On October 24 2014, the Prime Minister of the State Council, Li Keqiang opened an Executive Meeting of the State Council on innovation in the investment and financing of important areas in the Chinese economy. The meeting stated that financing facilities should be vigorously innovated and that public-private partnerships (PPPs) should be actively promoted, opening the door to social capital, especially private capital, in more areas. This meeting demonstrated the attitude of the Chinese government in developing and promoting PPPs.
According to data from the Ministry of Finance, up to February 29 2016 there have been 7,110 PPP projects recorded on the PPP Comprehensive Information Platform in China with a total investment value of Rmb8.3trn (US$1.3trn), covering numerous industry sectors including energy, transportation, hydraulic construction, ecological construction and environment protection, municipal engineering, area development, agriculture, forestry, science and technology, affordable housing projects, tourism, medical care and sanitation, education, culture, PE, social insurance and governmental infrastructure.
Among these projects, 91% is invested in newly built PPP projects valued at Rmb7.57trn (US$1.1trn), while only Rmb730bn (US$112bn) or 9% is invested in existing PPP projects. Seventy-eight percent of projects (5,542) are in the recognition stage, while only 5% or 351 are at the execution stage. This indicates the huge need for PPP investment, but that very few have achieved financing. Social capital and investors are showing both enthusiasm and despair at the slow pace of development of PPP projects.
The PPP is not a concept born in China and indeed there is no fixed definition in the language. The specific meaning of a PPP tends to be decided on a case-by-case basis. Despite this, in China it is summarised into three characters: partnership, interest-sharing relationship, and risk-sharing relationship.
[중국에서의 PPP사업은 파트너쉽, 이익분배관계형, 리스크분담관계형으로 3구분되고 있음]
The existing environment [현재 환경]
As PPP are newly emerging in China, both central and local governments have passed laws and regulations to control and administer the development of PPPs. The main legislation published by the State Council and ministries includes:
* September 23 2014, the Ministry of Finance issued the Notice on Relevant Issues for Promotion and Utilization of Public-Private Partnership (PPP)
* November 16 2014, the Guidance of the State Council on Innovating the Investment and Financing Mechanism in Key Sectors and Encouraging Social Investment was published by the State Council.
* November 29 2014, the Ministry of Finance issued the Operational Guidance on the Public-Private Partnership (PPP)
* December 2 2014, in order to implement the above Guidance, the National Development and Reform Commission issued the Guidance on Launching the Public-Private Partnership (PPP) and Guidance on the General Contract of the Public-Private Partnership Project.
* May 19 2015, the Notice of the General Office of the State Council Forwarding the Guidance of the Ministry of Finance, National Development and Reform Commission and the People’s Bank on the Promotion of Public-Private Partnership (PPP) in Areas of Public Service was issued by the General Office of the State Council.
* June 25 2015, the Ministry of Finance issued the Notice on Further Carrying Out the Pilot Work of Public-Private Partnership (PPP)
In addition to these State and Ministry regulations, many provincial or municipal governments also issued legislation on public-private partnerships that apply in their respective territories.
Recent practice
In 2014 and 2015, the Ministry of Finance and the National Development & Reform Commission announced a series of pilot PPP projects, and actively encouraged private sector participation. Subsequently, local governments announced their own PPP projects to stimulate the development of their local economies.
If the purpose of doing business is to make a profit and not make a loss, in a business deal, each party should bear in mind that risks exist in every deal and negligence of such risks may result in substantial losses. In a PPP project, typical risks include:
* Risk of compliance – Banks and other financial institutions need to conduct a strict compliance check on each PPP project. Whenever a PPP project is analysed it is necessary to identify if this is a true PPP project, and where the risk might be is under the surface. Typical false PPP projects include decorating a competitive project as a PPP; a nominal equity-investment project that is in fact a debt/loan project that contradicts the purpose and nature of a PPP project; and a project that the local government underpins or whose duration of debt-repayment has been extended.
If false PPP projects are identified, banks may choose to refuse to make a loan or conduct the compliance check after restoring the correct structure.
* Loan security – Loan security is the most important concern for all lenders in a PPP project and relies on two factors – first reimbursement ability and second the method of guarantee. The lenders usually believe that if local government is responsible for reimbursement, it is safe as it is effectively underwritten by the government. In fact, just the opposite might be the case. For different reasons such as the capaciousness of government, uncertainty of local budgets and the unreasonableness of the adjustment mechanism (non-market factors involved), contracts are frequently breached by local government and cause serious loss to the funders.
