Despite the market's maturity, the future shape of the Public Private Partnership (PPP) sector in Australia is uncertain.

On the one hand, individual states remain undecided about the value of the PPP approach. On the other, concerns over risk allocation have caused construction companies to adopt an increasingly cautious stance in their PPP bids.

A debate over the best financing model has also re-emerged and, in several deals this year, the investment banking approach, championed so successfully by ABN Amro in 2003 and 2004, has lost out to a more traditional funding model.

The deal which underscored the risk allocation problem more than any other was the A$425 million ($300 million) Spencer Street PPP (for more details search 'Spencer Street' on www.projctfinancemagazine.com). Problems associated with site access eventually forced the contractor, Leightons, to draw up A$110 million in provisions against its construction contract.

Growing caution in construction sector

Opinions vary about the long-term impact of this upset to the market. Several bankers suggest the problems that arose were the result of very specific project circumstances and argue that the controversy hasn't affected the market at large. But Mark Upfold, a partner at Mallesons Stephen Jaques suggests that a number of construction companies have been more cautious about risk allocation since, although he continues, "its not yet clear if this caution has translated into higher bid costs for government.

Just as important as the private sectors' reaction to Spencer Street has been the government's reply to calls for a "fairer" risk-reward template. Notably, in response to the argument that contractors bear disproportionate risks for minimal returns, the Victorian Treasurer has indicated that any deviation from the State's criteria for evaluating bids would require strong justification and demonstrations of a clear value for money outcome.

Alan Millhouse, a partner at Allens Arthur Robinson in Brisbane, sees more tangible concessions from the Victorian government. Standard Commercial Principles for PPPS have recently been released by the state, aiming to provide standardized commercial principles covering all aspects of a PPP, from insurance, to access, to changes in law, re-financing and intellectual property. "In an attempt to allay industry concerns, the standardized guidance material has abandoned the requirement to have finance locked in at the expressions of interest stage," Millhouse observes. Moreover, no more than three bidders will be included in the shortlist stage in order to control bidding costs.

But even though the Spencer Street project highlighted how badly wrong PPP projects can go, some important risks still go unmentioned in projects contracts.

In a recent Victorian hospital PPP deal, Millhouse says there was no contractually specified sharing of the risk of a potentially adverse change in Federal law. So, where a change in law leads to increased costs to the contractor, the company can notify the government of the fact, yet the government is not obliged to take any action. Millhouse expects to see more formal risk-sharing in the future, with financial consequences for the project company capped at specific levels.

Is PPP going to impact beyond transport?

A bigger threat to the PPP market than private sector fears over risk allocation is the apparent lack of enthusiasm in some government circles for PPP schemes. How far government will go in adopting the PPP approach is still an open question.

Outside Victoria, the PPP market is emerging at a glacial pace – assuming a fairly narrow definition for PPP projects (e.g. not including toll roads). In each of New South Wales, Queensland, Western Australia and the Northern Territory, only one PPP project has reached financial close to date, despite the fact that state guidelines for public private partnerships have existed for several years.

Queensland's first PPP, the Southbank Institute of TAFE redevelopment project appears to underscore a commitment to the PPP market. But the project was a struggle to close because the government was not happy with the value for money proposition. The ABN Amro sponsored consortium that won the PPP mandate had to lower the cost outlined in its preferred bid, in order to bring negotiations to a satisfactory close.

Queensland's Premier, Peter Beattie, has warned industry that, in the light of the state's growing budget surplus, it must clearly demonstrate that value for money can be achieved in any PPP bid.

Although Queensland has plenty of infrastructure projects in prospect, the only near-term project market sources firmly expect to be mandated to the private sector is the North-south bypass tunnel (expressions of interest for the project were sought by the Brisbane City Council in March).

The development is a toll road project rather than a PPP in the classic sense. However, the project is noteworthy as the first nominal PPP to be undertaken at local government level. The Council intends to procure the project as a PPP, generally following the principles in the Queensland Government's Value for Money framework.

The PPP market is gaining elsewhere. The Western Australian government is currently in negotiations for its first PPP, the A$195 million CBD courts project. Similarly, the government of South Australia has opted for a PPP scheme to cover the construction of regional police station and courts facilities.

The Commonwealth government is also diversifying the PPP asset base and is pressing on with its first PPP project – the A$300 million Defence Headquarters Joint Operations Command Facility. Three consortia have been selected for the final tender stage on the project. It is expected that this final bid stage will commence in the next few months.

A second potential Commonwealth PPP deal has also already been lined up, the Customs Coastwatch Aerial Surveillance deal. But the government is likely to want to digest the result of its first PPP tender, before deciding whether to put the project through another PPP bid.

