2.1
This chapter discusses the advice provided by the Department of Infrastructure and Regional Development (DIRD) to Ministers in relation to the funding approved for the East West Link and WestConnex projects, including:
Committee conclusions and recommendations
Committee conclusions and recommendations
Advice on infrastructure project assessments and risks
2.2
The Committee notes the importance of the assessment processes undertaken by Infrastructure Australia (IA) to defining the scope of potential infrastructure projects and establishing their economic merits.
2.3
Government policy committed to require ‘all Commonwealth infrastructure projects exceeding $100 million to be subject to analysis by Infrastructure Australia to test cost-effectiveness and financial viability’. Cost benefit assessments for fully developed business cases did not occur in relation to these projects prior to commitments being made, funding being allocated and payments made.
2.4
The Government’s decision to depart from a full IA assessment of the East West Link and WestConnex projects reduced the evidence bases for decision making. Full business cases were not considered before funding was allocated and documents relevant to administrative activities were unavailable at key points in time. The Committee was advised by DIRD that this was, in large part, to provide economic stimulus. While there may be circumstances in which national interest judgements support such an approach, the Committee concludes that this approach is best avoided given the scale of public funding and the risks involved in infrastructure projects, particularly where some risks may not have been identified as risks at the time key decisions are made.
2.5
The Committee notes the ANAO’s distinction between ‘a commitment to … a project at a concept stage’ and ‘partitioned money within the infrastructure investment program to be available for that project’ versus the ‘statutory approval processes which then subsequently follow to have actual money approved under legislation which is then followed by a project approval instrument being signed’.
2.6
The Committee considers that departments should advise Ministers of the importance of following established processes before decisions are taken and, once decisions are taken, assess and provide comprehensive advice on key areas of risk and consequential decisions.
2.7
In the case of the East West Link and WestConnex projects, departmental advice fulfilled the first of these responsibilities. The Committee notes that DIRD provided advice to the Government in the lead up to funding decisions, indicating that some project documentation was yet to be provided and assessments were yet to be undertaken. Advice was also provided in relation to matching payments to funding needs and the risks of advance payments.
2.8
The Government made advance payments of $500 million for WestConnex and $1.5 billion for the East West Link. The ANAO found that these payments prior to June 30 2014 for ‘budget presentation benefits to the Government by bringing forward the payments which resulted in a larger budget deficit for 2013–14’ – i.e. to increase the Commonwealth deficit in 2013–14. The Committee was not presented with any material that it considers provides a proper basis for these advance payments and the Committee noted the payments were not required to progress either project at that time.
2.9
The Government’s decision to make these payments resulted in significant extra costs to the taxpayer in terms of interest costs on borrowings. These costs were estimated as being around $70 million at the time the two audits were completed (in October 2015 and November 2016) and would have increased subsequently. The Committee considers that extra costs of this magnitude should be quantified at the time of providing advice, in order that an assessment might be made as to whether any accelerated payment is in the best interests of the Commonwealth.
2.10
Further, the Committee considers that advance payments unrelated to project need are generally undesirable. While such payments may be made at the discretion of executive government, Ministers should be fully and specifically informed by departments of additional interest charges and costs together with any further risks to the taxpayer arising from advance payments.
2.11
After funding decisions were taken by the Government, however, departmental advice failed to provide an assessment of compliance with land transport legislation. As a consequence, at least one legislative condition (for the East West Link project) was not met, a failing that DIRD knew existed at the time of providing instruments for the Minister to sign, and which was only corrected six months after the instruments were signed.
2.12
In relation to legislative compliance, the ANAO’s WestConnex audit found that the department did not have sufficient documentation to assess compliance. Additionally, the ANAO’s East West Link audit quotes a departmental record stating that DIRD decided not to provide its usual briefing because the government had already approved the project and committed to making a pre-payment. Despite these factors, the Committee considers it was DIRD’s responsibility to assess legislative compliance and provide clear advice to the Minister that the legislative requirements had or had not been met, or could not be assessed.
2.13
The Committee recommends that, in relation to project approval instruments for future infrastructure projects, the Department of Infrastructure and Regional Development provide explicit advice to its Ministers on whether the requirements of the land transport legislation have been met and, where sufficient information is not available to make such an assessment, identify this in its advice.
2.14
The Committee recommends that the Department of Infrastructure and Regional Development only make significant payments when required by a project according to agreed milestones due to the unnecessary interest and holding costs and risks, including unquantified risks, arising from advance payments.
2.15
The Committee recommends that the Department of Infrastructure and Regional Development’s advice in relation to significant payments in advance of project needs should clearly and specifically set out:
the additional interest charges and costs arising from additional Commonwealth borrowing so Ministers are fully informed of costs to the taxpayer if deciding to make advance payments; and
any identified risks and potential risks arising from advance payments so Ministers are fully informed of risks to the Commonwealth if deciding to make advance payments.
2.16
The Committee notes the importance of having detailed project assessment information available when developing approval instruments. The instruments, made under the land transport legislation, define the purposes for which funding may be used, by specifying what each project includes and any restrictions on funding use. The Committee recognises that detailed project information was not available to DIRD when originally preparing project approval instruments for the WestConnex project. It also recognises that DIRD later identified the risk of the East West Link project being cancelled and took reasonable steps to protect the Commonwealth’s interests by developing amendments limiting what Commonwealth funding to stage one of the project could be used for.
