Value for Money Test in Korea Jungwook KIM awaker2@kdi.re.kr Director, PPP Division Public and Private Infrastructure Investment Management Center PIMAC

1. Process of PPP Project Implementation

Project Initiation Both the government and a private company can initiate a PPP project Solicited Projects A solicited project is that the competent authority identifies a project for private investment and announces a RFP Competent authorities develop a potential project after considering related plans and demands for the facility. They then weight the procurement options in order to determine whether the PPP procurement is more efficient than the conventional procurement Unsolicited Projects For an unsolicited project, a private company (project proponent) submits a project proposal, and then the competent authority examines and evaluates the contents and value for money of the private proposal, and designates it as a PPP project 3

Procurement Steps of a Solicited Project Competent Authority Review by PIMAC Selection of PPP Project Designation as the PPP Project Announcement of RFPs Submission of Project Proposals Evaluation and Selection of Preferred Bidder VFM Test Negotiation and Contract Award (Designation of Concessionaire) Application for Approval of Detailed Implementation Plan Construction and Operation Private Sector → Competent Authority → Concessionaire → Concessionaire 4

Procurement Steps of an Unsolicited Project Submission of Project Proposal VFM Test Notification of Project Implementation PIMAC Private Sector → Competent Authority Competent Authority → Proponent Announcement of RFPs Submission of Project Proposals Evaluation and Selection of Preferred Bidder Negotiation and Contract Award (Designation of Concessionaire) Application for Approval of Detailed Implementation Plan Construction and Operation Concessionaire → Concessionaire Unsolicited Project 5

VFM : The Theory

The VFM Concept What is Value for Money? Why it is Used? The best available outcome after taking account of all benefits, costs and risk over the whole life of the project (HM TREASURY) Not lowest price Why it is Used? Seek the best use of available resources Efficient and effective public service delivery “ The competent authority uses VFM reports as basic material to make a judgment on whether to move forward with the PPP project proposed by the private proponent” according to the Article 7, Paragraph 3 of the Enforcement Decree of the PPP Act 7

Key Elements of VFM VFM is often a comparative assessment Requires a benchmark cost : PSC (Public Sector Comparator) PSC is a benchmarking and evaluation tool : a Key tool Benchmarks the cost of government service delivery Evaluates whether VFM is delivered from bids A Procurement principle, not only for PPP Adopted by different countries to meet government’s procurement practices Not a universal tool Applied on a project or program basis Innovation, asset utilization, risk sharing, competition, service integration ate main key drivers of VFM Presence of VFM drivers confirms suitability for PPP 8

The Role of PSC Promote whole life costing early in the project’s development Assist in assessing the project affordability Provide a means for demonstrating VFM Provide a consistent benchmarking and evaluation tool Encourage bidding competition Based on : Reference Project Risk analysis Cash flow over the life of the project (inflation, cost, revenue, discount rate..) Government procurement costs to asses project affordability 9

VFM Assesment Compare to PSC or between bidders Presence of VFM confirms suitability for PPP. NPV of Transferable Risk PSC PFI PPP Contract QUANTITATIVE VFM Retained Risk Competitive Neutrality Raw PSC 10

3. VFM : The Practice in Korea

Implementation PIMAC of KDI is in charge of VfM test as stipulated by the PPP Act VfM test is carried out in accordance with ‘Guidelines for implementation of VfM Test/Review of Proposal for unsolicited BTO projects’. Five interim review meetings are held during the VfM test The duration of each project research should take up to six months Same methodology and procedure are applied both to VfM Test and Review of Proposal Objectivity, consistency, independence as well as professional expertise are important elements in conducting VfM tests. 12

Organization of a Research Team A VfM test is carried out by a multi-disciplinary research team KDI (Project Manager) Experts with relevant skills and expertise for the project are selected at the preliminary stage External experts (selected from human resource pool) Demand forecasting : university professors Cost estimation: engineering companies Accounting: accounting firms 13

