New rules pave the road for PPP

The Shajiao B Power Plant in Guangdong Province, which came into operation in 1988, is generally regarded as China's first PPP project. Since that time, there have been a significant number of PPPs throughout the country, predominantly in the energy, transportation and water sectors.

There is no single authority or body charged with administering or regulating PPPs in China, nor is there a centralized database or generally accepted set of principles for classifying or assessing such projects. One of the goals of the Measures is to address this qualitative and quantitative deficiency.

What seems certain is that PPPs fit neatly into official central government policy about the “decisive” role that market forces should play in China's economy. This was articulated during the Third Plenum of the 18^th National Congress of the Communist Party of China (Third Plenum) in November 2013 and in the September announcement by the Ministry of Finance (MOF) of 206 new PPP projects worth a total of Rmb659 billion ($104 billion).

Supporting successful PPP

While there is no comprehensive database or review of all PPPs in China, several academic studies have kept track of the model's application and records may be enhanced moving forward. The influential Comparative Study of Critical Success Factors for Public-private Partnerships between Mainland China and Hong Kong SAR identified 7 principal critical success factors necessary for a successful PPP project in China:

(i) equitable allocation of risk; (ii) strong private consortium; (iii) judicious government control (inception to operation); (iv) transparent and efficient procurement; (v) project economic/business viability; (vi) adequate legal framework and stable socio-political environment; and (vii) strong funding options.

The support of the political, social, economic and legal environment in meeting these criteria will facilitate successful PPP projects that are more likely to produce beneficial outcomes for the public and private sectors, as well as the public at large.

The regulatory road

The Measures were jointly promulgated by National Development and Reform Commission (NDRC), MOF, the People's Bank of China and the Ministries of Housing and Urban-Rural Development, Transport and Water Resources.

Accordingly, the Measures have the endorsement of the key bodies responsible for major infrastructure development. Since the Third Plenum, there have been a number of regulatory instruments seeking to enhance public-private social investment, notably:

• The NDRC's Circular on Releasing the First List of Infrastructure Projects and Projects of Other Sectors in Which Private Investment is Encouraged (May 2014) and Guiding Opinions on Launching Public-private Partnerships (December 2014);
• The MOF's Circular on Issues Relevant to Promoting the Use of Public-private Partnerships (September 2014) and Operational Guidelines for Public-private Partnerships (Trial Implementation) (November 2014); and
• The State Council's Guiding Opinions on the Investment and Financing Mechanisms for Innovative Key Sectors and Encouraging Private Investment (November 2014).

The Measures are an important next step but far from the end of the regulatory road; on the contrary, they are essentially detailed principles which contemplate (and require) enabling legislation to be passed by the central, provincial and local governments to realize their stated aims.

They are comprised of 60 articles, broken down into 8 parts as follows:

Tackling structural challenges

The Measures are a clear response to certain structural issues in the PPP experience of China to-date and can help private sector participants (including project developers and investors) overcome these challenges.

Procurement and concessions

Despite the significant track record of PPP in China, the legal framework has long been fragmentary and often discretionary in nature, leading to inconsistent implementation and control of projects by different authorities.

The Measures mandate coordination of PPP regulations and practices at the provincial and higher levels of government. They also set out relatively detailed procedures for the implementation of projects, the requirements of the Concession Project implementation plan (Article 10), the review process (including contents of the feasibility assessment) (Articles 11-13), the criteria for awarding concessions (Article 17) and the matters required to be covered in the concession agreement (Article 18). The Measures also require an ongoing review of the projects and publication of the results to ensure greater transparency.

When drawing contracts, detailed terms and conditions should be negotiated, agreed and recorded that are signed-off by all interested persons (not just the contractual parties). To the extent possible, they should use standardized provisions and reflect published policies and legislation, which will make them easier to negotiate and enforce.

Inadequate legal framework

In any jurisdiction, an infrastructure model that brings together public and private entities must be supported by a robust, independent and fair regulatory framework that requires all parties to comply with their contractual and statutory obligations, and that provides enforcement and other remedies to either party if one fails to comply.