2.17
The Committee notes that specific project risks will always need to be considered when drafting project approval instruments. It is timely, however, for the department to consider whether improvements can be made to its templates to address generic risks, such as the diversion of project funds to pay for costs associated with a project being cancelled.
2.18
The Committee recommends that the Department of Infrastructure and Regional Development review its approach to drafting project approval instruments, to identify any risks that may be relevant to the use of Commonwealth funding and to develop a generic form of conditions that can be included in future instruments to address these risks.
Advice on WestConnex concessional loan
2.19
The Committee is concerned about the lack of consideration DIRD gave to relevant issues in developing the concessional loan for the WestConnex project and the resulting deficiencies in advice to Ministers.
2.20
Importantly, DIRD provided advice to Ministers before it had obtained the financing strategy document for the project, which suggested that an alternative to Commonwealth loan funding existed. DIRD’s submission to the Committee questions whether the alternative was realistic. Irrespective of this later analysis, the information would have provided a basis for more comprehensive advice to decision makers.
2.21
The Committee understands that project proponents are unlikely to want to put forward documentation casting doubt on the need for Commonwealth infrastructure funding when they are seeking funding. However, it remains important that, where something as critical as a financing strategy has been developed and referenced in project documents, at a minimum, departments should insist that it be provided as a pre-condition of project consideration.
2.22
In this regard, the administrative guidelines that DIRD has agreed to develop in response to recommendation 1 of the ANAO’s audit would be an appropriate place to specify the Commonwealth’s expectations. A requirement that project proponents identify alternative funding strategies to a Commonwealth contribution and include analysis of why Commonwealth funding is the most appropriate option would provide a stronger starting point for assessment.
2.23
The Committee recommends that the administrative guidelines for loans that the Department of Infrastructure and Regional Development is developing in response to Recommendation 1 in Audit Report No. 38 (2016–17) The Approval and Administration of Commonwealth Funding for the WestConnex project, include a requirement that project proponents identify alternative funding strategies to a Commonwealth loan, as well as information explaining why Commonwealth funding would be the most effective, efficient and economical option.
2.24
The Committee notes the ANAO’s assessment that stage two of the WestConnex project is not on track to be completed up to two-years earlier than planned, which had been the Government’s objective in providing the loan, and is now less than six-months ahead of time. However, the Committee also notes DIRD’s advice that some time has been saved by the first two stages of the project proceeding in parallel rather than sequentially.
2.25
The key issue, however, from the perspective of the Committee is that DIRD’s advice at the time of the decision to provide the loan was overly optimistic about the loan’s capacity to accelerate the project, having insufficient regard to project delivery risks that DIRD has since articulated in its submission to this Committee, namely:
The original timeline contained much uncertainty as it was developed prior to receiving planning approval, and prior to negotiations with constructors and financiers. It is not realistic to assume that the original timeline would not have changed as a result of the negotiations with financiers and constructors and the obtaining of required approvals.
2.26
Given these risks, it was incumbent on DIRD to relay specific advice to its Ministers about the achievability of project acceleration. This is a key issue for DIRD to focus on in future assessments of infrastructure acceleration proposals and reflect in its advice to Ministers.
2.27
The Committee is concerned by the ANAO’s findings that DIRD did not: seek agreement to key negotiation parameters for the loan; consider and articulate the value of the different components making up the concession; and address some relevant risks. Any decision about the merits of a concessional loan should be informed by advice on: the concession inherent in the interest rate for the loan and term structure; the merits (or otherwise) of not recovering administrative costs through an interest rate margin; the Commonwealth’s interest rate risk exposure; and the effect of a loan on taxation revenues. In contrast, the Committee notes the ANAO’s finding that DIRD effectively considered and managed the risk of the loan not being repaid.
2.28
The Committee is also concerned that DIRD agreed key terms and conditions of the loan quite soon after the funding decision and, with one exception, in advance of engaging advisors. The department’s capacity to identify risks and negotiate favourable terms was therefore more constrained than it could have been.
2.29
Given DIRD’s advice that the government will continue to use innovative infrastructure financing arrangements into the future, the Committee wishes to stress the importance of DIRD learning from the WestConnex experience and developing a stronger basis for considering and negotiating future loans. The Committee notes the department’s advice that it has applied WestConnex learnings to a recent concessional loan provided for the Sunshine Coast Airport expansion project.
2.30
The Auditor-General may wish to consider the merits of conducting a performance audit examining DIRD’s administration of the concessional loan to the Sunshine Coast Airport expansion project as part of the ANAO’s future work planning.
2.31
The Committee recommends that the Auditor-General consider conducting a performance audit into whether the advice supporting the concessional loan provided for the Sunshine Coast Airport expansion project appropriately reflected learnings from the deficiencies in advice identified in Audit Report No. 38 (2016–17) The Approval and Administration of Commonwealth Funding for the WestConnex project.
Review of evidence
2.32
This section reviews the evidence received by the Committee regarding the advice that was provided by DIRD to Ministers in relation to funding approved for the East West Link and WestConnex projects, including:
Decisions to commit funding to projects
Advice relating to funding profiles and advance payments
Advice on legislative requirements
Managing advance payment risks in approval instruments
Advice on the WestConnex concessional loan
Implementation of ANAO recommendations
Decisions to commit funding to projects
2.33
As set out in the ANAO’s audit reports, the East West Link and WestConnex projects were both the subject of funding commitments in the lead up to the 2013 Federal Election. These included:
commitments made by the Liberal/National Coalition and the Australian Labor Party to contribute funding to the WestConnex project; and
a commitment by the Coalition to provide funding for the East West Link project, subject to Infrastructure Australia (IA) support.
