MONTHLY FEATURE

February 2008

  PUBLIC PRIVATE PARTNERSHIPS (PPP) AND CSR

By

Julian Roche
Consultant, MHC International Ltd.

Abstract: The usefulness of Public-Private Partnerships (PPP) is one of the hot government procurement topics of the decade.  But is it consistent with CSR?  Julian Roche thinks not and calls for an ethical code of practice to enhance PP’s responsibility.

What connection does PPP have with CSR?

The usefulness of Public-Private Partnerships (PPP) – what began life as the Private Finance Initiative in the UK under the Major Government as long ago as 1992 – is one of the hot government procurement topics of the decade.  The idea is essentially simple: let the private sector provide services that had previously been provided by the public sector, and be rewarded not as in the conventional model by a stage payment system just as a contractor, but on the basis of a fixed payment to a Special Purpose Vehicle (SPV) formed by the contractor with other investors, as the service is used.  Payment is made either directly from government, more venturesomely from the users themselves, or a mixture of the two.  These SPVs are usually heavily indebted with the banks also receiving their returns from the project – making PPP an aggressive and attractive species of project finance.  

The PPP model has been used in the UK, Continental Europe and now throughout the world for power stations, schools, hospitals, toll roads, water and waste management facilities, and a host of other such facilities.  As a result, public services have generated private profits.  With progressively more developing countries looking to PPP as a way of improving their often desperately bad public services[1], it is surely timely to review the CSR implications of PPP.

 What connection does Corporate Social Responsibility have with PPP?

Firstly, a boundary question.  What is the limit of CSR?  Is it consistent with CSR to earn phenomenal profits from what is essentially a public service.  The National Audit Office of the UK thinks not.  What happened was that during the late 1990s and for some years hence, the interest rates on debt faced by SPVs fell consistently.  As a result of this and some shifting away from more expensive mezzanine to cheaper senior debt within the SPV, the refinanced debt burden on SPVs fell dramatically.  The savings became available for returns to the equity investors: the contractors and private equity investors. In one famous example studied by the NAO, the return went from an expected 18.1% to a spectacular 62%. 

The upshot of the NAO inquiry into this and other such refinancing led to a revision of the standard PPP contract so that any refinancing gains would be shared between the Treasury and the PPP financier.  However, this does not seem entirely satisfactory.  Windfall gains could still flow to equity investors who took disproportionately low risks to their returns: gains at the expense of the taxpayer.  Of course, equity investors can point out that no one would have rushed to save them if the cost of debt had risen, instead of fallen.  But the CSR question here is surely what level of equity return a firm working on a government project ought to make.  How about a commitment to Government from responsible PPP equity partners that they will donate all returns above a certain mutually agreed level to a socially worthwhile project? Then refinancing gains would flow straight back to the community, and the National Audit Office would never have to worry itself, or conduct expensive inquiries, into supernormal profits?

Secondly, what happens if things go wrong?  Does CSR also have a role here? PPP involves the transfer of risk into a Special Purpose Vehicle where the risks are supposedly isolated from the parent company.  If the contract gets into difficulties, children can end up not being able to go to school (as happened in Wandsworth in London), or a school ends up not happening at all (as happened in Scotland) because of the failure of the contract, either because costs have risen unacceptably or because of the commercial failure of a sub-contractor.  Legally, the shareholders of the parent company, who would have benefited from a spectacular return if things had gone well, are under no obligation to do anything at all.

Ethical obligation? 

But from a CSR standpoint, is that right?  Shouldn’t there be an ethical obligation on a contractor’s shareholders not to allow a public service, such as a school, to fall by the wayside when they are both financially capable of delivering help and surely morally obliged to do so.  In the case of PPP contracts, might a CSR solution be a shareholder compact to act in such cases?  Supporters of PPP would argue that this runs completely counter to the notion of the SPV, and that if such compacts became usual the number of companies willing to undertake PPP contracts would decline.  But in fact a nice relatively assured 18-25% shareholder return is hardly to be sniffed at, and there are not so many such contracts that Government need run scared. 

Anyway, the point about this idea is that it would be a voluntary CSR shareholder commitment, not part of the contract with government, and it would, as CSR tends to, reinforce the image of the company as a responsible contractor that will not leave pupils, electricity consumers or other public agencies in the lurch, with almost certainly beneficial results for the company’s share price in the long term.

