Service Concession Arrangement – shortsighted or visionary?

A Service Concession Arrangement (SCA) in the public sector generally refers to a negotiated contract which gives an entity the right to do business with government assets, with some specific requirements. Recently, Governmental Accounting Standards Board Statement No. 60, "Accounting and Financial Reporting for Service Concession Arrangements" became effective for periods beginning after December 15, 2011. This statement provides guidance on how to account for Service Concession Arrangements (SCAs) or what has been commonly called Public Private Partnerships (P3s) in the public sector. This article will discuss the potential that SCAs can have in helping governments with financing and transferring certain risks of large projects in your community.

In the public sector, SCAs typically occur between a government and a private operator. The private operator makes a lump sum upfront payment or, for a combination of revenue sharing and other compensation, receives the right to take operation of a capital asset (or develop a capital asset and then operate the asset) and collect fees from third parties for a significant period of time. In turn the operator is bound by a set of operating standards and an agreed-upon rate schedule. Typically, the operator is responsible to return the asset at the end of the agreement in a condition similar to that in which it was received. An example of an SCA in the public sector includes the Indiana Toll Road being leased for 75 years for a sum of $3.8 billion.

As one would imagine there are definite benefits to such arrangements. They allow:

• The government entity to provide specialized service to the citizens by having qualified private operators manage the operations of the asset
• The government to receive significant compensation that could be used for various purposes such as debt reduction (tax law does require outstanding tax exempt debt to be paid off), infrastructure improvements, and enhancing reserves
• Financial risks to be transferred to the operator

Interestingly enough, these arrangements have been common in Europe for quite some time. They are often put in place for assets such as toll roads and airports. In the United States, the first major service concession arrangement was completed in 2005 when the City of Chicago leased their seven-mile toll way for an upfront payment of $1.83 billion. This was followed by the previously mentioned Indiana Toll Road being leased. As a result of the Indiana Toll Road concession arrangement, the state used the proceeds to fund a 10-year transportation construction plan.

Suddenly, private equity and asset managers were touting infrastructure funds as the perfect investments for pension funds. The infrastructure funds were marketed to pension funds as a way to provide cash flow generated from long lived assets, leased through SCA arrangements that would match the nature of a pension liability.

As governments look for ways to finance the never-ending requirements of maintaining an aging infrastructure, many officials have speculated that these arrangements would become a common occurrence in the US, especially because revenues have dropped significantly as compared to the pre-2008 levels and Federal funding has also been cut.

Unfortunately, concession service arrangements never became a hot commodity even as governments have privatized other aspects of their operations. Why? Was it the idea that governments should not be leasing or selling the taxpayer’s assets? Or, was it the significant increase in the rates charged for using these assets after they were leased that caused public outcry and disabled elected officials from approving these transactions?

Many factors may inhibit these arrangements from becoming the next great financing tool. For one thing, the extensively long lease periods of 75 to 99 years could potentially hinder their use. Also, the problem of funding infrastructure still remains throughout the US. Governments cannot continue to issue bonds for these improvements without additional funding sources, and a pay-as-you-go program will not cover the backlog of needs.

So what has happened to Service Concession Arrangements?

It appears they are not completely dead yet, but rather have now morphed from transactions involving revenue generating assets to transactions involving so-called social infrastructure such as schools, prisons, and courthouses. As an example, Long Beach, California, recently had a $495 million courthouse completed through a service concession arrangement where the developer is paid through several mechanisms such as rent and parking revenue. Payments to the developer can be reduced if the courthouse is not operated appropriately.

Although SCAs have not developed into a significant market, they do have potential to help governments with financing and transferring certain risks of large projects. If you are interested in learning more about how SCAs can potentially benefit your community, contact your Baker Tilly advisor.