2.34
Government policy committed to require ‘all Commonwealth infrastructure projects exceeding $100 million to be subject to analysis by Infrastructure Australia to test cost-effectiveness and financial viability’.
2.35
In contravention of this policy the incoming Coalition Government took decisions in finalising the May 2014 Budget to allocate funding to both projects. This included $1.5 billion in grant funding for each project and a concessional loan of up to $2 billion for the WestConnex project.
2.36
There was interest at the Committee’s public hearing in examining why the projects were funded at very early stages of their development and prior to normal assessment processes for infrastructure projects. That assessment is usually undertaken by IA.
2.37
IA is an independent statutory body established to improve the quality of infrastructure planning and investment strategy in Australia. A key part of its work is the development of an Infrastructure Priority List. The List provides independent, evidence-based advice to governments and industry on specific infrastructure projects that would be of most benefit to the community.
2.38
The framework used to compile the Infrastructure Priority List takes account of the economic, social and environmental impact of both the problem being addressed, and the infrastructure solution being proposed. An important feature of this process is that it requires project proponents to develop a full business case that objectively considers the infrastructure options available to address the problem identified.
2.39
The Auditor-General has previously found that IA applies a rigorous process to scrutinizing projects, including: the claims made by proponents; seeking further information when needed; and engaging advisors to assist in deciding whether benefit cost ratios submitted by proponents can be relied upon or require moderation.
2.40
Both the East West Link and WestConnex projects had undergone limited assessment by IA when the decisions to allocate funding to the projects were made by the Commonwealth. In this regard, the ANAO’s audit report identifies that, at the time of the funding decisions, some important project documentation had yet to be developed, provided to Commonwealth agencies and/or assessed by IA and DIRD to support government decision making.
For the East West Link project this included that:
Infrastructure Australia was yet to receive a full business case and had unanswered questions about the underpinnings of the project’s short form business case. Similarly, DIRD had only recently received, and was yet to analyse, a project proposal report from the Victorian Government for stage one of the project.
significant project development work still needed to be done by the Victorian Government before a full business case could be prepared for stage two of the project. Summary information was available, but was ‘… insufficient to enable an informed assessment of the merits, estimated costs and timeframe …’.
For the WestConnex project, IA had previously examined a submission provided by the NSW Government in October 2012 (which did not include a business case) and its analysis was that the project was at a formative stage of development. DIRD had used the same information in concluding in November 2012 that the project was not, at that time, sufficiently developed for 2013 budget consideration.
2.41
DIRD’s submission to the inquiry identified that, when funding decisions were taken in 2014, the government had intended infrastructure investment to be a source of economic stimulus, noting:
As Budget Paper 1 from 2014 outlines, the Australian economy was in the midst of a major transformation, moving from growth led by investment in resource projects to broader-based drivers of activity in non-resources sectors. This was occurring at a time when the economy had generally been growing below its trend rate and the unemployment rate had been rising. Furthermore, the outlook for investment in engineering construction was forecast to decline by 13 per cent in 2014–15 and 20.5 per cent in 2015–16, as a result of declining investment in the resources sector … The Australian Government committed an additional $11.6 billion in the Budget for the Infrastructure Growth Package including [the funding for East West Link and WestConnex] … It was aimed at responding to the needs of the economy by building infrastructure that would drive economic growth, create jobs and improve productivity.
2.42
At the public hearing, DIRD also highlighted the ongoing (post-IA) nature of project scoping, advising that:
… the Infrastructure Australia assessment goes to the merits of the proposal, whether there is a significant problem to be addressed and whether the solution proposed has merit and economic value. Once you get past that stage, the projects still need to go through the process of detailed reference design. With a complex and large project of this nature, that can be an extended and iterative process.
2.43
In relation to the quality of departmental advice to Ministers, the ANAO found that it appropriately reflected the early stage of the two projects in their development and/or assessment:
In the case of the WestConnex project, the ANAO noted DIRD’s advice ‘… consistently flagged that the project was in the very early stages of development and could not yet be recommended for Australian Government financial support’.
Similarly, for East West Link, the ‘… advice identified that stage one of the East West Link project had not proceeded fully through the processes that have been established to assess the merits of nationally significant infrastructure investments’.
Advice relating to funding profiles and advance payments
2.44
A key feature of the Government’s approval of funding for the East West Link and WestConnex projects was a decision to make some of the funds available as upfront advance payments. This included payments made in June 2014 of $1.5 billion for East West Link and $500 million for WestConnex.
2.45
Prior to these decisions, DIRD provided Ministers with advice on the timing of payments relating to projects that had been 2013 election commitments. DIRD analysis examined the funding requirements for the two projects, and identified that:
the Victorian Government had already allocated funding in its budget to cover the 2013–14 costs for East West Link project; and
information provided by the NSW Government suggested that a WestConnex funding contribution of only $46 million was sufficient for 2013–14.
2.46
The ANAO identified that DIRD provided clear advice to its Ministers that the payments were in advance of project needs. It also noted that DIRD’s advice appropriately addressed the inter-year funding profiles for both projects:
recommending that payments be aligned with anticipated project progress; and
addressing the issue of whether making advance payments would compound an existing problem of some states underspending on current infrastructure programs.
