The Policy Interpretation of PPP

1.  What major regulations that have an impact on PPP projects have been enacted in the past 12 months?

(1) PPP Regulations (Draft for Comments)

In July 2016, when hearing a report on the promotion of the PPP model at an executive meeting of the State Council, Premier Li Keqiang proposed that the Legislative Affairs Office of the State Council should take the lead in accelerating the law-making process. On July 21, 2017, the Legislative Affairs Office of the State Council released a circular seeking comments on the Regulations for Public-private Partnerships in the Infrastructure and Public Service Sectors (Draft for Comments) (Draft).

Firstly, the Draft specifies the scope and term of PPPs. It proposes, for the first time, that authorities of the State Council may formulate a guiding catalogue for infrastructure and public service projects that apply the PPP model. It emphasizes that private and state-owned enterprises are to be treated equally when participating in PPP projects, and non-state enterprises may not be excluded or restricted from seeking involvement. The Draft also specifies that the State Council authorities are responsible for guiding and monitoring PPPs within their relevant jurisdiction, while the State Council will establish a coordination mechanism.

Secondly, the Draft clarifies the application of certain terms. For example, a “private party” refers to a legally-established enterprise with investment, construction, and operating capabilities. This means that financial institutions—which do not have construction and operating capabilities—may not independently serve as the bid-winning private party. Also, transferring equity of the project company is prohibited during the construction period of a PPP project, but it is permitted during the operating period with government approval. A private party may also undertake construction and production or provide specific services itself if it is recognized during the bidding process to be capable of doing so.

(2) Regulation of PPP project database — Cai Ban Jin [2017] No.92

With a view to thoroughly implementing the spirit of the National Financial Work Conference, further regulating the operation of PPP projects, preventing PPP from mutating into a new financing platform and resolutely putting a stop to increasing hidden debt risks, the Ministry of Finance issued the Circular on Regulating the Administration of the Comprehensive Public-private Partnership Information Platform Database (Cai Ban Jin [2017] No.92) (Document No.92) on November 10, 2017, defining compliant PPP projects by establishing three criteria for the inclusion of new PPP projects in the database and specifying seven circumstances under which a project already in the database shall be removed.

Document No.92 specifies that where an application has been made to include a project in the PPP project database and such project has been implemented using the PPP model, and where such model is inappropriate for the project, the preparatory work for a project has not been duly completed or a performance-based fee payment mechanism has not been established, the inclusion of such a project in the PPP database is prohibited. Where a project has already been included in the database but such project has been implemented applying the PPP model, where such model is inappropriate for the project, the preparatory work for which the project has not been duly completed, the “two verifications” were not conducted in accordance with provisions, continued implementation of the PPP model for the project is not appropriate, it does not satisfy compliant operation requirements, raising of debt/provision of security in a manner that violates laws or regulations is constituted or the disclosure of information has not been carried out in accordance with provisions, the financial authority at the level in question will arrange for and complete the concentrated PPP projects removal work by March 31, 2018.

The requirement against “using debt proceeds to serve as capital” among the criteria for the removal of projects from the database will have a relatively major impact on the “minimal equity, large debt” model that commonly exists in PPP project practice. In PPP project practice, particularly in projects requiring relatively large investments, project capital will usually be divided into a registered capital portion and a portion that is the gap between the registered capital and the project capital, with the private party paying in the registered capital by way of a paid-in capital contribution for equity, and the capital contribution for the gap is paid by way of a shareholder loan. As the funds for the gap portion under such a method are a “shareholder loan” made to the project by the private party, it is difficult for the project to avoid the restriction against “using debt proceeds to serve as capital” even if, in financial treatment, such proceeds appear to be compliantly listed as “capital reserve”. However, with respect to the private party itself carrying out financing and not generating debt funds for the project, the same can still be treated as project capital.

Furthermore, based on the compliance guidance of PPP projects by Document No.92, the problem of “emphasizing construction, disregarding operation” commonly existing in practice to date will be effectively resolved. In practice, certain enterprises whose main business is project construction, when participating in PPP projects, have not only shown an unwillingness to bear operating risks but have also lacked the operating capabilities, resulting in the PPP projects failing to become an effective tool for achieving the objective of sustainable development of public goods and services and running counter to the core objective of a PPP project of enhancing the efficiency and quality of public products and services. With the issuance of Document No.92, the inclusion in the database of projects the project construction costs of which are not included in the performance assessment, ones in which the connection with performance assessment results is less than 30% or ones that establish the public party's expenditure responsibility is prohibited, thus thoroughly resolving the trend of “disregarding operation” from the origin.