INTOSAI Privatisation Working Group PWG

1. INTOSAI Privatisation Working Group (PWG) Technical case study Series 1 – Privatisation

2. 2 Summary

3. 3 1. Reasons for appointing advisors Large scale/small scale asset sales Where the project/initiative is complex or large scale there are likely to be benefits to using an advisor. In such a case it will be unlikely that the Government will have all the necessary skills and knowledge required. Technical advice may be necessary on small projects, but care is necessary to ensure costs are affordable and proportionate to the benefits. In particular, governments should limit the cost of advisors by combining tasks and projects wherever possible. Example: Water privatization in the Windward Islands In preparing for the privatization of its water utility, the government of a Caribbean island nation recognized the need to hire technical advisors to assess the sector's long-term investment requirements. The advisors submitted their own plans, but the government restricted the scope of the work to match their restricted resources available. The use of consultants should not be an automatic choice. There should be a methodology in place to consider the use of advisors where they can add greatest value. It can be cheaper to buy in expertise from external consultants on a case-by-case basis and use internal resources where possible.

4. 4 Financial advisors Duties should centre on ensuring any transactions (e.g. asset sales) represent value for money and are deliverabl. Currently, investment banks and leading accountancy firms will comprise the bulk of candidates available in the field. 2. Types of advisors and how they add value

5. 5 2. Types of advisors and how they add value

6. 6 2. Types of advisors and how they add value Other specialist advisory services Consulting firms offering operational improvement and management/strategy services (especially during a pre-privatisation restructuring). Environmental consultants (used when privatising industries that cause damaging pollution or other environmental risks) will typically conduct environmental audits and risk assessments. Commercial/Technical experts with specialised industry skill and knowledge will provide much needed background detail when conducting feasibility studies and identifying candidates. Technical experts and possibly engineers will also advise on the condition of existing assets, rehabilitation needs and new investment requirements. Remuneration advisors will be necessary if share incentive plans are adopted Tax advisory services may be provided by accountancy firms, specialist tax consultancies or legal firms. Actuarial advisors will provide, amongst other things, pensions advice. HR advisors will consult on staffing arrangements, especially if there is a need for the company to be restructured as part of the privatisation. PR/Marketing advisors would manage the bidding process and deal with media interest. With a business sale, re-branding may be considered. Economic consultants may advise on industry and market structures.

7. 7 3. Defining advisors scope of work A Resource Planning Exercise may generate useful project requirements. This will include ensuring there is adequate information about the capacity and capabilities of internal resources. Lack of this type of information generally leads to turning to advisors unnecessarily (often at great expense). In inviting potential advisors to bid, procurers need to put together the following documents: · a full client brief for detailed definition of what is required of the advisors; · terms and conditions of contract with the advisors (including fees and payment terms); · final evaluation criteria for award; and · a request for a response to the first two bullet points above. A good engagement letter will then highlight and define the key advisor requirements and will detail what is and is not expected of them. Client Brief It is critical when selecting advisors to give them as much information as is reasonable and to define roles and tasks as clearly as possible. This should cover the nature of the assistance sought in terms of advice, support, review, responsibility for the process etc. The clearer the brief, the easier it is for advisors to assess the experience and expertise required, and to price the advisory service accordingly.

8. 8 3. Defining advisors scope of work A clear brief will also help the procurer to: · specify the terms and conditions of appointment; · achieve value for money from advisers; · keep control of costs; · produce a mechanism for managing advisers and the procurement process; and · understand the internal project management arrangements - who performs what role with what responsibilities The Client Brief should first outline what is required to take the project forward. As a guide, it should at least include the following: · the role of the procurer and any other stakeholder in the project; · the background to the project, how it fits into the procurer's business strategy; and · details of any existing service provision. The Client Brief should then define the separate roles of lead advisor, financial, legal and technical advisers, as appropriate.

9. 9 4. Selection and appointment Selection should be according to the requirements of the project. These should have been carefully considered as per Section 1: Reasons for appointing advisors A competition tender is normally appropriate if there are multiple companies which supply the requisite service. This may not be appropriate if the service requires specialist/technical skill-sets or if there is no alternative supplier. However, competitive tendering is still preferable as it creates pressure on advisory service pricing. EXAMPLE: Flotation of Railtrack (UK) Solid Solutions were appointed as retail advisors, without competition, because of their unique expertise which was highly relevant to that particular project. However, a number of major accountancy firms had experience of handling some retail logistics work although they had not carried out the wider role undertaken by Solid Solutions. The NAO recommended in its report that it is desirable to put a contract out to tender, even where one firm is regarded as clearly better than others, to test the pre-disposition in favour of the firm that is regularly used. Even if the same firm is eventually appointed, competition could put pressure on the price agreed. Financial advisors Should there be several independent and reputable companies, financial advisors should be based on their terms of reference including application of different valuation methods. The financial advisor should be selected before the auditor so that the advisor can help prepare the terms of reference for the audit Financial advisors will be giving a more specialised service compared to the other types of advisor. A ‘short list’ of firms with appropriate experience and marketing capability should help to avoid too few bidders. Interested firms should submit written proposals against broad terms of reference leading to interviews with key officials of the best firm. If the privatisation involves a small enterprise, accounting firms and financial consultants will suffice. But if the enterprise is larger or has an international dimension, valuation may be better carried out by an investment bank (depending on market awareness, technical skills and the ability to provide timely market information).