2.47
At the public hearing, there was interest in identifying and quantifying any costs to taxpayers of making advance payments for the projects. The ANAO’s evidence noted:
We assess the direct cost in terms of the extra interest, which is estimated to be paid on borrowing the money before it actually needed to be paid … For WestConnex, the extra interest at the time we finished our work was $20 million … Based on our estimates, interest on the advance payments until the end of October 2015 for East West Link was estimated at more than $49 million.
2.48
Interest costs as a result of these unnecessary advance payments totalled nearly $70 million (as at the completion of the ANAO’s audits in October 2015 and November 2016) which the ANAO’s evidence noted was:
…interest that would not have needed to have been paid if we had paid the money for the projects when the project financials said they needed their money, rather than in advance …
Advice on legislative requirements
2.49
At the time of approving funding and making payments for the projects, there were three relevant legislative requirements:
the approval of each spending proposal as being an efficient, effective and economical use of public money—required by the then Financial Management and Accountability Regulations 1997 (FMA Regulations);
the approval of the project, the funding amount and any project conditions in accordance with requirements of the Nation Building Program (National Land Transport) Act 2009 (land transport legislation); and
the signing of a determination to make the (National Partnership) payments relying on the authority of an appropriation under the Federal Financial Relations Act 2009 (FFR Act).
2.50
It was the ANAO’s conclusion that funding approval for both projects was given without any documented analysis and advice to Ministers that the statutory criteria for approval in the FMA Regulations and land transport legislation had been met.
2.51
In relation to the FMA Regulations, advice was not provided because the spending proposals were approved by the Prime Minister as part of 2014 Budget considerations. The more usual process for infrastructure projects is for DIRD to brief its Minister; include explicit advice on whether a spending proposal was an efficient, effective, economical and ethical use of public money (the requirements of the FMA Regulations); and seek approval.
2.52
A key way in which compliance with the criteria set out in the land transport legislation is documented is through the development of a project approval instrument. The instrument is a formal document signed by a Minister under the land transport legislation to approve funding for a project.
2.53
Following the funding decisions, DIRD provided a briefing to its Minister, with recommendations to sign four project approval instruments, including those relating to the East West Link and WestConnex projects. The instruments set out that the Minister was satisfied each project was eligible and appropriate for approval under the relevant sections of the legislation.
2.54
A significant deficiency with the department’s briefing was that it excluded any assessment as to whether the requirements of the land transport legislation had actually been met. The ANAO advised that:
The difficulty there is that from the department's perspective the decision had been made to commit funds to the project. Therefore they did not think it was worthwhile undertaking an assessment against the legislative criteria after the event, so they did not do so.
2.55
DIRD was not in a position to make such an assessment for the WestConnex project. It had not yet received documentation from the NSW Government that would enable consideration of whether the $500 million advance payment for the project met the statutory criteria.
2.56
For the $1.5 billion in advance payments to the East West Link project, the ANAO identified a departmental record suggesting that DIRD did not provide advice on legislative compliance because Ministers had already approved funding and pre-payment. This was a critical decision, because the ANAO has identified that at least one of the legislative conditions had not been met at the time of the advice. This related to the listing of the project on the National Land Transport Network. DIRD advised the Committee that it was aware of the discrepancy at the time it provided the instruments to its Minister. The problem was corrected in December 2014, six months after the original instrument was signed (June 2014).
2.57
At the public hearing, the ANAO noted that departments should take responsibility for providing advice which would allow governments to address statutory requirements after funding commitments are made:
It is difficult, as you say, when systems and processes designed to manage the risks are not followed. We recognise here in both cases governments have made decisions to commit funding to projects at a fairly early stage, but there is a distinction … between a commitment to … a project at a concept stage and, almost, partitioned money within the infrastructure investment program to be available for that project versus the statutory approval processes which then subsequently follow to have actual money approved under legislation which is then followed by a project approval instrument being signed … [T]hat distinction is quite important to then understand how departments, once they have received … the commitments government has made and wants to see delivered upon, then advise how to proceed with delivering on those commitments in a way which meets the requirements of statute.
2.58
The authority required for the payment of project funds is an end point in the assessment and approval processes, relying on the decisions made under the two preceding legislative processes. Following a recommendation by the Department of the Treasury, the Treasurer signed determinations approving (national partnership) payments for the two projects under the FFR Act on 24 and 26 June 2014. The role of the FFR Act in recouping unspent funding is addressed in Chapter 3.
Managing advance payment risks in approval instruments
2.59
The processes involved in obtaining documentation and assessing the merits of infrastructure projects provide key details that are required to support subsequent administrative activities. One of these activities is the development of project approval instruments under the land transport legislation. At the public hearing, the ANAO informed the Committee that:
The way the system is documented and designed to work is that … [the instruments] … are developed after the Commonwealth has a significant amount of information on a project. [The department usually obtains from the project proponent] … what is called a project proposal report, which generally reflects the business case and so forth. Ordinarily, if projects proceed through expected processes, the Commonwealth should know enough to be able to put the detail in … the project approval instruments. The problem is that in these cases, when a project is approved earlier than that information is to hand, it is very difficult to put specifics in there.
2.60
At the time that Ministers approved funding for the two projects, key project documents either were not yet available or had not yet been assessed:
The Victorian Government had recently submitted a project proposal report for stage one of the East West Link project (but not stage two) and DIRD had only undertaken limited departmental analysis of its contents; and
The NSW Government had advised DIRD that a project proposal report for the WestConnex project was not likely be available until early 2015. The report was eventually approved in June 2015.
