Roundtable: Public Procurement
Who's Who Legal has brought together three of the leading practitioners in the world to discuss key issues facing public procurement lawyers today.
Participants
Karen Manos
Gibson Dunn & Crutcher LLP
USA
Geoffrey Wood
Baker & McKenzie
Australia
Olav Wagner
Noerr LLP
Germany
Regulation
Who’s Who Legal: What do you consider to be the most important recent regulatory changes in your jurisdiction that are currently affecting your procurement practice? Are there any planned for the future?
Karen Manos: In the United States, the so-called “mandatory disclosure rule” that took effect in December 2008 is perhaps the most significant regulatory development. That rule, 48 CFR. 52.203-13, requires US government contractors to disclose, in a timely manner, to the government when in connection with the award, performance or closeout of the contract or any subcontract therein they have credible evidence of a violation of (1) federal criminal law involving fraud, conflict of interest, bribery or gratuity violations found in Title 18 of the US Code, or (2) the civil False Claims Act, 31 USC. 3729-3733. The failure to timely disclose these violations, or a significant overpayment, is cause for suspension or debarment. There have been other recent regulations (both published and proposed) and executive orders focused on increasing accountability, which tend to increase the risks inherent in public procurement.
Geoffrey Wood: Although now almost 18 months old, I think by far the most significant change in Australia was the adoption by COAG (the Coalition of Australian Governments) of a consistent approach in all Australian jurisdictions to the regualtion of PPP processes, through its endorsement of the National Public Private Partnership Policy and Guidelines.
Prior to this, private-sector participants in Australian PPPs often faced significantly inconsistent approaches by the state and territory governments to running their PPP processes, which added significant costs and inefficiencies, as the wheel was reinvented every time.
Fixing this problem was identified as a key priority by the new Labor Commonwealth government in 2007, which for the first time created a separate Ministry of Infrastructure, and the new advisory body Infrastructure Australia, which spearheaded the compilation of the new, consistent national approach endorsed by COAG.
All Australian, state and territory government agencies now apply the National Policy and Guidelines. The National Policy and Guidelines, which effectively replace previously existing policy and guidelines in those jurisdictions, consist of the National PPP Policy Framework; the National PPP Guidelines Overview; Volume 1, Procurement Options Analysis; Volume 2, Practitioners’ Guide; Volume 3, Commercial Principles for Social Infrastructure; Volume 4, Public Sector Comparator Guidance; Volume 5, Discount Rate Methodology; and Volume 6, Jurisdictional Requirements. The Commercial Principles for Economic Infrastructure, which will complete the suite of National PPP Guidelines, at this stage have been released in draft only.
One significant upcoming regulatory change in Australia is a new national regime to develop a National Prequalification System, expected to be in place by 1 January 2011, which would mean a private contractor registered in one state or territory would automatically have its qualifications recognised everywhere else in the country.
At present, the six states and two territories operate their own separate pre-qualification regimes, with each requiring contractors to prove their technical and financial bona fides as well as their ability to deliver value for money before being allowed to operate.
Initially, the national system would replace existing state and territory regimes for road, bridge and commercial construction tenders, valued at over A$50 million, with a more ambitious threshold to be considered once these new arrangements have been bedded down.
The consultations with industry began on 10 June 2010 and are being undertaken by the Australian Construction Industry Forum, the Australian Procurement and Construction Council and Austroads. At the conclusion of their consultations, Austroads and the Australian Procurement and Construction Council will prepare a detailed reform plan for consideration and endorsement by COAG later this year.
Olav Wagner: After more than seven years of discussion, major revisions of the German rules governing public procurement have been undertaken in several steps between April 2009 and June 2010. Although the initial goal of a substantial simplification and harmonisation of the quite complex set of rules has been achieved only partially, there have been some major changes which already do affect our procurement practice. The obligation to separate a tender into lots, in order to foster small and medium enterprises, has been reinforced; the possibility to consider social, environmental and innovative aspects when assigning a contract has been opened up; pre-qualification systems have been established; the obligation to inform the bidders who are not successful in the procedure, including a substantial explanation on the grounds for the exclusion, has been sharpened; and, finally, contracts concluded in breach of procurement rules are now invalid, but only if a public procurement review board has ruled so.
