Special Purpose Entities

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Special Purpose Entities
(SPEs) and

Public
-
Private Partnerships
(PPPs)

Government Finance Division

Statistics Department

IMF

June 1
-
12, 2009

Government Finance Division, IMF Statistics Department

2

Introduction

Governments often create “independent” institutions or
entities to perform certain functions on their behalf

Widely used in recent years

From a
GFSM 2001

perspective, the legal framework
of such an entity is less important than the
economic
substance of their operations

Two types of such arrangements in this lecture:

Part I: Special Purpose Entities (SPEs)

Part II: Public
-
private Partnerships (PPPs)

Part I


Special Purpose Entities (SPEs)

Government Finance Division, IMF Statistics Department

4

Contents of Lecture

Definition of SPEs

Uses of SPEs

SPE measurement challenges

Sectorization of SPEs



Government Finance Division, IMF Statistics Department

5

Definition of SPEs

(1/2)

An SPE is an entity that is created, through the
transfer
of assets, liabilities, or rights,

to
carry out a well
-
specified activity

or series of transactions

These activities are directly related to the specific purpose for
which it was formed

SPE’s can be in nonfinancial and financial corporate sector

In public sector, SPE activities are often instrumental to
public private partnerships, BOOT schemes, or joint ventures

Securitization of assets/liabilities

Government Finance Division, IMF Statistics Department

6

Definition of SPEs

(2/2)

SPEs often involve three groups:

Transferor


The entity that transfers the assets, liabilities or rights


The entity that creates the SPE


Equity could be vested in transferor and/or partners

Transferee


The newly created SPE that receives the assets, liabilities or rights

Investors


Typically provide all funding requirements for SPE activities
through loans extended to SPE or securities other than shares
(e.g., bonds) issued by SPE

Government Finance Division, IMF Statistics Department

7

Some Uses of SPEs

Can be misused (e.g., to conceal involvement of
transferor), but justifiable and legitimate business
purposes exist for use of SPEs, such as

Securitization of assets


Securitization/recognition of liabilities

Pre
-
funding certain payments

Managing risks in financial entities

Facilitating market development

Limiting tax liabilities

Gaining efficiency

Government Finance Division, IMF Statistics Department

8

SPE Measurement Challenges

Existing financial and economic analytical tools do not
always capture the financial and economic activities of
SPEs sufficiently due to

Lack of disclosure transparency


What about off
-
balance sheet assets & liabilities?


Poorly performing assets may be hidden

Establishment of layers of accountabilities


Who are participants in SPE, and how are risks, rewards, and
control divided among all participants?

Thus, legal framework does not always reflect
economic
substance

of SPE’s operations

Government Finance Division, IMF Statistics Department

9

Treatment of SPEs in Macroeconomic
Statistics

Make sure it is securitization

Securitization can only occur when an existing asset is sold


A future stream of revenue is not recognized as an asset, and is
treated as borrowing by the creator of the SPE (i.e, NOT
securitization)

Treat SPEs (other than future streams of revenue) similar to
all other entities in macroeconomic statistics regarding


Sectorization


Recording of flows and stocks

Sectorization of SPEs in GFSM 2001
(1/3)

Is SPE an


institutional unit?

Classify with operations

of unit that controls SPE

Is SPE resident

or nonresident?

Who controls

resident SPE?

Who controls non
-

resident SPE?

(it is always a unit)

Government


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Yes

Resident

Nonresident

No

Government Finance Division, IMF Statistics Department

11

Sectorization of SPEs in GFSM 2001 (and
other macroeconomic statistics)
(2/3)

For a nonresident institutional unit that performs fiscal (or
quasi
-
fiscal) activities on behalf of government

Record all flows between general government sector and the
nonresident SPE

If no flows occurred between general government and SPE,
impute flows between the general government sector and the
SPE

Other nonresident SPEs

Part of “Rest of World”


Government Finance Division, IMF Statistics Department

12

Sectorization of SPEs

(3/3)

To determine control, use
indicators of control


Ownership of majority of voting rights


Control of board or other governing body


Control of appointment and removal of key personnel


Control of key committees of entity


Golden shares and options


Regulation so tight that it amounts to control


Control by a dominant customer (e.g., government)