Over the next 12 months, New South Wales will seek proposals for two projects, which also underscore its commitment to the PPP concept, says Upfold. The two projects are the New Schools Project 2 and the Bonnyrigg Living Communities Project, a social housing PPP scheme.

ABN Amro grip on PPP weakens

Trends in the financing market imply a better choice for government in funding PPPs. Until recently the most competitive financing option was that delivered by ABN Amro. The bank won PPP deals left, right and center thanks to its willingness to take 100% of the project equity and to underwrite project bonds in their entirety. ABN followed up the financing package by negotiating fixed price contracts with construction, retail and maintenance to undertake the project work.

This model accounted for almost all mandated deals in 2004, including, says Malcolm Macintyre, executive director at ABN Amro Infrastructure Capital Group, the $1 billion Darwin City Waterfront development (Northern Territory's first PPP project), which recently closed.

However, in other recent PPP bids, competing consortia have pipped ABN Amro with bond solutions of their own. Bay Health Partnership (featuring Bilfinger Berger, Baulderstone Hornibrook, Macquarie Bank and United KG) won the recently bid $128 million Long Bay Prisons and Forensic Hospitals project.

A source close to the Long Bay financing confirms that there is no bank debt in the transaction, but instead, A$290 million of inflation-linked and nominal bonds. Roadshows for the bond issue are already complete. Macquarie is acting as financial adviser and, together with ANZ, as bond underwriter.

The exact same consortium has also been selected as preferred bidder for the A$250 million Royal Women's Hospital redevelopment project in Victoria. The project includes a 25-year maintenance contract for the hospital building.

Furthermore, in December last year, the PPP Solutions Consortium was selected as preferred bidder for the A$700 million Royal Melbourne Showgrounds redevelopment. The consortium includes Multiplex, Babcock & Brown, and Spotless Services. Societe Generale (SG) is arranging the bond program to fund the redevelopment.

A key difference between these transactions and the ABN Amro model is that equity is provided by the members of the consortia and not just a single financial institution.

Return to traditional PPP models

Some of these sponsors intend to hold onto their stakes for the long term, and will not be selling down shortly after financial close. Bankers argue that this characteristic helped give the consortia an edge in the tender processes. "Government is more comfortable with this technique, rather than the ABN Amro approach where the equity is sold shortly after financial close, as it has a better idea of who the counterparty is going to be through the life of the PPP contract," comments a market source.

It is probable that PricewaterhouseCoopers (PWC) had some hand in the re-emergence of a financing approach more common in the UK. PWC has a dominant position in advising government on PPPs in Australia. Tony Poulter, global head of project finance at PWC, says there are some doubts about the ABN Amro model. "Under this model the financial investor has not necessarily agreed prices with the contractors and service providers it will work with in advance. There is nothing wrong in principle with bidding contracts later, and the financing package may look cheap, but this approach could potentially lead to trouble later on," he says.

Despite losing several recent PPP bids, ABN Amro is by no means out of the market. The bank is part of the winning Western Liberty Group consortium, which is negotiating with Western Australia on the CBD courts scheme.

ABN Amro has also formed, a strategic alliance with Development Australia Fund Management to create a special investment vehicle for superannuation funds seeking to invest in social infrastructure assets. The move follows the recent Fitzgerald review of the Partnerships Victoria policy. The review recommended that the Victorian government should consider opportunities within the PPP framework to pilot new financial and partnership structures, including the involvement of non-profit and other public sector agencies.

A more general shift in government's approach to financing is also likely to mean more bank debt transactions. "Bonds have been the cheaper solution in the PPP market to date. But bond issues in Australia are normally inflation-linked and government has now realised that it needs to take full account of the inflation risks that it is absorbing," says Poulter.

At the same time, government is now more willing to accept interest rate risk in bank debt transactions rather than having costly hedges established. "The playing field between bonds and bank debt is becoming a bit more level as a result of this and the increasingly competitive structures and margins in the bank market," adds Poulter.

Even ABN Amro sees value in a different financing approach for at least one upcoming PPP – the RailCorp rolling stock PPP. The deal involves the design, manufacture and maintenance of a new fleet of rolling stock for New South Wales' CityRail network, and the refurbishment and maintenance of existing rolling stock.

The RailCorp deal, on which PWC is advising, is a performance based PPP project for rolling stock and the first of its kind in Australia. ABN Amro is involved in the Reliance Rail bid, one of four shortlisted bids for the RailCorp mandate, and is discussing a bank debt transaction option with several lenders.

"This project does have some unique characteristics which make bank debt a more competitive solution," says Macintyre. "Because the construction period is four years, a bond financing would be at a disadvantage because of the negative carry. There are also some very aggressive banks in the market at the moment, willing to lend at very good rates for PPP and other project assets."