2.61
The absence of such information limited DIRD’s ability to detail the scope of the projects, and any restrictions on the use of funding, in approval instruments. For example, in its audit of the East West Link project, the ANAO noted:
As originally signed, the project approval instruments inadequately set out the works that Commonwealth funding could be used for, and any project costs that were not to be met from the Commonwealth funding. This situation reflected that specific information on the two stages of the project was not available at the time the advance payments were made.
2.62
The level of detail in the East West Link project approval instruments became quite important, in terms of the capacity to recoup funding, when DIRD identified risks such as unresolved legal challenges and the potential for the East West Link project being cancelled. The recoupment of funding is discussed in Chapter 3.
2.63
In response, DIRD developed an amendment to the instrument for stage one of the project, to more clearly define what Commonwealth funding could and could not be used for. One of the key changes was to exclude Commonwealth funding being used as payment for any penalties, legal costs or court ordered costs if the project was delayed or cancelled. The instrument for stage two of the project remained unchanged, with the ANAO noting that:
This reflects that more precise information on the scope for that stage was not available, and the procurement processes for the work had not proceeded to a stage where there was any risk of contract payments being required in the event the project was delayed or cancelled.
2.64
In a submission to the Committee, DIRD noted that the inclusion of conditions in project approval instruments is ‘not standard practice’ and that standard conditions on the uses of funding are included in the land transport legislation. Such conditions, however, are limited to reporting and inspection obligations, a requirement to use public tender processes, and the return of funds where land purchased with Commonwealth funding is subsequently sold.
2.65
In terms of defining how Commonwealth funding can be used, the land transport legislation only includes a very broad obligation that funding be wholly expended for ‘approved purposes’. The importance of setting out the details of a project and any limiting conditions in approval instruments is demonstrated by the legislation’s definition of ‘approved purposes’, which includes spending on ‘… purposes forming part of the project, other than any purposes that are excluded by the project approval instrument …’.
Advice on WestConnex concessional loan
2.66
DIRD’s evidence at the public hearing was that the WestConnex concessional loan should be viewed within the government’s 2014 budget objectives, including the intent to:
… use alternative financing to complement traditional grant funding and more effectively use its balance sheet to support infrastructure projects—where this was an appropriate mechanism—and to help mitigate investment risks and generate significant additional state and private sector participation.
2.67
The advice DIRD provided to its Ministers reflected these priorities, focusing on the benefits of establishing a concessional loan for stage two of the WestConnex project, including: a lower net impact on the budget (than grant funding); the bringing forward of construction activity; and reinvigorating private sector lending to demand-risk toll roads.
2.68
Advice on further issues could have provided Ministers with a sound basis on which to make decisions. The ANAO’s report identifies another three areas:
addressing whether a Commonwealth loan would displace other project financing options;
assessing the likelihood of project acceleration succeeding; and
the level of consideration given to identifying and quantifying costs and risks to the Commonwealth.
Other WestConnex project financing options
2.69
The ANAO’s audit report identifies that the idea for providing a concessional loan to the WestConnex project emanated from a broader consideration of alternative funding options to infrastructure grants, including the impacts of using concessional loans and guarantees. DIRD sought and obtained approval to negotiate such options for certain projects, including WestConnex, both before and after the September 2013 election.
2.70
After the election, DIRD’s advice to Ministers reflected upon the likelihood that further funding would be sought for the WestConnex project and that additional funding options could address a $4.73 billion funding shortfall for election commitment projects. The NSW Government’s formal proposal for the $2 billion concessional loan aimed to accelerate the completion of stage two of the project by up to two years.
2.71
In other areas of public sector administration, a key question that is asked in preparing advice for funding decisions is whether a Commonwealth payment would achieve an outcome that would not occur without the Commonwealth’s involvement. This can be seen in:
the Commonwealth Grants Rules and Guidelines, which state that ‘A fundamental appraisal criterion is that a grant should add value by achieving something worthwhile that would not occur without the grant …’; and
the rules governing the allocation of financial assistance from the Northern Australia Infrastructure Facility, which limits eligibility for funding to projects that are unable to obtain sufficient financing from other financiers.
2.72
In their own frameworks, these principles are central to maximising the outcomes achieved from limited Commonwealth resources, but they have wider relevance. Importantly, they place an onus on those supporting decision makers to consider and provide clear advice on the additional outcomes to be achieved.
2.73
In this context, there was interest at the public hearing in whether the loan was actually needed. A starting point for such a consideration is whether DIRD gathered available information and sought advice to appropriately inform itself about the financing options available to the project and the benefits claimed to be provided by committing funding for a concessional loan.
2.74
A key document in this regard was the NSW Government’s financing strategy for WestConnex. The strategy document indicated that stage two of WestConnex could have been delivered through the privatisation of stage one (in 2019–20) and private sector borrowing, concluding that ‘… no further State (or Commonwealth Government) financing is required to deliver WestConnex …’. The level of detail contained in the document extended to estimated cash flows including funding sources and uses.
2.75
The ANAO noted that the strategy document was an attachment to the 2013 project business case. The business case was received by DIRD in September 2013, but the attachment was not provided to DIRD until mid-March 2014. In between these dates, in December 2013, DIRD briefed its Assistant Minister about the concessional loan proposal, advising that it had not yet determined whether the funding was required. Little external advice had been procured at this point in time, and the ANAO noted that subsequent departmental advice did not provide a conclusion on the issue.