Although the reform has just been completed, the debate about the next reform has already started. This concerns, in particular, the introduction of legal remedies against procurement decisions regarding contracts below the EU thresholds and the implementation of the new EU directives on procurement in the defence and security sector, which is due by August 2011.
Public Projects
Who’s Who Legal: The global recession had a significant impact on the volume of public procurement work for lawyers in many countries as private credit became difficult to obtain. What effect has government spending had on the volume and continuity of projects? Is this likely to continue into the future?
Geoffrey Wood: In response to the gold financial crisis, the Australian Commonwealth government, working closely with the state and territory governments, moved quickly, decisively and very successfully to place public sector capital works spending, particularly in the educational and health sectors, as the centrepiece of its efforts to prevent the country from falling into recession. Virtually every school in the land has a new library or hall completed or under construction!
Speed was judged to be of the essence, so the spending was made in hundreds and thousands of small lumps on straightforward contracts, to stimulate local communities’ economies everywhere, rather than in respect of larger, more complex projects that would have been more productive of significant work for public procurement lawyers.
Whilst these efforts have garnered significant praise for the Australian government from international economic organisations impressed with the country’s almost single-handed avoidance of recession, the spending has been strongly criticised by opposition parties as profligate and scattergun, and the press is currently full of stories emerging of contractors having “ripped off” the governments with inflated pricing, and the Commonwealth government has responded by setting up a body to review the whole process. Because of this, plus the fact that there is little money “left in the till”, and a feeling that the spending programme has done its job here, it is unlikely that this unprecedented spate of huge spending on many small projects will be repeated soon. The government’s rhetoric is now shifting to focus on how they can help facilitate private sector infrastructure spending again, which augurs well for the PPP market.
Olav Wagner: In Germany, we have experienced similar effects as those in Australia. The German government has set up two major stimulus packages in 2008/09 which included, in particular, increased funds for public construction works. However, as the focus was on spending the funds quickly, the biggest part of them went to minor repair and rehabilation work as the funds initially had to be spent by the end of 2009. This was later extended to the end of 2010. However, one of the conditions was that projects, which were already programmed, were not eligible. This excluded, in particular, major PPP projects which will need about 24 months from project start to contract closing. As public authorities focused on the subsidised minor projects, the dealflow for PPP projects slowed down considerably.
As the costs of private financing increased, if such financing was available at all, this made project financing more expensive as compared with conventional public funding, thus preventing economical feasibility of these projects. In most German states specific budget provisions require that PPP projects have to meet this test. This resulted in an increased use of alternative financing models, like the “forfeiting model”, where payments to the private partner are assigned to the financing banks and the public authority waives any withholding rights against the financing banks. This creates a guaranteed income stream for the banks, thus reducing risk and reducing interest rates. As this model is more suitable for smaller projects, this strengthened the trend from major to minor projects even more.
Markets recovered slowly towards the end of 2009, but with the Greek crisis, financing costs were back at their peak by May 2010 again. At present, the outlook for major PPP projects remains gloomy. In the long term, however, it is expected that the need to curb public deficit spending will lead to an increased number of project financings.
Karen Manos: The US government procurement budget increased dramatically after the terrorist attacks on 11 September 2001, and has continued to increase since that time. During the same period, there has been a gradual growth in the amount of public procurement work for lawyers. The stimulus bill enacted last year has further added to this growth, and for many law firms, public procurement practices are thriving despite a downturn in other practice areas. I suspect we will see a decrease in the US government procurement budget because the current level of spending is simply not sustainable.
Alternative Financing
Who’s Who Legal: It has been reported that alternative sources of finance, such as pension funds, are being used to fund public-private partnerships as traditional bank lending has dried up. Have you seen new sources of finance in your jurisdiction? How has this changed the nature of your practice?
Geoffrey Wood: In Australia, the main observable change has been the need for private-sector bidding consortia to increase the equity component of their bids as the ability to structure viable debt components has been restricted post-gold financial crisis by a number of factors: dramatically fewer active lenders, much more expensive and draconian terms, shorter tenors on offer and the disappearance of what had been the very popular device of bond “credit wrapping” by the monoline insurers who have lost the credit ratings that underwrote their attractiveness.
The need to broaden equity participation has certainly seen a focus by the traditional major players in the Australian PPP market (the major contractors, major Australian banks and few remaining investment banks and specialist PPP firms) on renewing their efforts to have pension/superannuation funds, both Australian and foreign, increase their investment in the sector.