The opening provisions of the Measures expressly emphasize openness, fairness and justice, as well as the protection of all PPP parties' interests. These general principles are elaborated in Part 3, which states all parties must fully and in good faith comply with the concession agreement, that no individual or authority may abuse laws, administrative regulations or the provisions of the Measures to interfere with the legitimate business of the concessionaire and that the concessionaire may initiate proceedings (civil and criminal) for breach against the public sector participants.

Parties to a project should protect themselves with dispute resolution mechanisms that address private sector concerns within China's particular disputes framework. While re-negotiation is often more efficient than an arbitration or lawsuit to settle disagreements in this area, having the ability to invoke an effective formal dispute resolution process may provide a private sector participant with some leverage in such re-negotiations.

Availability and use of funds

The burden on provincial and municipal authorities for developing and maintaining social infrastructure has been a key factor of the historically high debt among local Chinese governments. As such, encouraging budgetary prudence, where the government must incur financial liability, and identifying ways to minimize such balance sheet liabilities in the first place (like involving the private sector through the PPP model) are paramount.

The Measures tackle this issue on two fronts. To limit local budgetary issues, Article 35 requires any proposed government financial contribution (including guarantees and subsidies) to be assessed by referring to existing levels of debt, the government's annual budget and its medium-term fiscal planning.

The PPP model requires the private participant to procure and service debt or other funding. The Measures support this by encouraging the participation of Chinese and other financial institutions and existing private funds, as well as the establishment of subsidized infrastructure and public utilities concession funds. Participation may take the form of syndicated loans (up to 30 years in duration), structured financing, project yield notes and bonds, asset-backed bills, income stream securities, credit support, financial advice and other services.

Managing changes mid-project

The duration of a PPP concession must be set by referring to factors such as the project life cycle and the investment payback period, but generally should not exceed 30 years. The concession agreement should anticipate changing circumstances and developments during this period, including by way of restricting the development of competing projects, but, in the interest of certainty, the concession agreement should remain unchanged throughout the term.

Certainty of terms was crucial to PPPs prior to the Measures. However, this had the unintended consequence that (absent a default mechanism to address unforeseen changes), concessionaires were faced with pursuing financially disadvantageous projects or abandoning them. The Measures address this by requiring the government to provide adequate compensation if the financial projections of a project prove to be inaccurate or a change of law or policy causes damage to the concessionaire's expected benefits.

Investors should include the aspect of dealing with changing circumstances in contracts – simply remaining silent on issues, and hoping that provisions can be re-negotiated if the project does not go as planned, has caused significant issues in past projects and is rarely as successful as agreeing them upfront.

Dealing with regulators and approvals

Regulatory approval for PPP projects may involve up to 30 agencies at the central, provincial and municipal levels, each with separate responsibility for areas as diverse as foreign-investment policy, macroeconomic planning, labor issues, commercial registration, customs, utilities and environmental protection.

Each authority often operates under different and sometimes conflicting policy constraints, making the approval procedure difficult and uncertain for private sector participants.

While the Measures attempt to address this complex area, careful planning of the approval process and early engagement with regulators will always streamline this process.

In past projects, as part of the concession negotiation Chinese authorities have been willing to 'bundle' certain regulatory approvals for the benefit of the concessionaire, but this requires early involvement of relevant regulators.

Moving forward

PPPs provide an opportunity for public and private sector entities to cooperate in social projects in China. It encourages a mutually beneficial relationship in which government authorities satisfy their significant public utility and infrastructure requirements while private parties are able to leverage their skills, technology and capital in this burgeoning market.

The ability to bring together relationships based on reliability, probity and efficiency, is crucial to the delivery of a successful major infrastructure project.

However, structural issues within the Chinese PPP space, whether actual or perceived, must be tackled. The Measures are the latest – and one of the most thorough – steps in this process. They illustrate the commitment of the government at the highest levels to this development and opportunity for investment.

Whether this will be realized largely depends on the implementing regulations and legislation to be passed by other authorities. Nonetheless, these rules lay a foundation of principles upon which such work can be built.

Nicholas Molan, Vinson & Elkins, Beijing