Things can go wrong in the other direction, too. PPP projects can become surplus to requirements, leaving councils and other government agencies with huge bills for services they no longer need.  When PPP schools close[2] because of a lack of pupils, councils are still contracted to pay the bills.  What does this say about the social responsibility of the companies concerned?  A CSR company would not enforce payment from a customer  - any customer, actually, let alone the government – that no longer wanted the service.  It’s not the way to treat your customers.

Employment and working conditions 

Thirdly, the question of employment transfer and working conditions.  To some extent in the EU this problem is legislated through the Transfer of Undertakings (Protection of Employment) Act.  This excellent Act (neutrality is not required of me in this article, but most readers will by now have expected my view to be thus) requires that in the case of an M&A transaction, including a privatisation of a service (and thus several PPPs) employees’ pay and conditions cannot be downgraded in the interests of profit.  A code of conduct based on TUPE (Transfer of Undertakings Protection of Employment) within PPP with wider scope, however, such that PPP contractors agree on at least rates of pay and working conditions comparable to the public sector (for example in refuse collection and hospital cleaning) would go a long way to allaying the many justly held fears of Trades Unions that PPP is an excuse for reducing pay, inflicting poorer working conditions and cutting staff levels.  If this had the result that PPP became unprofitable in a range of different projects, that would surely not be something to regret: PPP should stand on its own feet, not on workers’ heads. 

Quality Issue 

Fourthly, PPP has gained an ugly reputation, for example in Scotland, for cutting corners wherever possible.  Schools replicated with identical architecture, hospitals built with poor quality cement so that operating theatres leak, and IT projects that completely fail to deliver are some of the best examples. Here again there must be room for a Code of Conduct.  This could involve the work of an independent project auditor appointed by the Public Private Partnership Network (in the UK) or its equivalent, to review the use of materials, quality of design and other elements of the project to ensure that corners are not cut in the interests of profit. 

Cost of service provision 

Fifthly, the question of the cost of service provision to the less advantaged members of the community.  Progressively more services that used to be provided free of charge now seem to involve one or another charge. Libraries, schools, care homes for the elderly, dentists, hospitals (in many countries) and roads are good examples.  Other services, such as rail, which used to be run as public services now aim to make a profit.  Those least able to bear these costs are driven away from these services and left abandoned, unable to afford sometimes the most basic of services.  The privatisation of services, in which PPP plays a part, therefore succours increasing inequality and division in society.  Whereas government seems in many cases to have abandoned its traditional role as equaliser, private firms’ CSR projects almost by definition are aimed at the less advantaged in society.  Within the provision of a public service, therefore, there may be numerous opportunities for the application of CSR.  These applications could range from subsidised service provision for the elderly, for the disadvantaged or the sick, to overseas aid and reciprocal arrangements, and public participation in corporate decision-making on the provision of the service.

So now what?

All of these issues, as numerous PPP analysts have made clear, revolve around the complex contracts that are signed between the private sector SPV and the government agency concerned.  All too often problems have arisen because of a legal, rather than a moral, interpretation of the contractual relationship between the SPV and the agency.  As one recent witness to the Education Select Committee, David Kester of the Design Council, said: "Half the problem we have here is that this is the first big capital project that most clients have ever run at this level”.  Maybe.  But it’s hard to believe that the same goes for the companies on the other side of the fence.  They ought to have known about some of the possibilities, and should, as responsible contractors, have disclosed this to the clients.  No one should walk out of a negotiation, punch their fist in the air, and shout ‘gotcha’.  On the contrary, the widest possible stakeholder consultation and free disclosure of contracts should be part of the PPP process.

CSR means that companies should behave responsibly in negotiating contracts with government agencies.  That’s what CSR companies do in all their negotiations and contracts, which is why, in the long run, they keep their clients – and their reputations.  But to be on the safe side, the PPP industry globally needs an ethical code of practice, and it needs it urgently, before the whole – sometimes quite effective – procurement method of PPP is discredited. 

  [Contributed by Julian Roche, MHCi associate]

Every month or so we have a new item of interest to the corporate responsibility world. See previous titles .

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