The topics to discuss by the moderator is:

1. Do you need a critical market size to justify such an approach?

2. How do you deal with many different types of project - are there enough core elements that can be standardized?

3. How do you enforce the use of standard documents across Government, especially with more Federal structures?

4. How do you avoid locking out innovation?

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[1]

Dear All,

In response to the request that I initiate the discussion on contract standardization, please find below some initial comments.

By way of background, we have used the contract standardization approach in the UK for the past 7 years and have found it generally to work well. It has led to a very noticeable improvement in quality of contracts in all sectors. We have a standard guidance and drafting document which sets out general principles for each main component of the project agreement. The main purpose of the guidance and the drafting is to allocate each risk to the party best able to manage that risk. It also provides some standard drafting for inclusion in agreements. In some cases this drafting is obligatory and funding (to pay for the long term unitary payments) will not be provided if it is not used. In other cases it is recommended, giving the parties a strong indication of what would be appropriate. The guidance is called "Standardisation of PFI Contracts Version 4" (shortened to SOPC4).

We have also developed sector specific standard form agreements (eg schools, health, street lighting, social housing). These are all based on the central standard document - SOPC4: this is the 4th version of the guidance and drafting which reflects the fact that we amend it from time to time to take into account developments in the market through a process of consultation (e.g. the latest version has much more detail on managing change).

HM Treasury has commissioned PUK to develop the guidance and drafting (SOPC) and also to act as a regulator in examining and advising on departures from the core principles and required drafting in each project, before funding is released and the contract signed. You can access these documents (both SOPC4 and the sector specific standard forms) on the guidance section of our website (www.partnershipsuk.org.uk)

I would imagine that some of the key questions for this topic are:

Do you need a critical market size to justify such an approach?

How do you deal with many different types of project - are there enough core elements that can be standardized?

How do you enforce the use of standard documents across Government, especially with more Federal structures?

How do you avoid locking out innovation?

I know that some other markets are looking at this approach and some have developed model contracts for sectors. It would be interesting to hear your views on this approach.
Kind regards

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[2]

There have been some recent concerns among private providers in the UK that standardization has not significantly reduced costs, and that standard clauses have been applied in an unimaginative way, seriously inhibiting innovation. This is a subject that requires much closer empirical analysis.

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[3]

Here are some observations from an Australian State context on the issues raised by Ed Farquharson, including how standardisation is developing in our federal structure and the approach we have taken in seeking standardisation for our relatively small deal flow - on average 2 or 3 new PPPs each year. Thanks you to my colleague Tara Spivakovsky for her input.

In Australia, most PPPs undertaken by State governments and currently each State has its own policies and documents. However a process of harmonisation, which began with States working together for consistency where they thought this appropriate, is expected to accelerate with the recent formation of a new Commonwealth (that is, national government) body, Infrastructure Australia. Commonwealth Minister for Infrastructure Anthony Albanese has committed the new body to:

The standardisation of tender processes and contract documentation between Commonwealth and state jurisdictions for the use of PPPs and other relevant procurement options;

Standardising project approval techniques; and

Streamlining planning and approval processes by harmonising guidelines, legislation and regulation across jurisdictions.

Infrastructure Australia will develop nationally consistent guidelines for PPPs by the end of 2008.

In Victoria, we have not yet developed a standard contract, but we have a set of Partnerships Victoria Standard Commercial Principles. The Standard Commercial Principles apply to core services/accommodation type Partnerships Victoria projects, where the site has been chosen by government, payment is based on availability and the facility reverts to the State at no cost at contract end. However, many of the principles are also applicable to other Partnerships Victoria projects, including economic infrastructure projects.

The Standard Commercial Principles provide a consistent and efficient risk allocation framework, while recognising the need for flexibility for individual project needs. However, any derogation must be documented and agreed with the Department of Treasury and Finance when approval is sought to issue the project brief. We are fortunate that, due to our small number of projects, the Department of Treasury and Finance can have significant involvement in every project and should therefore have a strong understanding of why a departure from the principles may be warranted in a particular project - we hope that this will enable us to avoid the trap, identified by Garry Sturgess, of standard clauses being applied in an unimaginative way, seriously inhibiting innovation.

In the future, our Standard Commercial Principles will form the base for development of standard contractual clauses to help reduce the cost and time of contractual negotiations. In the meantime, we are seeking to ensure that current social infrastructure projects utilise a common base contract to the extent possible. Flexibility for innovation is retained by allowing derogation from the Standard Commercial Principles, when approved by the Department of Treasury and Finance, for an individual project. It is also important to bear in mind that, while commercial aspects of contracts can be standardised up to a point, technical aspects will largely be specific to the individual project.