In a typical PPP project, the funders usually require the project company to provide a mortgage secured against its assets, or that its parent company provides a guarantee, or that the local government makes a commitment as guarantor. Even so, there exists the risk that such a guarantee may not be realised due to the nature of the PPP project.
For example, on a mortgage on assets PPP projects are usually applied to infrastructure and public services. The fundamental nature of these is to satisfy the needs of the public and thus it is unlikely to change its terms of use. However, poor liquidity and low level commercialisation can have a dramatic effect on the terms of the mortgage as well.
In conclusion, the funder needs to confirm with the local government that the social capital and project company is entitled to set the above guarantee on these assets, and that the local government is fully aware of and accepts the results and consequences of exercising the guarantee. Under many circumstances, the legal consequence of exercising the guarantee are in contradiction with the administrative obligation, and indeed, public responsibility undertaken by the government, and this may inhibit the funder’s ability to exercise its rights as a creditor.
An effective way to protect the funder’s interest is the right of direct intervention. The financing party may sign an intervention agreement with local government, a project company or social capital, or set out their intervention rights in the PPP agreement.
Once a trigger event occurs (such as a significant operational or financial risk that gives rise to the right of intervention), the financing party is entitled to intervene in the project. After such risk has been removed, the funder shall cease to intervene any longer. The consequence of intervention and the mechanism for remedy or compensation will also be included in the Intervention agreement and/or PPP agreement. By doing so, the creditor’s right of the financing party is protected from any loss.
Problems and solutions [문제점과 해결방안]
First, the potential imbalance in the rights and obligations of local government and private investors.
At the early stages of recognition, preparation and purchase, the public authority is always in charge of the whole project, often leaving very limited choice and rights for the private investors. Typically, the financing parties only come on board in the secondary execution stage and indeed many private investors are indifferent before this stage. This imbalance can mean that the over-powerful public authority could damage the whole project.
A solution is to encourage funders who are interested in a PPP to actively participate at an early stage in the communication and scoping of the project and provide key opinions on the availability of the private funding. This would form a solid basis for decision-making of the funders and on whether they sign the financing contract at the execution stage.
Second, although it makes common sense that payment by a public sector authority is the most reliable income for project companies, in the eyes of the funders it is treated as a loan with the least “political” risk. However, there is another issue in practice, because of the wide range of government power, it is common that public sector authorities violate the contract, sometimes in quite unforeseeable and sudden ways, which can be categorised as “non-market elements”.
As it is frequently difficult for private investors to stand against the power and activities of public authorities, funders should focus on whether there is a steady cashflow to maintain both the operational cost and debt servicing when analysing the early-stage project, rather than looking merely at the payment terms.
The third problem that indicates the imbalance between the public authorities and private investors is the absence of a Sole Project Clause. The best example is the Hangzhou Bay Cross-Sea Bridge project, valued Rmb10bn (US$1.54bn) and one of the most important state-level transportation financing projects that attracted 17 private investors, which was purchased back at 80% of the project capital value by the public sector authority only five years after completion.
To illustrate another issue, in July the same year, another cross-sea bridge came into use on the same site, with a third cross-sea tunnel completed one year later, which further divided the traffic stream, and thus the projected project revenue. This caused severe benefit conflicts between the contractual PPP project and publicly planned projects, and led to the factual failure of the whole PPP project.
The failure was caused by improper government planning of the other two projects, yet the real reason was the lack of Sole Project Clause in the contract, which left the public sector authorities free of any liability for their behaviour and of the consequence of violation of the initial PPP contract.
Fortunately, there are now regulations in place with these issues such as in Article 21 of the Franchise Operation and Management Solutions of Fundamental Infrastructure and Public Facilities, as well as Article 5, Section 13 of the PPP Project Contract Guidance (Trial) published by the Ministry of Finance.
In addition, the private sector can also use the provisions of the contract to consolidate the Sole Project Clause by, for example, providing breach of contract liabilities and other remedy mechanisms in the PPP contracts. Private investors should also physically pre-research the site to avoid any possibility that there will be any competitive project within say 50km of the target area.
Finally, there is an inherent conflict between PPPs and the current legal system in China. On one hand, it is a fact that there is no legislation specifically regulating PPPs. However, some of the principles of PPPs have been incorporated in the Government Purchase Law, Tendering and Bidding Law and even the Contract Law of China.
On the other hand, although there is considerable ministerial-level legislation in China at the moment as set out above, it is obvious that the public authorities have been paying increasing attention to PPPs since late 2014, demonstrated by the fact that in 2015 alone there were more than 10 ministerial regulations published.
We are firmly convinced that in the coming few years, the absence of national legislation will be properly addressed and PPP projects will flourish in China.