Scope of a VFM Test Phase 1: Feasibility study (Decision to Invest) The cost- benefit analysis is conducted to determine feasibility of the project from a national economy perspective. Phase 2: Value for Money Assessment (Decision on PFI) The government payment of PSC (Public Sector Comparator) is compared against that of PFI (Private Finance Initiative) to assess whether the PFI achieves VfM. Phase 3: Formulation of PFI alternatives Based on the results of phase 2, an appropriate PFI alternatives are formulated The level of project cost, user fee, subsidy scale, etc. are suggested from the government. Phase 4: Award bonus points to the initial proponent Bonus points (10% max.) awarded to the initial proponent are estimated based on the results of VfM tests and the quality of the proposal. 14 14

VfM Analysis Implementation Method Setting Comparators for VFM Test VfM Analysis Implementation Method Unsolicited With Public Plan Solicited Private Finance Initiate PFIp (based on proposal) PFIp (proposal) PFIG (research team) PFIG (research team) Public Sector Comparator PSCp (estimated by research team) PSCp (research team) PSCG PSCG (research team) 15

Flowchart of a VFM Test (Unsolicited) Project Proposal(PFI0) Construction of PSC(PSC0) Phase 1 N Feasibility analysis Construction of PSC1, PFI1 VFM test of private proposal (VFM1=PSC1-PFI1≥0) Phase 2 N Y Construction of PFI2-i, Phases 3 & 4 VFM test of PFI alternative (VFM2=PSC1-PFI2 * ≥0) N Y PFI Alternative (PFI2*) Calculation of bonus points Rejection 16 Implementation of PPP Project 16

Flowchart of a VFM Test (Unsolicited with Public Plan) Construction of PSC (PSCp ) VFM test (VFMP1) VFM test (VFMG1) Construction of PFIp2 Calculation of Bonus Points (VFMp ) PFI Alternative (PFI2* ) With bigger NPV Rejection Implementation of PPP VFM test (VFMP2=PSCp2-PFIp2≥0) (VFMg2=PSCg2-PFIg2≥0) PSCp1, PFIP1 PSCG1, PFIG1 N Y PSC by Public Plan (PSCG) Phase 1 Phase 2 Phases 3 & 4 Construction of PFIP2 Feasibility Test (PSCp PSCG) Project Proposal (PFIp)

Flowchart of a VFM Test (Solicited Project) Construction of PSC (PSCG) Feasibility Test (PSCG) VFM test (VFMG1) Construction of PFI Alternative Rejection Implementation of PPP N Y Construction of PSCG1, PFIG1 Phase 1 Phase 2 Phases 3 & 4

Phase 1: Feasibility Study (1) Assess project feasibility and necessity in the context of national economy and policy directions Cost-benefit analysis method is used to assess the economic feasibility of a project CBA is conducted in accordance with sectoral guidelines (e.g. roads, railroads, ports, seaports, dams, and environment facilities) for PFS (Preliminary Feasibility Study) B/C ratios calculated based on Estimation of demand, costs, and benefits Sensitivity analysis Policy analyses, if necessary, are carried out 19

Phase 1: Feasibility Study (2) Setting a PSC (Public Sector Comparator) Setting an appropriate PSC option is very important both to feasibility and VfM of a project A basic assumption of VfM test (including FS) is that the same level of service will be provided by both PSC and PFI options In reality, a PSC option that is compatible with PFI proposal is formulated Total, (risk adjusted) whole-of-life cost of the project is estimated if government is to undertake the project. User fee and project cost of PSC are not necessarily same as those of PFI The user fee of PFI is usually larger than that of PSC 20 20

Phase 1: Feasibility Study (3) Policy analyses are carried out if necessary Evaluation in qualitative/quantitative terms whether the project is justified in relation to relevant policy issues Relevant policy issues: balanced regional development; consistency with higher level plan and policy directions; and environment impact analysis, etc. The overall feasibility of a project is assessed based on economic and policy analyses If the FS results demonstrate that the project is feasible, then VfM assessment ensues. If not, the VfM test process as a whole is suspended, and PIMAC recommends the Competent Authority to reject the project proposal. 21