10. 10 4. Selection and appointment Conflict of Interest The selection process should aim to avoid both actual and perceived conflicts of interests. A ‘perceived’ conflict of interest arises in a situation where, although we are satisfied that there is no or minimal conflict, a client, other stakeholder or commentator may consider that there is material conflict. Conflicts of interests can arise in a number of different types of situation, including those set out below. · Current or previous direct involvement of the contractors (or its personnel) · Other existing contracts between the contractor and the vendor, particularly where the contracts amount to a significant portion of the turnover of the contractor or they have a high public profile. · Work for or with a third party whose interests may conflict with those of the audited body. Appointing the financial advisor to carry out the early stages of privatisation and implement the sale creates conflicts of interests. Advisory firms, however, are often reluctant to participate in only one stage of the sale as the services provided are generally less profitable (time and expense in understanding the business). This may be managed by applying competitive tendering for both stages but not to restrict the winner of the first stage from participating in the second. Alternatively the advisor could be hired for both stages but the procurer of advice should be allowed an exit strategy option after the first stage. Example: Flotation of Railtrack (UK) SBC Warburg were employed as financial advisors as well as global co-ordinators of the share offer sale. DfT saw advantages in this dual role including improved quality of research due to their closer involvement in the sale, the cheaper overall price and increased co-ordination between the two roles. Furthermore, the risk of an unsuccessful sale was increasingly transferred to SBC Warburg as their reputation as global co-ordinators was put at stake. The NAO was critical of this dual role as it provided a financial incentive for SBC Warburg to recommend a 100 per cent sale against a partial sale (a greater size of sale would result in a larger commission for SBC Warburg). DfT assured the NAO that they would have re-visited the terms of SBC Warburg’s remuneration if a partial (rather than 100% sale) had been agreed.

11. 11 4. Selection and appointment

12. 12 4. Selection and appointment The selection process should be fully transparent and all relevant information should be made available to the parties involved. All parties should be treated fairly and equally with adequate confidentiality undertakings e.g. Information available to the bidder should not be used in an advantageous way during a subsequent competition. Evaluation Criteria Companies/individuals best placed to undertake the project should be identified and assessed against evaluation criteria. Major variations in quality with advisory firms is possible. The service and the individuals providing the service need to be considered as in some cases they are different to the team who were involved in pitching or contract negotiation. Example Evaluation Criteria Scorecard

13. 13 Underlying assessment criteria The bidder's understanding of relevant privatisations is important in demonstrating advisors ability to deliver the required service. They should establish within their bids which privatisation (or even PPP/PFI) projects have been involved in. Non-UK experience, if relevant, should not be discounted. What about similar project experience? Privatisations can vary enormously; Experience of working on similar types of project is important, although any potential conflicts of interest will need to be identified and dealt with at an early stage. The actual privatisation or equivalent experience that the relevant individuals themselves had should be considered. This should be explained in detail and in the context of the rest of the team that they are working with. This will also be a factor to address in any prequalification process. The experience that individuals have had in advising the public sector is also important.

14. 14 5.Costs of service At the earliest possible stage, accurate budgets should be prepared. This will aid future management and cost control. The costs of advisors can vary considerably due to the size and complexity of the project, activity within different markets and reputation of advisors. The INTOSAI Privatisation Working Group Technical case example Managing an IPO provides an example of the cost breakdown for Underwriting services. Once the contract is underway, the need for an advisor varies considerably and will involve monitoring performance, reviewing the contract and providing support on price reviews. Example: Flotation of Railtrack (UK) Costs in The privatisation of Railtrack were controlled through the use of pre-determined ceilings on advisors’ fees, although some of these ceilings were revised after consultation and agreement with the Department of Transport. Costs were also monitored against monthly targets which gave early indication of any difficulties. The Department’s team also included staff who had worked on previous sales. Example: Privatisation of Sydney Airport The Australian NAO recommended that the Office of Asset Sales and IT Outsourcing strengthen its contracting for services including performance monitoring arrangements in all major contracts such as reports on progress, resources used and costs incurred. Different payment mechanisms tailored to the client should help control cash and maintain strong working relationships with the advisor. Advisors involved in privatisations often ask to be recompensed by success fees. These can only be paid after identifying clear outputs against deadlines which are agreed by all interested parties. Example: Sale of British Energy (UK) The DTI sought to minimise the fees paid to their advisers by conducting competitions for key advisory appointments, negotiating caps on fees, and monitoring costs throughout the project. The internal audit division also concluded that the DTI had engaged in firm and rigorous negotiations with potential advisers with regard to fees.

