Governance structures: A crucial prerequisite

By Hemant Sahai and Sunei Kapur, HSA Advocates

Developing a smart city is not for the faint hearted and will require a paradigm shift in vision and execution. The existing governance structures will come under stress and citizens will demand dramatically higher levels of efficiency in administration. If the current urban managers cannot deliver, what are the alternatives? More significantly, does India’s constitutional and legal framework permit such radical change? These issues are more complex for cities transitioning to the “smart” tag than for greenfield cities, as the bureaucratic structures tend to be slow, opaque and do not encourage innovation, all of which is anathema to a smart city.

Hemant Sahai
Hemant Sahai

The creation of infrastructure on a massive scale and now the smart cities in the Delhi-Mumbai Industrial Corridor (DMIC) requires balancing the interests of private investors and public policy. While designing the governance structures for DMIC and now for the Chennai-Bangalore Industrial Corridor, HSA’s mandate was to ensure the creation of institutionalized structures with adequate legal authority to design and award projects to private investors in a transparent and effective manner and at the same time ensure that the projects are bankable, provide appropriate allocation of risk among the stakeholders and avoid cancellation risks.

DMIC is one of the world’s largest diversified infrastructure projects. It envisages developing six greenfield cities in the first phase, along the 1,483-kilometre western dedicated railway freight corridor. These cities will be designed with all the smart-city attributes including carbon neutrality. The areas currently demarcated for these cities are each under the jurisdiction of multiple administrative authorities.

The immediate challenge was to create a unified authority with legal powers over master planning, project development and award to private investors. This authority will take policy decisions and delegate the execution and implementation of the components to diverse special purpose vehicles either under a public-private partnership (PPP) framework or engineering, procurement and construction execution mode. Institutional safeguards are included to avoid distortions arising from conflicts of interest and concentration of power. All of this should eventually result in leveraging the execution efficiencies and capital of the private sector.

Article 243Q of India’s constitution is the bedrock of the framework that emerged. The article mandates the creation of popularly elected urban local bodies (ULBs), but allows state governments to entrust the administration of urban areas to bodies other than ULBs. Additional legal authority was derived from specific state legislation dealing with town planning and industrial regions. Legislative amendments and new legislation were required for some states.

Sunei Kapur
Sunei Kapur

Since only the state can impose and recover taxes, the commercial and financial models for development and financing of the infrastructure projects were based on “user charges” recoverable by the private developer. This required designing concession framework agreements conferring sustainable authority on a private developer to recover user charges from private users of the infrastructure. These frameworks had to be expanded beyond the conventional highways and akin sectors to other services such as water, sanitation, transportation hubs, education sub-cities, etc.

It is clear that significant private capital will be required to help fund the development of smart cities and that private capital can be attracted through PPP initiatives. For PPP projects to succeed, precise and predictable policy and regulatory frameworks are required. International experience shows that regulation by contract is typically robust and predictable, provided the contractual framework is sophisticated and designed to balance and appropriately allocate technical and commercial risks.

To increase bankability and financial viability of projects, private developers will require greater flexibility to raise equity, including the ability to dilute ownership and opportunities to exit completely from the project in a predictable manner in favour of long-term investors that are not willing to take development risk but are willing to take operational risk, such as pension funds. Infrastructure financing in India today remains skewed in favour of commercial banks, whereas global experience shows a clear distinction between investors during the development and construction phase and investors during the operations phase.

In recent times, asset-liability management issues and liquidity constraints because of sectoral lending limits have had a negative impact on the liquidity of the project finance market. Medium to long-term lending remains an unattractive proposition for many banks.

Drawing on these experiences, designing governance structures for the coming smart cities, especially the brownfield cities, may require significant legislative and policy changes in addition to creation of contractual frameworks for developing the required infrastructure. HSA is engaged in several of these endeavours and is assisting diverse stakeholders in designing of legislative, policy, legal, regulatory and contractual frameworks.

Hemant Sahai is the managing partner and Sunei Kapur is a senior associate at the New Delhi office of HSA Advocates. HSA is a full-service firm with offices in New Delhi, Mumbai and Kolkata, and with a correspondent relationship in Bangalore.

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