for more systematic assessment of risk in comparing public investment and PFI options.

    While not a PPP, the channel tunnel between the United Kingdom and France illustrates this point; it was chosen over a road tunnel that would have offered better service to users because private investors favored the lower-cost option offering quicker, more secure returns (see Kay, 1993).

    The Merloni Law contains specific provisions on concessions. One requirement of the law is that the winner of a concession contract is required to set up an SPV, with a structure and capitalization established by the public agency that awards the contract. For further discussion, see De Pierris (2003).

    The law facilitates private financing by allowing a number of financing techniques, including securitization and shadow tolls. Concessions can also be used for practically any kind of infrastructure and not only for roads as previously. See Montesinos and Benito (2000) and Acereite (2003) for further discussion of PPPs in Spain.

    The Unità Tecnica per la Finanza di Progetto (UTPF) in Italy, which began operating in 2000, is by name a project financing unit, but in practice it helps the public administration to identify projects that could attract private sector investment.

    Partly in response to such concerns, in Chile and Italy private sector entities are allowed to propose projects to be developed as PPPs.

    International Public Sector Accounting Standards (IPSAS) 13, Leases, issued in December 2001. IFAC is a global accountancy organization whose main purpose is to establish high-quality accounting standards and to promote international convergence of standards. It also recommends accounting standards for the public sector through the International Public Sector Accounting Standards Board (IPSASB), which was formerly IFAC’s Public Sector Committee (IFAC-PSC).

    Since 1990, the U.S. Office of Management and Budget (OMB) has used these three criteria, and three others—1) who owns the asset during the contract period, 2) whether the asset is a general- or specific-purpose asset, and 3) whether there is a private market for the asset—to distinguish an operating lease from a financial lease (or in U.S. terminology, a capital lease). See U.S. OMB (2002) and U.S. CBO (2003b) for more details.

    Residual value risk is borne by the government because the private operator reflects the difference between the expected residual value of the asset and the price at which the asset will be transferred to the government in the price it charges the government for services, or in the revenue the government receives from a project. If the asset ends up being worth more or less than the amount reflected in the service payment or government revenue, any resulting gain benefits the government and any resulting loss is borne by the government.

    It is interesting that Eurostat does not place any emphasis on residual value risk, given that it is a clear ownership risk.

    This is being done for service concession arrangements under the auspices of IPSASB. An Interagency Task Force on Harmonization of Public Sector Accounting is also addressing this topic. With the exception of Donaghue (2002), little has been written about the accounting treatment of PPPs.

    See, respectively, Inter-Secretariat Working Group on National Accounts (ISWGNA, 1993), European Communities (2003), and Eurostat (2002).

    Although ESA 95 is accepted only in the European Union, while the 1993 SNA is internationally accepted, it is likely that a harmonization of the two standards will move the 1993 SNA in the direction of ESA 95 as far as PPPs are concerned.

    Existing accounting and reporting standards also cover government guarantees. Their recording is covered in Chapters 2 and 3.

    The term “operating statement” refers to the GFSM 2001 Statement of Government Operations.

    The treatment of concessions has been questioned. Because a concession involves the transfer of the government’s monopoly power to the private sector, one view is that concessions should be considered nonfinancial assets. This view can be seen as an extension of the discussion about how to treat mobile phone licenses. However, in the case of mobile phone licenses, it was agreed that the government retained ownership of an underlying asset, the spectrum, whereas in the case of concessions no such asset exists.

    When the government leases an asset from a private owner, lease payments by the government are recorded as an expense; however, this is not usually regarded as a PPP since it does not involve private service provision.

    Provided that the liability is reduced at a faster rate than that at which the asset is depreciated.

    As noted below, PPPs do not typically take the form of financial leases, although they can be treated as such.

    If the government pays more than residual value for an asset, the asset is still acquired by the government at its true residual value, and there is also a capital transfer from the government to the private operator.

    In the case of the United Kingdom, this practice has resulted in 57 percent of PFI assets being classified as government assets (H.M. Treasury, 2003).

    A shift in focus from ownership to control in determining private sector accounting is proposed in IFRIC (2005), which has been circulated for public comment.

    An obligation arising from an expectation that the government will behave in a particular manner is more generally referred to as a constructive obligation, although this term can usefully be restricted to the government’s obligation to continue ongoing policies (as distinct from one triggered by an uncertain event).

    For further discussion of how different government obligations are characterized, see Heller (2004).

    This is because contract prices for services provided by the private sector to the government take into account the transfer price. Whatever the transfer price, as long as it is fixed, the government loses if the asset is worth less than the transfer price and gains if the asset is worth more than the transfer price.