15. 15 5.Costs of service Example: Sydney Airport Privatisation To manage the cost of the sale, OASITO introduced fixed fee arrangements or fee caps for advisors in a number of instances. In a number of instances OASITO was unable to enforce fixed fee arrangements or otherwise constrain costs because the contractor was required to undertake work outside the scope specified in the Request for Proposals and included in the contract. The ANAO suggested caps for sub-contractor fees and expenses in major adviser contracts to ensure that the Commonwealth did not bear the commercial risk of cost overruns Where appropriate, proposed advisers should be requested to put forward alternative fee structures in deciding fees for each area of work they are planning to undertake, for example: · hourly rates for individuals; · fixed fees for each defined stage (agreed in advance within an overall budget); · if a success fee element is a possibility, a clear definition of the "success“ involved and what proportion against hourly/fixed fees; · if appropriate, regressive fee rates e.g. as agreed levels of fees are earned the charge-out rates (i.e. hourly/daily) are reduced by a set sum or percentage

16. 16 6.Managing advisors Tasking and managing the advisors Some form of contract monitoring will be required to assess whether the private sector provider is providing the appropriate range of services to the agreed standard. This will help to ensure contracted agreements are met by the client and costly overruns do not occur. This may involve the appointment of an auditor to monitor and test operational performance e.g. through post project reviews. In addition, a review of performance indicators should take place against evidence collected by the vendor throughout the sale process. Working with advisors The desired aim is to facilitate a good working partnership with the advisors which helps to complete the project as budgeted and allows for skills transfer. Example: Privatisation of Sydney Airport Frequent meetings were held between OASITO, Department of Transport and Regional Development and OASITO’s advisers, to discuss bid evaluation generally and, in particular, key issues and recommendations/assessments. This was deemed a good way of building good working partnerships and may be enhanced by forming a tender evaluation committee Regular planning for and carrying out of training, recruitment and skills transfer from consultants to internal staff should be promoted in order to maintain internal capabilities. Example: AEA Technology Sale Government staff handling the sale were experienced in matters relating to trade sales, which was seen initially as the most likely method of sale. The NAO concluded that when the decision was made to privatise through flotation, staff had very little experience of this type of sale which may have affected VFM. Staff with such experience are in a better position to question advisers and perhaps take decisions with which advisers do not necessarily agree.

17. 17 6.Managing advisors The transfer of skills from advisors is an ever increasing area where VFM can be achieved Example (non-privatisation): UK Central government’s use of consultants One of the key decision criteria for the Home Office in selecting advisors for its Process Improvement Programme was the advisors’ ability to transfer skills to department staff. The aim of this programme was to trial changes in processes in different parts of the Department to produce efficiency savings. The Department planned to use consultants for 4 initial trial projects working alongside a group of civil servants who would then lead any subsequent projects. Consultants’ ability to coach their civil servant counterparts and their approach to skills transfer were key criteria in selecting the consultancy companies. Effectively managing an advisor can lead to long term VFM Actively engaging with and managing the relationships with key consultancy suppliers to better understand how they work and align objectives (i.e. making it easier to identify needs and decide more effectively who is best for the job) should always be considered. Procurers are encouraged to record information on the performance of advisors and make forms available upon request to other procurers (e.g. other government asset sales) who seek references in order to help choose a preferred bidder from the shortlist. It is best to complete the reference forms as soon as possible after the work has been carried out. Example: The Shareholder Executive and Public Sector Businesses (UK) The Executive set up in 2003 to bring focus to shareholder issues and to improve the Government’s ability to act as an effective shareholder. An aim of the Executive was to reduce dependence and increase value for money from the use of private sector advisors. Because it is able to provide more expertise within government and through tighter specification of work the Executive has estimated that it will have achieved savings of £12.1 million (17%) by 2007. the Executive has helped achieve savings of this order of magnitude through a more timely appointment of advisors and by negotiating tighter terms of engagement. As part of the privatisation process, successful parties are often required to carry out environmental audits. For instance, in the Czech Republic, privatisation only occurs if the investor conducts an environmental audit which is approved by the authorities. SAIs could inspect whether measures put in place following the audit are still relevant – perhaps by performing a 3-5 year health check.

18. 18 Lessons for auditors

19. 19 Lessons for auditors

20. 20 List of Acronyms

21. 21 References Reports Central government’s use of consultants. Comptroller and Auditor General: UK National Audit Office [2006] Toolkit. A guide for hiring and managing advisors for private participation in infrastructure. World Bank Private Sector Advisory Group [1999] Ensuring Sustainable Value from Consultants, Management Consultancies Association / Management Today, [2006] The case-by-case approach to privatization. World Bank Technical Paper no.403 [1998] The Flotation of Railtrack. Comptroller and Auditor General: UK National Audit Office [1998] Sale of Brisbane, Melbourne and Perth Airports: Australian National Audit Office [1998] Websites The Research Councils’ Internal Audit Service Good Practice Bulletin (No.12 – Employing Consultants) The Management Consultancies Association: ‘Working with Consultants’ INTOSAI PWG Guidelines on privatisation World Bank Toolkit on appointing and managing advisors NAO PPP/PFI recommendations database UK HM Treasury guidelines on appointment and management of advisors for PFI/PPPs