While the take-up remains slow, with the superfunds generally preferring safer, more lucrative brownfield investment outside Australia to taking any construction risk exposure on Australian greenfields PPPs, there is sign of movement. One reason for this appears to be the lack of bond issues for the pensions funds to invest in in the current still restrained capital markets.
In this context, the involvement of two pension funds, Australian Super and Industry Funds Management, as part of the syndicate of 35 lenders that provided the main A$3.67 billion term loan to the winning Aquasure consortium on the Melbourne Desalination PPP recently (which pays a spread of 350 basis points more than the bank bill swap rate) is seen locally as very significant.
The emergence of pension funds as players in this market has not had a huge effect on the nature of our practice as procurement lawyers, since the deals are still being structured in fundamentally the same way, but it is seeing some new members of our firm’s team added (those with strong connections to the funds) to the traditional “A team” of project finance and construction lawyers.
Olav Wagner: Alternative financing still doesn’t play a major role in Germany. The pension system is mainly financed by the current contributions of the active workforce, so there are no funds to be invested. There are some alternative pension funds for individual professions, but they tend to follow a very conservative investment strategy preventing them from investing in PPP projects. Foreign pension funds have mainly invested in German real estate in the pre-crisis years and their appetite for new projects seems to be limited. This leaves banks as the only major player for private financing of public projects.
Geoffrey Wood: Further to my earlier comment, I thought I should add that a very useful paper, entitled “The Role of Superannuation in Building Australia’s Future”, has just been released by the nations’s peak infrastructure organisation, Infrastructure Partnerships Australia, which can be accessed from their website www.infrastructure.org.au.
The paper makes a number of recommendations to the Australian government as to how it should work in partnership with the infrastructure and superannuation industries to promote and support investment, discusses the barriers currently existing to further investment and what might be done to remove those barriers.
There is a lot of interesting information in the paper concerning the current involvement in and attitudes to infrastructure investment of Australian superfunds and international pension funds, for those interested.
Public-Private Partnerships
Who’s Who Legal: Are public-private partnerships going to be a more favoured model in your jurisdiction as governments scale back their level of expenditure following the economic downturn?
Karen Manos: I believe public-private partnerships are going to be a more favoured model in the United States, particuarly at the state level. States have been particularly hard-hit by the economic downturn, and we are already seeing a significant increase in public-private partnerships and privatisation of what were formerly public infrastructure projects.
Olav Wagner: Although the combined effect of the financial crisis and the stimulus packages led to a reduced number of PPP projects, the expectation is that high public deficits will lead to more PPP projects in the medium and long term. However, there are many uncertainties around this expectation. Many banks have already withdrawn from the PPP market and closed their project finance departments. More banks might follow if financing conditions do not improve soon. Another factor is that public opinion has become more critical of private financing, so political support gets more and more difficult to obtain, even the advantage of a PPP solution has been proved by an economical feasibility study.
Geoffrey Wood: I believe in Australia the answer to this question is clearly yes. While the gold financial crisis undoubtedly saw a retreat by many foreign banks which had previously been enthusiastic participators as lenders in Australia’s mature PPP market, allowing the big four local banks to increase their dominant market position, PPP deals were nevertheless still pursued by Australian governments, albeit at a reduced rate, and a number managed to reach financial close, including the massive (A$3.6 billion-plus) Melbourne desalination project. On that deal and others, the relevant governments displayed a pragmatic preparedness to adapt to the challenging market, and offered to guarantee repayments where necessary to allow deals to proceed.
Now, as the private financial markets slowly recover, there is evidence of some enthusiasm to return by some of the foreign banks, and interest from new banks (especially Japanese) to seek participation.
A greater focus by the Commonwealth government in recent years on the PPP space (including the formation of Infrastructure Australia, a PPP-specific body charged with reviewing projects and prioritising them to ensure a clear “pipeline” for bidders to focus their efforts on), together with the recent adoption of a standardised approach to bidding processes by all governments, will see the Australian PPP market continue to flourish. Social infrastructure projects (hospitals, prisons, etc) have a long pipeline, whereas economic infrastructure projects, especially roads, are currently on the backburner due to the failure of a number of them in recent times (mostly due to wildly inaccurate traffic forecasting), although the recent financial close of the Peninsula Link PPP in Victoria, where the government took the traffic risk, shows a way forward in this sector too.