2.76
DIRD’s submission to the inquiry advised that the strategy:
… required Stage 2 construction contracts to be executed before sale proceeds from Stage 1 had been secured. The Department did not share the view that a construction firm would be willing to enter into a construction contract prior to all funding being secured given the uncertainty in the value of Stage 1 at the time Stage 2 was proposed to be contracted.
Assessing the likelihood of project acceleration succeeding
2.77
A related issue to be considered in advice on the merits of a proposal to accelerate a project is an assessment of whether the acceleration period is realistic. In the case of WestConnex, stage two of the project is not on track to be completed up to two years earlier than planned. At the conclusion of the ANAO’s audit, stage two was less than six months ahead of time based on the ANAO’s assessment of data held by DIRD. The ANAO’s audit report concluded that:
In the context of the lengthy approvals, compulsory acquisitions of property, and consultation processes that must be undertaken in respect to an infrastructure project of this size, committing to an accelerated delivery of up to 24 months was too optimistic.
2.78
In its evidence to the public hearing, DIRD noted that providing certainty about the project’s progress and the sequencing of project stages was central amongst its considerations, noting that the concessional loan:
… was to get the project going and to actually give that confidence to the construction industry that the project was going to proceed, and proceed at an appropriate rate. Therefore, it is our view that that concessional loan allowed the two stages of the project to actually proceed in parallel, rather than one following the other, as was the original strategy in that regard.
2.79
However, DIRD’s submission raises the issue of the readiness of stage two to proceed in parallel with stage one, noting:
The original timeline contained much uncertainty as it was developed prior to receiving planning approval, and prior to negotiations with constructors and financiers. It is not realistic to assume that the original timeline would not have changed as a result of the negotiations with financiers and constructors and the obtaining of required approvals.
2.80
In evidence to a Senate Estimates hearing before the Senate Rural and Regional Affairs and Transport Legislation Committee in February 2017, the Secretary of DIRD confirmed that pre-construction lead times were the main reason for the delay:
Certainly during the process of developing the loan, the timeframe for WestConnex has taken longer to come to market and start construction than was originally envisaged. But I do not think that was the problem of the concessional loan. That simply reflected the design and procurement work which needed to be undertaken.
2.81
The need to establish adequate lead times for infrastructure projects is a theme highlighted by DIRD in 2013. At the same time as DIRD was providing advice to its Assistant Minister on the loan accelerating stage two of the WestConnex project, its December 2013 submission to the Productivity Commission’s Inquiry into Infrastructure highlighted some of the risks associated with inadequate project lead times:
Recent transport construction statistics suggest that when investment in transport infrastructure by governments increases, private sector investment slows, indicating a fixed growth capacity in the market. In addition, recent spikes in government investment in transport infrastructure (2008 and 2010) are associated with spikes in construction prices. This highlights the need for government to coordinate investments and to provide industry with adequate lead times for any new investments.
Identifying and quantifying loan costs and risks
2.82
The basic principles of the WestConnex loan arrangements were agreed and set out in a Memorandum of Understanding (MoU) signed by the Prime Minister and NSW Premier in May 2014, which included such things as:
the size and purpose of the loan facility;
the level of security provided to the Commonwealth; and
the interest rate and repayment structure (including an interest capitalisation period).
2.83
The signing of the MoU was informed by DIRD advice provided in April 2014. By that time, the department had engaged only one of its six external advisors, a commercial and financial services advisor. The ANAO’s assessment was that advisory services (particularly legal services) and risk assessment processes were engaged or undertaken too late in the process to influence the MoU, resulting in few substantive changes being made between the signing of the MoU (in May 2014) and the signing of the final loan contract in November 2015.
2.84
An area of interest to the Committee in the public hearing was the extent to which DIRD had considered and provided Ministers with comprehensive advice about the full value of the concession being applied to the loan and the risks of the loan.
2.85
The ANAO assessment was that DIRD’s advice to its Minister lacked appropriate consideration of the full costs associated with concessional loan arrangements, as it explained at the public hearing:
It is easy to say there is a concessional loan, but there are many aspects of a loan where you can offer concessions. In this case, there is the interest rate less than the market. We capitalise interest for a longer period than the
private-sector borrowers do. There is the tax issue. So there are a whole range of things, not just level of interest rate, which can make a loan concessional. Our point was that we thought that there would be more comprehensive advice to decision-makers, covering the full gamut of concessions being proposed, so that ministers could make an informed decision. Yes, we are comfortable with this whole package and what it will cost to provide it.
2.86
One of the key areas of deficiency identified by the ANAO was the lack of advice provided about the setting of a rate of interest for the loan. DIRD had received advice in April 2014 from its commercial advisor reflecting on the pricing of the loan and suggesting that an interest rate range of between eight and 11 per cent could be used for estimation purposes. DIRD’s subsequent advice to its Minister in the same month indicated that the loan would at least target the long term bond rate. At 3.3637 per cent (the yield on the 2033 Australian Government Bond), this interest rate is significantly lower than the range in the initial advice and raises a question about how large a concession was intended. In this context, it is worth noting the ANAO’s estimate that a 0.25 per cent increase in the interest rate would have increased earnings on the loan by $87.5 million.
2.87
Evidence identifying the logic supporting the ultimate interest rate would normally be expected to be detailed in advice to government. However, the ANAO’s summation of DIRD’s advice reflects that DIRD did not:
set out any options or seek a decision on an acceptable interest rate range within which the department should negotiate; or
address the extent of the concession that was proposed (the advice did not identify a comparative market interest rate for the loan) or seek endorsement of:
how the size of the interest concession would be arrived at, or
the acceptable cost of that concession to the Australian Government.