Controls attached to borrowing from government


Other controls associated with entity’s constitution and rules

Totality of indicators


judgmental in nature

Also see “Risk Transfer” later in PPP lecture

Part II


Public
-
Private Partnerships

(PPPs)

Government Finance Division, IMF Statistics Department

14

Contents of Lecture

Definition of PPPs (or “service concession
arrangements”)

Reasons for establishing PPPs

Fiscal risks of PPPs

Risk transfer, leasing, and ownership

Managing and reporting fiscal risks of PPPs

Recording of PPPs in accounting standards and GFSM 2001

Government Finance Division, IMF Statistics Department

15

Definition of PPPs

(1/4)

“Public sector contracts to purchase quality services on a
long
-
term basis

principally involving the construction of
new infrastructure to provide such services.”

(UK Government)

“Contract between a public sector institution/municipality
and a private party, in which the private party assumes
substantial financial, technical and operational risk in the
design, financing, building and operation of a project.”
(South African Treasury)

Government Finance Division, IMF Statistics Department

16

Definition of PPPs

(2/4)

The IMF definition of PPPs

Arrangements where the private sector supplies
infrastructure assets and services that traditionally have been
provided by the government.


Main characteristics:


Private execution and financing of public investment


An emphasis on investment and service provision by private sector


Risk transfer from government to private sector

Classic scheme: Design
-
Build
-
Finance
-
Operate (DBFO)

Government Finance Division, IMF Statistics Department

17

Definition of PPPs

(3/4)

PPPs have been used as an alternative to public
procurement in different sectors

Education (e.g., schools, museums, libraries)

Health (e.g., hospitals and clinics)

Water (e.g., sanitation plants, irrigation systems, pipelines)

Public administration (e.g., courts, police stations, and prisons)

Transport (e.g., roads, bridges, tunnels, railways, airports, ports)

PPPs provide services to the government or directly to
consumers

Definition of PPPs

(4/4)

Government

Operating Firm

Bank

Construction Firm

Construction contract

Financing contract

Operating contract

Public Procurement

Government

PPP
-
Special

Purpose Vehicle

Operating Firm

Bank

Construction Firm

Construction contract

Financing contract

Operating contract

Long
-
term service contract

PPP

Government Finance Division, IMF Statistics Department

19

Uses of PPPs

Particularly
well
-
suited for economic infrastructure
,
less so for social infrastructure because:

High economic rates of return of sound projects, that address
clear bottlenecks, are attractive to private sector

Services are directly provided to final users, so user charges
are more feasible and even desirable

Economic infrastructure projects have a more developed
market for bundling construction with services than social
infrastructure projects


Government Finance Division, IMF Statistics Department

20

Reasons for Establishing PPPs

(1/4)

Increase efficiency

Benefit from private sector expertise

Improve timely delivery of quality services

Infrastructure “for free”

Tempting particularly for cash strapped governments trying to
meet fiscal targets

Government Finance Division, IMF Statistics Department

21

Reasons for Establishing PPPs

(2/4)

However,
PPPs can be risky

from a fiscal perspective:

Move spending off budget and can create (explicit and
implicit) contingent liabilities for government

Potentially threaten integrity of budget process and
undermine efforts to safeguard macroeconomic stability

Perhaps more difficult to achieve fiscal discipline and good
governance with PPPs

Government Finance Division, IMF Statistics Department

22

Reasons for Establishing PPPs

(3/4)

Right Approach:

PPPs should provide better value for
money

Responsibility for designing, building, financing, and operating
(DBFO) an asset lies with private sector

Private sector provides service with higher efficiency

Efficiency gains need to make up for higher cost of private
capital, fixed cost of administering PPPs, and lack of flexibility
in long
-
term contracts

Government Finance Division, IMF Statistics Department

23

Reasons for Establishing PPPs

(4/4)

Wrong Approach:

PPPs allow investments to be
recorded off budget

PPPs can circumvent fiscal constraints (e.g., formal rules) for
infrastructure investment

PPPs can, but should not, be used to solely


bypass expenditure controls


delay borrowing


move public investment off budget


move debt off the government balance sheet

Government can be left bearing most of the risk involved,
facing potentially large fiscal costs over the medium term

Government Finance Division, IMF Statistics Department

24

Fiscal Risks of PPPs

PPPs entail a variety of risks:

Construction risk, financial risk, demand risk, availability risk,
political risk, natural disasters

Who should bear the risk?