    Regarding the experience with infrastructure guarantees in the Asian crisis countries, see Mody (2002).

    Similarly, public enterprises privatized during the 1990s in Argentina were granted revenue guarantees, many of which were called when the economy stagnated.

    European Commission (2004a) discusses the fairly extensive guarantees and other contingent liabilities in the new EU member states. Table II.8 in particular provides some quantitative estimates, but these are not comparable across countries. However, a number of countries have explicitly guaranteed debt (and therefore a maximum risk exposure) in the range of 10-15 percent of GDP (Cyprus, Czech Republic, Slovakia), and guaranteed debt is of a similar order of magnitude elsewhere (India, Thailand). The table also quantifies some other significant contingent liabilities, including the debt of privatized enterprises and decommissioning costs in Lithuania (6¼ and 7 percent of GDP, respectively) and reprivatization in Poland (5½ percent of GDP).

    The Report on Public Finances also provides information on expected cash flows through 2024 under the minimum revenue guarantee, revenue sharing, the exchange rate guarantee, and the minimum pension guarantee. The minimum pension guarantee is estimated to be considerably more costly than the guarantees provided to concession operators.

    Lithuania has used a similar approach to value loan guarantees provided to private firms.

    If a guarantee fee is charged at origination, this is recorded as nontax revenue. Guarantee fees are discussed below.

    In general, contingent contracts are not recognized as liabilities under GFSM 2001 because they are not unconditional claims or obligations. Only where a contingent contract relates to a financial arrangement that has value because it is tradable (a financial derivative) does GFSM 2001 treat the contingent obligation as a liability.

    Of the countries that provide examples of good practice, the detailed assessment of various guarantee programs in the United States is the most easily accessible (see U.S. OMB, 2004a). Other country examples include Brazil, Czech Republic, Pakistan, and South Africa.

    However, inclusion as contingent liabilities of the net present value of obligations under social security schemes (in addition to the stock of explicit government guarantees) is a mistake for the reasons outlined earlier.

    Information on guarantees (and other contingent liabilities) is subject to audit by the supreme audit institutions in Canada, New Zealand, and the United States.

    There may be some situations in which disclosure of an estimate of the likely fiscal cost may prejudice the government’s position in a dispute with third parties—for example, estimating the expected cost of legal action being brought against the government. In these situations, which will be infrequent, it may be sufficient to disclose just the gross exposure (accompanied, in the case of potential legal liabilities, by a disclaimer that this in no way reflects an admission of liability).

    Whether the central government specifies a ceiling that covers subnational governments will depend primarily on whether the central government explicitly or implicitly stands behind subnational governments.

    In addition to Canada, other countries that have quantitative ceilings on guarantees include Hungary, Israel, Japan, Kazakhstan, Latvia, the Netherlands, Portugal, and Tunisia.

    It is also important that the government make it clear when it does not stand behind a project or an entity; in other words, it should be explicit about the lack of an implicit contingent liability.

    For example, in South Africa the Municipal Finance Act 2003 stipulates that municipal debt guarantees can only be issued with national government approval and only if the municipality creates a cash-backed reserve or purchases insurance to cover the debt. This limits the national government’s implicit counterguarantee.

    This appropriation might be a general contingency appropriation, covering a variety of contingent and unexpected events, but in countries where payments on called guarantees are significant, a separate guarantee appropriation is likely to improve transparency and accountability. This is the practice, for instance, in Hungary, Japan, Kazakhstan, Malaysia, Mexico, and the Slovak Republic.

    Policies will be required to establish the point at which payments under called guarantees are treated as public debt service and cease to be a charge against the guarantee appropriation.

    For the very small number of countries that both report and budget on an accrual basis, and where the calling of a guarantee is not expected to result in a liability that is matched by an asset, a decision to recognize a guarantee as a liability will mean that an expense equivalent to the full expected cost is automatically recorded in the budget.

    Where uncertainty over expected costs is high, the level of existing exposures is high, and/or guarantees have proliferated out of control, a government may wish to adopt a cautious approach to deciding the margin. At the limit, it would be possible to budget for the full gross exposure under new guarantees, as the Netherlands did at one stage before moving to budgeting for a measure based on expected cost.

    For a description of how the federal credit guarantee operates, see U.S. OMB (2004b). Similar issues arise with respect to government-provided insurance, and it has been proposed in the United States to introduce for insurance programs the same sort of expected cost budgeting that operates for the credit guarantee, although this has not been adopted to date.