2.88
At the public hearing, the Auditor-General provided a frame of reference for considering what an appropriate bond rate might look like in the context of the WestConnex financing objectives:
The alternative scenario is that the state government borrowed in the market itself for this money rather than borrowing it off the Commonwealth at the Commonwealth bond rate. The proposition being put is that the reason that this money was needed to bring forward a project was the state government would not have done it, because of the gap between the state borrowing rate and the Commonwealth borrowing rate. The state entity has borrowed off the Commonwealth. They could quite as easily have borrowed off the state government. They are both government borrowing authorities. Another way of looking at the concession, from a decision-making point of view, is the gap between the Commonwealth borrowing lent into the state its interest rate and the state itself borrowing at its interest rate.
2.89
Figure 2.1 provides a rough guide to the difference in yields between NSW and Commonwealth bonds of different durations using the data that is published by the Reserve Bank of Australia. The difference has remained at less than one half of one percent for most of the last four years and was 0.19 per cent on the date that the WestConnex rate was set (noting that this relates to bonds with terms of maturity of 10-years or less).
2.90
During the audit, DIRD advised the ANAO that it sought agreement to the interest pricing methodology from the Departments of the Treasury and Finance and that ‘Their Ministers expressed support for the proposed concessional loan terms and conditions (including the interest rate) prior to the MoU being signed’. The ANAO noted that this support had been qualified with commentary referencing due diligence that was still to occur and important details still to be negotiated.
2.91
Other factors relating to the size of the interest rate considered by the department did not have a bearing on the final design. For example, DIRD’s commercial advisor had recommended that a 0.25 per cent margin be added to the interest rate. By way of comparison, a margin for profit, risk and cost was included in the interest rate payable to senior debt. The Auditor-General’s noted:
At the end of the day, the government is making a decision to put a concession in place. It could make a decision to do it at the bond rate or it could say, ‘This is going to require some administration.’ Remembering that this is a 30-year loan, the loan will have to have supervision by the Commonwealth for a
30-year period in order to manage it. It could argue that it needs to cover the cost of that as well, otherwise the cost is borne by the taxpayer. The level of concession the government chooses to make is what the government chooses to make. Our commentary with respect to that is that … [the margin] was considered, and we could not see the reason why it was not implemented, we are not making an observation … [about] who should pay those costs …
2.92
While a margin appeared in early drafts of the MoU, DIRD advised the ANAO that it ‘… was removed following negotiations with NSW’ and because it was not intended that the financial instrument be profitable for the Australian Government.
2.93
Contrary advice to the public hearing from DIRD was that ‘The government has articulated clear policy to try to maximise value from taxpayers’ dollars by making sure that we are getting a return, rather than just providing grant payments to these projects.’ Similarly, DIRD’s April 2014 advice to its Minister noted that the loan would have a positive Budget impact of $292 million over its life. If it was not intended for the loan to be profitable for the Australian Government, advice recommending a zero budget impact through the adoption of a lower interest rate or other concessions could have been provided when decisions were being made.
2.94
Another area in which DIRD’s advice on interest rates was lacking was in relation to interest rate risk. From the Commonwealth’s perspective there were both borrowing and lending aspects to administering the WestConnex loan, including a difference between:
the cost of the interest the Commonwealth would incur when borrowing money to fund each payment to the WestConnex project; and
the interest payments the Commonwealth would receive when the loan was being repaid.
2.95
The difference between these amounts is inherently uncertain because the interest rate applicable to the concessional loan was fixed to a long term bond rate, but the interest rate on Commonwealth borrowings is determined each time the Commonwealth raises funds. This risk was the subject of advice from the Treasury to the Treasurer in April 2014, which noted:
By providing a fixed interest rate, the Australian Government takes all the risk that interest rates on Commonwealth Government securities move in future. Interest rate risk can only be mitigated either by charging a premium for offering a fixed rate or setting a variable interest rate that tracks a relevant Commonwealth Government Security benchmark.
2.96
DIRD’s advice did not identify exposure to interest rate risk, value it, or put in place strategies to mitigate it. At the public hearing, the Auditor-General advised the Committee that this should be a routine aspect of its advice, noting:
How you deal with interest rate risk is a normal commercial arrangement and costing of interest rate risk is a relatively simple process. These things you would normally expect, when you are undertaking a commercial transaction, would be valued and be given to decision-makers.
2.97
One of the risks that the ANAO found DIRD to have managed well was the risk of the loan not being repaid. This was a key area in which DIRD negotiated changes with the NSW Government to protect the Commonwealth’s interests. DIRD linked loan repayments to NSW’s ability to generate sufficient income through toll revenue. DIRD was also able, with support of its legal advisors, to negotiate an improvement on how the loan was secured, aligning arrangements to those of more senior ranking lenders.
2.98
There were two other areas that the ANAO identified as not being appropriately addressed in DIRD’s advice: interest capitalisation and taxation revenue.
2.99
The first involves the comprehensiveness of advice about a concession built into the loan structure: a capitalisation period comprising the first 12 years of the loan (2015 to 2027). The concession provided that interest payments which would otherwise have been received by the Commonwealth over this period were to be accrued and added to the balance of the loan. The accompanying cash flow effect was that the Commonwealth would be borrowing funds to meet each of its loan payments but only start to receive interest on those payments in 2027.