We do not have enough projects in individual government sectors to justify sector-specific standard principles or contracts. We seek to match our approach to standardisation to the needs of our project pipeline - if we had no pipeline of future PPP projects, we would not need standardised guidance and drafting. However this does not mean that a market must be of a critical size before development of standards can take place. Starting with a small number of pilot projects first is worthwhile to gain experience, and consideration can then be given to whether enough has been learnt to implement a standard document or standard principles. It is preferable to have guidelines and procedures already in place before undertaking a substantial number of projects.

While consistency is always preferable to an ad hoc approach, our guidance has been continually refined as government and the private sector have learnt from additional projects.

Kind regards,

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[4]

1.Do you need a critical market size to justify such an approach?
First of all, we would like to express our appreciation to Mr. Farquharson for giving us advises when we visited London in March.
We studied Standardisation of PFI Contracts version 4, and are now preparing non-mandatory guidance for standardization of PFI contracts.
As for the question about a critical market size, we believe that it depends on situations. Through publication of our guidance, we think we can provide forum for discussion and sharing know-how. In Japan, majorities of the PFI projects are implemented by local governments. Our department, PFI Promotion Office, does not have authority to approve or subsidize any PFI projects. Thus, the vehicle for sharing know-how is necessary, and the size of market is not important.

2.How do you deal with many different types of project - are there enough core elements that can be standardized?
Our attempt of standardisation has just started. We are now trying to find some core elements for resolving some pressing issues, such as change in service, price variation, change in law, voluntary termination, and payment mechanism.
Currently, as a general rule, our draft guidance does not deal with projects where demand risk is transferred to contractors. Further, it is expected that standardised PFI contracts for each type of projects will be prepared in the future.

3.How do you enforce the use of standard documents across Government, especially with more Federal structures?
Guidelines for PFI projects prepared by the national government are not binding on local governments. However, we made intensive discussion on major topics with PFI players (including local government officers) and we believe that our guidance is helpful also for local governments.


4.How do you avoid locking out innovation?
This is a difficult question which we are also struggling with. We are preparing a manual for drafting output specifications for simulating innovation by presenting what drafters of output specification should do and should not do (including checklists for drafting).
For simulating innovations while ensuring that proposals by potential contractors are in consistent with intention of the government, we believe followings are important:
(1) clarify the purpose of the project;
(2) clarify what the government expects contractors to contribute the project through PFI;
(3) include non-binding input specifications into service specifications presented to bidders, if it is useful for clarification of intention of the government; and
(4) prepare effective oral dialogue procedures.
However, our attempt is on the way and it would be appreciated if you would make comments on how to simulate innovations while ensuring that proposals are in line with governments' preference.

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[5]

We would like to begin by apologizing for our delayed response after receiving your comments. The following is an update of our situation. In July, we published an exposure draft of the new guidelines for PFI contracts which included sample provisions, but did not include a completed model contract. The draft was published for discussion purposes only. There remain many issues to be discussed, and the following will introduce some of the major challenges we face.

1. Increase in Construction Costs
Partly because of the worldwide rise of steel and oil prices, increase in construction costs is a serious issue in Japan. The issues we need to discuss are (1) whether or not private contractors are capable of mitigating the impact of these rising prices, and (2) if price adjustment is necessary, how to calculate the impact of rising prices objectively. The latter is difficult because when a private contractor determines the bid price, details of the design have yet to be determined, thus the amount of materials necessary for the construction of the project is unknown.

2. Compensation for Voluntary Termination
PFI contracts may be terminated due to, for example, political change. The problem is how to calculate compensation for the contractor involved following the voluntary termination of a PFI contract by the public sector.
We especially need to discuss how to deal with lost earnings and the various other risks involved.

3. Sharing of information
To enable the objective calculation of price changes following the changes in output specification, or the objective calculation of compensation for the partial or whole termination of PFI contracts, the sharing of information regarding subcontract terms and the cost of each job may be useful. However, there is disagreement regarding the scope and timing of disclosure.

4. Standard for Changes in Law
In many cases, costs arising from "general change" must be borne by the contractor while costs arising from "direct change" must be borne by the public sector. The problem is, the distinction between general and direct change is vague. In addition it is unsure whether the distinction is reasonable. However, we have not yet found better criteria.

5. Role of SPC
The issue is whether SPC should have an active role, such as the arrangement of subcontracts, or if SPC is just a vehicle for pass-through.

6. Project Finance
There are many relatively small and simple PFI projects in Japan. Some argued that the project finance in many PFI projects is not "true" project finance (but finance to governments) and they also argued that our current guidelines for PFI contracts are not adequately suited for project finance. So we need to discuss whether project finance is essential for PFI projects.

We believe you face similar problems (especially the increase in construction costs). We would appreciate it if you could post your comments on the issues.

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PPP Web Tokyo Conference 2008