Public and private sector have certain advantages relative to the
other in managing specific risks, e.g.,


Private sector


construction risk


Public sector


political risk

Appropriate level of risk transfer depends on each project and
country

Adequate risk sharing is essential to achieve value for money!

Government Finance Division, IMF Statistics Department

25

Risk Transfer, Leasing, and Ownership

(1/2)

Risk transfer from government to private sector has
significant influence on whether PPP is more efficient
and cost
-
effective alternative to public investment and
government provision of services


Have to assess risk transfer and ownership by looking
at:

Risks in owning asset

Risks in operating asset

Government Finance Division, IMF Statistics Department

26

Risk Transfer, Leasing, and Ownership

(2/2)

Leasing

PPPs can be set up as operating leases, unusual to take form
of a financial lease

But, from GFS and fiscal risk point of view, we look at
economic owner of asset

by asking who bears the ultimate
risk or most of the risks associated with ownership


If government, then impute a financial lease through which
government acquires the asset

Often difficult to assess risk transfer

Full disclosure essential, but even then it may be problematic
to assess risk transfer

Government Finance Division, IMF Statistics Department

27

Managing and Reporting Fiscal Risks

(1/4)

Currently, significant scope to strengthen the
environment for PPPs to mitigate fiscal risks, focusing on
four areas:

Good projects

Good laws

Good institutions

Good accounting and reporting

Government Finance Division, IMF Statistics Department

28

Managing and Reporting Fiscal Risks

(2/4)

Good projects

Systematic 2
-
step investment process:


Choose right projects (strategy, prioritize)


Do PPPs for the right reasons (value for money, include in
medium
-
term budget framework)

Good laws

Legal framework for PPPs:


Introduce a clear and consistent PPP law or harmonize existing
laws to provide consistent legal framework


Integrate PPP proposals and guarantees with budget cycle


Clarify roles and responsibilities

Government Finance Division, IMF Statistics Department

29

Managing and Reporting Fiscal Risks

(3/4)

Good institutions

Management and oversight framework


Clarify institutional roles and responsibilities


Introduce a central PPP unit


Implement a “gateway process” overseen by Ministry of Finance to
authorize PPPs at each stage of project life cycle


Strengthen technical capacities throughout government institutions
handling PPPs

Government Finance Division, IMF Statistics Department

30

Managing and Reporting Fiscal Risks

(4/4)

Good fiscal accounting and reporting

Problems!


PPPs are chosen to move public investment off budget and debt off
government balance sheet


Government still bears considerable risk and potentially faces large
fiscal costs


General accounting and reporting standards for PPPs are still to be
developed

Proper accounting and reporting of the fiscal
implications of PPPs is essential to prevent their
misuse, and to make increased efficiency their main
motivation

Government Finance Division, IMF Statistics Department

31

Recording of PPPs in Accounting
Standards and GFSM 2001

(1/2)

Topic was extensively discussed in review of SNA93

Not yet reached a final outcome
(as of May 2007)

But, already agreed to

Look at each PPP contract to determine recording

Follow the outcome of international accounting standards in
recording of PPPs

In the mean time, we have fairly straight forward existing
accounting and GFSM 2001 reporting standards for

Operating contracts; concessions and operating leases; financial
leases; and the transfer of PPP assets to government


Government Finance Division, IMF Statistics Department

32

Recording of PPPs in Accounting
Standards and GFSM 2001

(2/2)

Accounting for risk transfer

Eurostat: Classify PPPs as in the private sector if private
partner bears most construction risk,
and

either most
availability risk or most demand risk.

IMF: Should look at all risks to determine who bears ultimate
risk to determine control


If government controls, then PPP assets are government assets

IPSAS:
Not yet determined.

Leaning towards the notion of
who controls asset (Consistent with SNA)


If government controls, then PPP assets are government assets

33

IMF Operational Approach to Managing and
Reporting Fiscal Risks

Aims to mitigate potential moral hazard

Emphasis on comprehensive disclosure of known and
potential future costs of PPPs for public finances

Incorporation of costs into Debt Sustainability Analysis
and medium
-
term budget framework