Phase 2: VFM Assessment (1) Government spending of the PSC is compared against government payment requested by PFI proposal to assess if PPP procurement improves the value of tax payer’s money Features of VfM assessment It assists government making decision on appropriate procurement options: conventional public procurement vs. PPP procurement. It provides a quantitative VfM level and a justification for the decision on procurement option. It provides a reliable benchmark and specifies project scope. It encourages project appraiser to consider risks early in the project lifecycle, and address risk transfer options in the bidding process. It reduces negotiation time and increases the efficiency of bidding costs as the scope of private sector bids are more aligned with the public sector needs, and risk transfer profiles. 22

Phase 2: VFM Assessment (2) Cost items adjusted for competitive neutrality between PSC and PFI options Revenue from user fee is deducted from government payment of PSC Revenue from supplementary project is taken into account in consideration of both options VAT and other tax payments are adjusted Same amount and payment schedule of land acquisition is applied to both options Administrative costs incurred by governments for project management are excluded from both options Insurance fee are estimated in different ways, reflecting the difference in market valuation of project risk by project owners Additional government support if requested by private company is included in both options based on estimated spending 23

(Capital costs + operating costs) Total government payment Phase 2: VFM Assessment (3) Item PSC PFI Capital costs Project costs Construction cost (1) Cost of survey (2) Design cost (3) Construction cost Land acquisition cost (4) Compensation for land and other possessions Supplementary cost (5) Cost for feasibility study (6) Cost for transportation impact assessment (7) Cost for environmental (8) Cost for supervision (9) Insurance costs (10) Cost for operation equipment (11) Taxes and fees (12) Business setup costs Financing costs (13) Financing costs operating costs (14) Operation costs (15) Maintenance costs (16) Management and supervision costs ① Base cost born by the government (Capital costs + operating costs) - operating revenue Construction subsidy + land acquisition cost +additional government support ② Risk adjustment costs Cost and time overrun Total government payment ① + ② 24

Phase 2: VFM Assessment (4) Present value of government payments for PSC and PFI options are estimated (discount rate = 5.5%) and VfM(%) is calculated GP(PSC) = Capital costs + operating costs – Revenue GP(PFI) = Construction subsidy + Compensation costs + Additional government support GP(PFI) is the government subsidy requested by the private party in the project proposal 25

Phase 2: VFM Assessment (5) Qualitative VfM assessment Allocation of risks (construction, operation risks, etc.) Improvement of service qualities And other ripple effects (positive externalities): Promote the financial market through the adoption of an advanced financial technique, etc. Quantification of project risk transfer is not satisfactory and those qualitative effects are not incorporated into overall VfM assessment so far 26 26

Phase 3: Formulation of PFI Alternatives Financial analysis and sensitivity analysis are carried out to assess the profitability (bankability) of a project Based on the VfM assessment and financial analyses, PFI alternatives including the following components, are formulated: Total project costs User fee IRR (Internal Rate of Return) Total government payments Other components related to the implementation of the project The Competent Authority chooses the most appropriate PFI option and invites third parties to tendering If it is impossible to formulate a PFI alternative that delivers VfM at a reasonable level of IRR, then the PFI option is rejected 27

Phase 4: Bonus Points for Initial Proponent (4) The VfM test team makes decision on bonus points (10% max) to be awarded to the initial proponents based on the VfM(%) and quality of the proposal The quality of a proposal is evaluated based on the following criteria: ① Priority of the project in the mid- to long-term government investment plan (10 points) ② Composition of equity investors (10 points) ③ Excellency of construction and operation plan (30 points) ④ Accuracy of demand forecast (30 points) ⑤ Prior consultation with relevant government agencies and plan of addressing of civil complaints (10 points) ⑥ Adequacy of required documentation (10 points) 28

Phase 4: Bonus Points for Initial Proponent (4) Swiss Challenge: the original proponent has right to counter-match any superior offer. Best and Final Offer: the winning bidder must compensate the original proponent for project development costs. 29

Phase 4: Bonus Points for Initial Proponent (4) 30

Use of VFM Test Results The VfM test sets the bottom line to meet the condition of ‘VfM≥0’ in selecting preferred bidder and following phases of a project. VfM reports are used as an important reference when tender evaluation committee conducts their work. VfM reports provide useful information to prompt negotiation process. VfM reports are used as reference when ex-post VfM tests are conducted. 31 31