Local authorities face tough targets for reducing landfill. In looking for partners for integrated waste management schemes, a balance has to be reached on financing and allocating risk
Every year in England and Wales, some 80% of the 30 million tonnes of municipal waste collected by or on behalf of local authorities is landfilled.

The EC Landfill Directive has set an ambitious programme for reduction, abetted by progressive increases in landfill tax and the authorities are at the forefront of the struggle to meet targets.

Faced with the UK's relatively underdeveloped alternative means of disposal and the scale of new investment required, local authorities are choosing integrated waste management contracts, or IWMCs, as a main weapon, procured via the PFI model. These are some of the issues: Legal capacity and credit The Local Government (Contracts) Act 1997 removed most of the "vires" problems that retarded the growth of PFI/public-private partnerships within the sector.

On credit risk, investors and funders appear generally comfortable with the formal position that local authorities are not guaranteed by central government, particularly where projects survive the scrutiny of the Treasury-chaired Projects Review Group, and where compliance with the recently amended Capital Finance Regulations removes the need for credit cover.

Best value legislation Following the 1999 Local Government Act, project participants must now translate the best value requirements into bankable IWMCs. Many features – recycling/recovery targets and benchmarking/market testing – are inherently compatible with the relevant best value performance indicators.

A settled approach is emerging across the local authority PFI/PPP sector to the passing down to contractors of best value requirements via the compensated change procedure.

Demand risk Recent amendments in the Capital Finance Regulations mean that local authority schemes are now analysed for accounting purposes primarily by reference to financial reporting standard five, commonly known as FRS 5.

The minimum throughput mechanisms local authorities were using to meet bankability requirements may change to a more aggressive transfer of demand risk. It is unclear how senior funders would share this risk with sponsors and subcontractors.

Change in law The general outline of legislative change risk sharing within PPP schemes is now well established. The waste sector is, however, unusually prone to change given the strong policy trends. Sector-specific risk-sharing provisions are therefore needed.

  • Best value met by contractors via compensated change procedure
  • Sector-specific risk-sharing provisions needed
  • Delayed consent protection for funders

  • Procurement regulation Despite the general move away from compulsory competitive tendering in the local authority sector, the EU procurement regime (in tandem with provisions in the Environmental Protection Act) continues to apply a relatively strict regime to the letting of IWMCs. This presents tactical challenges in the bidding process and is inconsistent with the encouragement of innovation and reliance on output-based specifications that are at the heart of PPP and the best value concept.

    More procurement issues arise where the IWMC includes an energy-from-waste facility and selling surplus power.

    Consenting issues Most IWMCs involve developing new capital assets to enhance recycling and recovery rates. Energy from waste plants is the most conspicuous example, but others include materials recycling, digestion and composting facilities which may prompt objections to specific schemes. Most IWMCs, therefore, need to contemplate a lengthy period between signing and completing the consenting process. This raises complex issues in relation to: the allocation between the public and private sector partners of the risk of consenting delay, refusal or unusually onerous conditions; funding structure; and approach to subcontracting.

    One option is to fund the project on the sponsor's balance sheet, refinancing once the consents have been obtained and contracts let. However, this increases the overall cost of capital.

    An alternative is to share the consenting risk with the authority so that funders are assured of a compensated escape route.

    In relation to construction risk, landfill is likely to provide a baseline revenue, and in practice, risk is distributed among a number of separate sites and assets.

    A typical structure might involve some form of assurance from the sponsors on cost, performance and delivery times of key assets; a lesser degree of formal comfort in relation to the balance of assets – possibly a construction management-based procurement method.

    Upside sharing IWMC contractors are generally encouraged to promote third-party commercial use of facilities. For funders, this partially mitigates throughput risk; for the authority, it provides expansion/ standby capacity without excessive cost. Most local authorities now negotiate additional "upside sharing" provisions on commercial revenues, raising complex issues of accounting and definition.