2.100
The capitalisation concession improved project liquidity, significantly reducing the debt-servicing risks during the capitalisation period to the benefit of the NSW Government and the senior debt providers. DIRD’s advice to Ministers did not draw their attention to the specific cost of this concession (separate from total effect of the loan on the fiscal balance) or include a justification for reducing liquidity risk on the project. DIRD’s submission explains that:
The modelling provided to the Department by the NSW Government indicated that the debt service coverage ratio required by Senior Debt would not be achieved without the interest capitalisation period on the concessional loan. The Department accepted this view on the basis of advice from its commercial advisers.
2.101
The remaining area in which DIRD’s advice was found to be lacking by the ANAO was in relation to the effect of the loan on taxation revenues. The taxation arrangements for the project were a specific focus for the NSW government, with the ANAO noting:
Part of the work conducted by NSW’s commercial adviser was to recommend how to optimise the amount generated on the refinancing of the project company. This included maximising the tax deductions available to the future private sector equity owner, making the project company more valuable to the private sector, and leading to a better sale price upon privatisation for the NSW Government.
2.102
The ANAO’s report also notes that ‘This work resulted in a successful private tax ruling application for the tax deductibility of the capitalised interest applied to the Australian Government loan.’
Implementation of ANAO recommendations
2.103
The lessons arising out of the WestConnex concessional loan have ongoing relevance given the government’s commitment to the wider use of innovative funding and financing, as noted in DIRD’s submission:
The Australian Government recognises the limits of public funding for infrastructure, particularly with consideration of the growth pressures for investment … The Australian Government publicly committed to the wider use of innovative funding and financing and delivery options, beyond the traditional provision of capital grants as part of its response to the Productivity Commission’s Public Infrastructure Inquiry in 2014. It further articulated this commitment through the February 2016 release of its Principles of Innovative Financing.
2.104
The ANAO made two recommendations in its audit reports (see Appendix B), with one recommendation related to DIRD’s future consideration and advice on concessional loans:
Recommendation No.1
Department of Infrastructure and Regional Development improve the advice on any future loans for major infrastructure projects by:
a
developing a more robust and tailored administrative framework to govern the possible provision of loans;
b
clearly identifying, and quantifying the impact of, all key aspects of the proposed commercial arrangements; and
c
providing Ministers with a range of options on the key terms for agreement on the parameters within which the Department is authorised to negotiate.
2.105
DIRD agreed to the recommendation and noted that it had conducted its own lessons learned workshop in early 2016 to improve due diligence processes. Further, its submission advised of ‘… changes to its approach in seeking legal advice, and in the creation of the term sheets for a concessional loan to strengthen due diligence processes and considerations.’
2.106
In evidence to a Senate Estimates hearing before the Senate Rural and Regional Affairs and Transport Legislation Committee, the Secretary of DIRD flagged that the department has been seeking to learn from the WestConnex experience:
There are certainly some lessons to be learned. Certainly through the process we have done a number of debriefs and sessions around how this process worked, because clearly the Commonwealth has utilised concessional loans in other areas. We are trying to get this process much better defined as the government increasingly looks to use its balance sheet to fund infrastructure much more. Concessional loans are one of those avenues we are looking to use more of in the appropriate circumstances.
2.107
At the public hearing, DIRD advised that a more recent concessional loan has been made to the Sunshine Coast Council for the Sunshine Coast Airport Expansion Project (SCAEP) and that DIRD drew on its experiences with the WestConnex loan, noting:
At the last election, a commitment was made to provide a concessional loan for the Sunshine Coast Airport and we have certainly, in our advice and our analysis, taken on board all the lessons we have learnt from this WestConnex concessional loan process and the advice from our colleagues in the ANAO. I would expect, once government has considered that advice and made the relevant announcements, you will see the benefits of the lessons we have learnt in this process.
2.108
After the public hearing, DIRD provided the Committee with a submission identifying the following ‘better practice measures’ it had adopted in relation to the SCAEP concessional loan:
The Department determined that the Australian Government should only make an ‘in-principle’ commitment to a concessional loan, with approval to follow due diligence outcomes. This serves to protect both the reputation and the negotiating position of the Australian Government. In relation to the SCAEP, the Department sought early agreement from Ministers around the parameters upon which the Department would negotiate the concessional loan.
The Department has taken a revised approach to the creation of the Concessional Loan Term Sheet. The Department sought early legal advice regarding the SCAEP concessional loan proposal and the creation of the Concessional Loan Term sheet.
In agreeing to the terms of the SCAEP concessional loan, Ministers were provided with extensive information on the costs to government of the arrangements. Additionally, the interest rate, taking into account public debt interest impacts, was set following extensive consultation with the Department of Finance and the Treasury.
The Department is taking greater consideration of whether the proponent is sufficiently ready for due diligence activities to commence. For the SCAEP, the Sunshine Coast Council had already commenced the process of negotiating a loan from the Queensland Treasury Corporation and had sufficient information to do so. The Department was able to leverage off analysis the Queensland Treasury Corporation had in undertaking its own due diligence. In addition, the Department undertook a risk review workshop on the concessional loan proposal on 19 October 2016, ahead of the finalisation of the Term Sheet on 28 October 2016.
2.109
DIRD also advised the Committee that it will work with the soon-to-be-created Infrastructure and Project Financing Agency (IPFA) on future concessional loans and other innovative financing proposals. The creation of the IPFA was announced in the 2017 Budget, which noted that the IPFA’s role will be to ‘… assist in the identification, development and assessment of innovative financing options for investment in major infrastructure projects.’