    Future payments from such a fund would not impact the budget measured on an accrual basis at the time they are made, as the money in the fund would already have been appropriated and incorporated in the budget at the time the guarantees were initially granted.

    The amount to be set aside will not necessarily be the same as the amount budgeted. This would depend on the anticipated distribution of costs over time and the extent to which the government wishes to ensure there will be sufficient funds to meet the costs of possible calls or guarantees under various eventualities. The size of the fund should be subject to regular actuarial review to ensure that it is sufficient to meet its intended objectives.

    For instance, overall risk may be reduced by pooling unrelated risk exposures, so that earmarking funds for the expected cost of each individual guarantee and guarantee program may result in over-reserving of funds.

    Origination fees may at least help to establish a link to the annual budget process; also, the sponsoring department could be required to report a contingent liability on its books with respect to the copayment (it would be required to do so under accrual accounting).

    This also improves allocative efficiency by fully costing all inputs to infrastructure projects and by removing implicit untargeted subsidies to consumers.

    However, financial markets in the United Kingdom are aware that these payments—which are fully disclosed—are a liability and there have been some calls for this liability to be added to public debt.

    Indeed, it will require the disclosure of additional information about guarantees, beyond that recommended in Box 7. To ensure consistency with the debt sustainability analysis, economic and financial assumptions used for valuation, together with the currency composition of guarantees, would have to be disclosed, while the disclosure of the riskiness of expected guarantee payments would facilitate sensitivity analysis.

    Moreover, such an approach could end up being tantamount to a blanket prohibition of new guarantees when the aim of being alert to fiscal risks is to filter out unjustifiable guarantees.

    Barnhill and Kopits (2004) also apply the VAR approach to assess government balance sheet risks and fiscal sustainability in Ecuador, and they conclude that traditional debt sustainability significantly understates fiscal vulnerability in the face of volatile sovereign yield spreads, exchange rates, and oil prices, combined with fiscal rigidities.

    Based on discussions with officials at the Ministry of Finance, Ministry of Public Works, Ministry of Planning, representatives of the financial and nonfinancial private sector, and academics. It also draws on Cruz, Barrientos, and Babbar (2000); Gómez-Lobo and Hinojosa (2000); and Engel, Fischer, and Galetovic (2003).

    As an alternative to the minimum revenue guarantee, since 2002, highway concession firms have been allowed to switch to a revenue distribution mechanism whereby the concession contract is changed from fixed to variable term, with the duration of the contract depending on future revenue. A least-present-value-of-revenue franchising mechanism has also been tried, where the concession ends when the contracted present value of revenue is reached. Only a few concession firms have opted for these alternatives.

    Based on material available on the Department of Finance Public-Private Partnership website ( and on discussions with Pat O’Neill and Cormac Gilhooly of the Central PPP Unit in the Department of Finance.

    Most notable are the Eastlink and Westlink bridges on the M50 in Dublin, which have been operated by the private National Toll Roads Company (NTRC) on a concession basis since 1984 and 1990, respectively.

    Of total infrastructure investment amounting to I?17.6 billion for 2000–06 (about 22 percent of annual GDP), I?1.85 billion was to be in the form of PPP projects.

    In addition to PPP projects financed by user charges amounting to €1.35 billion targeted for 2004—08, the National Development Finance Agency (NDFA) would raise and additional €3.6 billion in private finance for infrastructure investment, including through PPPs.

    This was subsequent reaffirmed in Framework for Public Private Partnerships in Ireland, a statement of high-level principles for the conduct of PPPs, which was published in November 2001.

    The two largest ongoing public transportation construction projects, the Dublin light rail system (LUAS) and the port tunnel, involve traditional public investment and are therefore not part of the PPP program. The concession contract to operate the LUAS is one of the PPP program pilot projects.

    Based on information on the website of the PPP Unit of the National Treasury (

    Based primarily on H.M. Treasury (2003) and discussions with David Goldstone of Partnerships UK and Larry Pinkney of H.M. Treasury.

    For more details about the PPP program, see H.M. Treasury (2000).

    The largest transportation project in the United Kingdom has been the Channel Tunnel Rail Link (CTRL), for which the government guarantees bonds issued by CTRL consortia members. Major investment in National Air Traffic Services (NATS), which runs the air traffic control system, was achieved by selling part of NATS to a consortium of U.K. airlines. Both of these projects are PPPs (according to the broad U.K. definition), but they are not regarded as part of the PFI.

