3  Discount Rate Methodology for PPP projects - Social Infrastructure

This Guidance has been developed specifically for social infrastructure PPP projects.  The methodology for establishing a Discount Rate for Economic Infrastructure projects is included in Appendix D.

The specific allocation of Systematic Risk within the PPP arrangement will impact on the appropriate Discount Rate for evaluation and comparison of Private Sector bids.  The Methodology is applied by evaluating the proportion of Systematic Risk held by the Public and Private Sectors and using this information to adjust the Project Rate and accordingly to arrive at appropriate PPP Discount Rates to evaluate competing Private Sector bids.  Practitioners should note that, where competing bids demonstrate materially different Systematic Risk allocations, this process would need to be repeated on a bid-by-bid basis.

The Methodology requires procuring agencies to focus on what is the best VFM procurement decision for the Public Sector (note - this is not just a Financing Decision).  The key issue is how much risk transfer the Public Sector desires to undertake, as part of the proposed procurement and how much of a premium ("compensation") the Public Sector is prepared to pay for that risk transfer in the VFM context.  Using the decision tree below, this premium is represented by the difference between the Project Rate and the Risk-free Rate.  There is a positive relationship between the amount of risk transferred from the Public Sector and the Discount Rate to be applied to the PSC and Private Sector bids.

The important questions that need to be considered by the practitioner in relation to Systematic Risks are; What are they? How important is the risk? Who is bearing the risk? These questions are addressed in applying the Methodology to arrive at the appropriate PPP Discount Rate for a PPP Project. The Methodology is illustrated as a decision tree below.

The following pages take practitioners through each step of the Methodology to demonstrate how it should be applied in practice and will also discuss the critical issue(s) that will need to be considered before proceeding to the next step.  While the question of the specific allocation of Systematic Risk within the PPP arrangement is not dealt with until Step 5, it is possible to expedite the process where it is clear that predominantly all Systematic Risk is with the Public Sector.  This is considered in Step 2.

It is expected that in the majority of cases an adjustment for Systematic Risk transferred will be required.