Concerns and solutions in the post-PPP era

By Wang Jihong and Liu Ying, Zhong Lun Law Firm
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China sees remarkable progress in its public-private partnership (PPP) mechanism now since its fast growth in the past four years. Both the number and total investment of PPPs show leapfrog growth. As at the end of 14 December 2017, 424 PPPs with a combined investment of RMB18.2 trillion (US$2.87 trillion) were entered into the integrated data platform of the Ministry of Finance (MOF).

王霁虹 WANG JIHONG 中伦律师事务所合伙人 Partner Zhong Lun Law Firm
王霁虹
WANG JIHONG
中伦律师事务所合伙人
Partner
Zhong Lun Law Firm

Although the MOF’s data of government indebtedness do not include payables under government-funded PPPs, the ministry is vigilant about the concerns and risks of local government insolvency as they are incurring substantially more debt to accommodate the explosive growth of PPPs. It issued a circular No.92 just in time, which requires a thorough review of all projects recorded in PPP libraries and imposes more stringent conditions for including new PPPs into the libraries.

State-owned enterprises (SOEs), the key players in PPPs, are raising their debt/asset ratios to new levels. The State-owned Assets Supervision and Administration Commission (SASAC) is acutely aware of the tremendous pressure and danger that the elevated ratios may pose to SOEs in the future. Following in the footsteps of the MOF, the SASAC released circular No. 192 in November 2017, imposing rigorous requirements on the PPP risk controls of central enterprises.

CONFUSION AND PERPLEXITY

The introduction of circulars No. 92 and No. 192 has driven waves of PPP library review and remediation by local governments. In the week immediately before the 2018 Spring Festival, 742 projects were removed from the libraries. There were also some enterprises which, one after another, received notice of removal or remediation by prescribed deadlines. In the long run, cleaning up non-compliant PPPs is undoubtedly critical for the healthy and benign development of the PPP mechanism in China. The campaign is also expected to provide better protection for the legitimate rights and interests of private investors in the future.

刘瑛 LIU YING 中伦律师事务所律师 Associate Zhong Lun Law Firm
刘瑛
LIU YING
中伦律师事务所律师
Associate
Zhong Lun Law Firm

However, for individual PPP projects removed from the libraries, the removal means complicated civil and even administrative and legal consequences, especially in cases where a contract has been signed and project execution has begun. It is foreseeable that termination or cancellation of the PPP contract could give rise to a series of long-term, ongoing issues that may include indemnification, winding-up and liquidation, which if not properly resolved are very likely to lead to litigation or arbitration proceedings.

Here are some questions to consider: How can one deal with the PPP contracts that have been signed? How can one recover the capital invested into the projects? How can one deal with the project companies that have received investment from founding private investors and local governments? What about the handover between the existing and new private investors? What remedial measures can be taken if termination of the project causes any liability for breach to third parties, such as financial institutions? If removal of a project from libraries is attributable to the government, how to compensate or indemnify any private investor for the losses arising from the fault of the government? And how can one indemnify the investors if the removal of a project is a result of an inappropriate PPP mechanism, or the project does not get necessary approvals and reviews from relevant authorities, or it exceeds the 10% (general public budgets) limit of local
government’s financial affordability, which are purely faults of the government parties?

First of all, now that the power to approve PPPs has been taken back by the headquarters of the involved SOE, as required by circular No. 192 of the SASAC, subsidiaries are no longer empowered to approve projects below RMB500 million or RMB1 billion, as they used to over the years. Second, circular No. 192 restricts a central group’s net aggregate investments in PPPs to 50% of its consolidated net assets in the previous year, and prohibits subsidiaries with debt/asset ratio above 85% or operating at a loss for the latest two years from investing in PPPs independently. As an immediate impact of these quantitative thresholds, central enterprises will cut their investments in PPPs substantially in the coming years, translating into a sharp decrease in PPP investments nationwide that will open up the post-PPP era in China.

TRANSITIONS AND SOLUTIONS

In the post-PPP era, PPP projects generally face increasingly rigorous requirements as to legitimacy, compliance and specialization. How, then, can enterprises survive and grow?

On the one hand, as payback is more closely linked with performance assessment, enterprises must focus on building their fundraising, project control and operational capabilities, and bid farewell to their previous strategies that prioritize construction and take little account of operation. Enterprises that fail to do so may risk losing their commitments, not to mention the entitlement to full payment of government subsidies and allowances.

On the other hand, private investors should seek to diversify their investment approaches, and look beyond the 10% of general public budgets. After all, a public-private partnership is just one of the many approaches to operating a project. In the post-PPP era, a private investor needs to take the role of an urban development and investment operator very shortly after it transforms from a traditional constructor to an investor, which also needs to be completed very swiftly.

In other words, as pure players no longer meet market demands for project operations, private investors need to take a holistic view of urban development projects, making unified planning as planner, designer, investor, developer and operator of the projects. They need to consolidate planning, land, capital, construction, management and many other resources in the wider community by joining hands with entities that include, but are not limited to, financial institutions, design service providers, environmental companies, smart city investors and property developers.

Taking advantage of opportunities emerging from the new strategic phase of China’s urbanization process, as well as the national policies that encourage and support aligned development of industries and cities, construction of feature towns and transfer of collective lands, they may be able to capture new, better growth opportunities.

At present, however, investors should look before they leap, as specific implementing regulations have yet to be introduced under these directional policies. Before the implementing regulations are in place, private investors seeking a shortcut to successful transition may advisably use the services of experienced external counsel and advisers to minimize detours.

Wang Jihong is a partner and Liu Ying is an associate at Zhong Lun Law Firm

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