    Accounting for the PFI is guided by the Accounting Standards Board Financial Reporting Standard 5 (FRS5)—Reporting the Substance of Transactions: Application Note F—Private Finance Initiative and Other Similar Contracts, supplemented by Treasury Technical Note 1 (TTN1) on the use of this application note in the public sector. It is also subject to audit by the Comptroller and Auditor General or the Audit Commission (for local government and health sector projects) or other audit body.

    TTN1 provides guidance on how to judge whether the government or the private sector “has an asset in the property.” This is discussed in Section VI. If the government is judged to be the owner of a PFI asset, the transaction is accounted for as a financial lease. TTN1 indicates that the fair value of the asset and a corresponding liability should be recorded on the government balance sheet, the asset should be depreciated, capital repayments and finance charges should be imputed, and unitary charges less capital repayments and finance charges should be reported as an operating expense. This treatment is reflected in relevant budget aggregates reported in the FSBR, except that the liability referred to above is not reflected in official public debt figures (although the Office of National Statistics has said that these figures should be amended in respect of on-budget PFI projects), and imputed capital repayments and finance charges are not deducted from future payments under signed PFI contracts as reported in the FSBR.

    One criticism of U.K. accounting and reporting practice is that the future service payments under PFI contracts amount to an explicit off-balance-sheet liability totaling £100 billion, which has significant implications for future borrowing or taxes (see, for example, The Times, July 7, 2003). It has therefore been suggested by some financial market observers that these liabilities should be disclosed as such, rather than as a stream of future payments.

    One widely quoted report estimates an average saving of 17 percent (Arthur Anderson and Enterprise LSE, 2000).

    There still remain suspicions about the PFI program. For example, Spackman (2002) argues that the main attractions of the PFI are that it fits in with prevailing political ideology and that private financing is off budget. This being the case, he suggests that there will there be insufficient recognition of the fact that the benefits attributed to the PFI could be achieved with public financing.

    This was judged by some to be a source of bias against PFI projects (see Grout, 1997).

    However, consumption of fixed capital is offset by the disposal of a nonfinancial asset in calculating net lending/borrowing, which is therefore unaffected.

    GFSM 2001 refers to them as “core balances.”

    A further problem is that, from the standpoint of the national accounts, the transfer of the asset to the government balance sheet has to be matched by its removal from the private sector balance (even though it remains on the private operator’s own balance sheet), otherwise it would lead to double counting of PPP investment in the national accounts.

    It is important to note that the government is not repudiating a liability, because neither the private operator nor the government acknowledges the existence of a liability.

    The model used in Chile is more sophisticated than this and allows for correlations between the revenue generated by different projects and between revenues and macroeconomic variables such as GDP and the exchange rate.

    Starting with the initial value of the risky variable, binomial trees depict upward or downward movements in this variable and associated guarantee payments depending on two possible states of the world that occur with known probabilities. This process is repeated over successive periods, with the number of branches doubling each period, until the guarantee expires. The full range of outcomes provides the probability distribution of guarantee payments over the life of the guarantee, and the value of the guarantee is computed by taking the present value of all the values for guarantee payments in this distribution, weighted by their respective probabilities. While binomial trees allow considerable flexibility in modeling the behavior of the risky variable from period to period, they are computationally cumbersome.

    The models used in Chile generate information on the entire distribution of expected guarantee costs, which allows a probability to be assigned to all possible outcomes (including worst cases). This would be particularly useful information from a risk management perspective, although only in the context of assessing the risk characteristics of the government’s overall liabilities.

    IPSAS is issued by the International Federation of Accountants (IFAC). The IAS is issued by the International Accounting Standards Board (IASB); interpretations are issued by the International Financial Reporting Interpretations Committee (IFRIC), an IASB committee. IFRIC interpretations provide guidance on newly identified financial reporting issues not specifically addressed in International Reporting Standards. Entities must comply with these interpretations if their statements are described as complying with International Accounting Standards. The standards are contained in International Federation of Accountants (2004) and International Accounting Standards Board (2003).

    Insurance contracts are covered by IFRS 4 (Insurance Contracts).

    However, IAS 39 does not cover financial guarantees that transfer significant risk to the issuer, which are covered by IFRS 4. An amendment currently being proposed by IASB would see all financial guarantee contracts, including those that transfer significant risk, being covered by IAS 39.

    The commentary in the standard indicates it will only be in extremely rare cases that no reliable estimate can be made of an existing liability; in such case the liability should be disclosed as a contingent liability.

    These requirements are also part of a set of best practices included in the Manual on Fiscal Transparency (IMF, 2001b).

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