Innovation the key for PPP project operational models

By Wang Jihong and Liu Ying, Zhong Lun Law Firm
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In addition to the traditional BOT (build-operate-transfer), TOT (transfer-operate-transfer), and ROT (rehabilitate-operate-transfer) models, a vast number of innovative operational models for PPP (public-private partnership) projects have arisen in light of the specific circumstances of each such project.

Project bundling model

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

Looking at current PPP project practice, on the one hand there is a stampede by investors towards for-profit type projects that produce good returns, whereas quasi-for-profit projects are unable to cover the investment costs and produce reasonable returns, and non-profit projects are unsaleable, requiring fiscal subsidies or the injection of capital by the government. As an answer to this problem, a number of projects appeared in 2015 where the private investor was selected by project bundling. A non-profit project or quasi-for-profit project is bundled with a for-profit project that produces relatively good returns, thus ensuring that the private investor receives a reasonable return while also driving the development and construction of the non-profit or quasi-for-profit project.

The authors have seen a variety of ways in which projects can be bundled. For example, highway projects with different traffic volumes and different return rates can be bundled together. Or a public interest project and its adjacent extension or complementary commercial projects can be combined into a project bundle and investors then sought to operate in the same way as a single PPP project, e.g. the “subway plus the property above the subway” development model, and the stadium plus adjacent catering, leisure and other such complementary facilities model. Or small and scattered projects can be bundled together as one to achieve economies of scale, e.g. rural sewage treatment projects.

One of the infrastructure projects handled by the authors in a certain area falls into the typical project bundling model, with the types of project involved covering a shanty area improvement, a railway project, a new coastal city, and construction of a new economic development zone.

Participation of equipment suppliers

刘瑛 Liu Ying 中伦律师事务所 律师 Lawyer Zhong Lun Law Firm
刘瑛
Liu Ying
中伦律师事务所
律师
Lawyer
Zhong Lun Law Firm

In PPP project practice in China, large state-owned enterprises (SOEs) under the central government usually assume the role of private investor as they have abundant funds, strong financing capabilities and the qualifications and capacity to undertake large projects. However, as the number of PPP projects in which such SOEs are involved has increased, contributing capital to such projects has become a major burden, and the SOEs typically have numerous project bureaus under them that also undertake the heavy task of investment driven construction. Under such a circumstance, bringing in co-operating parties both lightens the investment burden and permits the role of construction general contractor to be assumed through participation in the project, thereby achieving output targets – a win-win scenario.

A project in Fuzhou in which the authors recently participated proposed an innovative co-operation model whereby an equipment supplier and a traditional construction-type SOE co-operated in a PPP project. The construction enterprise (a subsidiary of an SOE) and a certain large construction equipment manufacturer formed a consortium to participate in a PPP project. The construction equipment manufacturer assumed the bulk of the capital contributions and responsibility for all of the financing work of the project company, and the SOE’s subsidiary assumed a minor portion of the capital contributions and responsibility for the construction general contractor work for the PPP project. During the PPP project construction period, the SOE’s subsidiary will procure construction equipment of a certain amount from the construction equipment manufacturer. As, at the time that the SOE’s subsidiary won the bid to undertake construction of the project, purchasing construction equipment was an expense that it would inevitably incur, accordingly the co-operation model does not increase its expenditures.

A construction equipment manufacturer is only one of the options for partners open to large SOEs. In practice, the field of co-operating parties open to them is very broad, and the co-operation between SOEs and private enterprises is increasingly common. As long as the parties can reach agreement on the conditions of co-operation, they can share in the market cake.

Involvement of funds

Encouraged by state policies, funds have shown a strong appetite for participation in PPP projects. The Administrative Measures for Infrastructure and Utilities Concessions, issued by six ministerial-level authorities, encourage industrial funds, private equity funds and government-guided funds to participate in PPP projects. The state encourages the provision of capital to concession projects by the taking of equity stakes through the establishment of industrial funds. It encourages concession project companies to carry out structured financing and issue project revenue notes and asset-backed notes.

The state encourages concession projects to expand investment/financing channels through establishing private equity funds, bringing in strategic investors, and the issuance of project revenue bonds, corporate bonds and non-financial enterprise debt financing instruments. Authorities at county level and above can explore the establishment with financial institutions of infrastructure and utility concession guidance funds, and support the construction and operation of relevant projects through investment subsidies, fiscal subsidies, and loan interest discounts.

In the past, fund participation in PPP projects was usually of relatively short duration, taking the form of an equity or debt participation, serving only as a short-term shareholder, receiving a fixed return, divesting within two to three years after completion of construction of the project, and not sharing in the risks of operating the project. Under the new operational model, cases of long-term shareholding by funds have arisen. If, after conducting a comprehensive assessment of the project, the fund company has confidence in the project operating returns, it will serve as a shareholder of the project company, with its existence of equal duration as the project concession term. These cases no longer involve the fixed return model, and the project traffic volume risks and return rate risks are directly linked to the fund’s returns.

Additionally, there are numerous other innovative PPP project operational models, but none of these is straightforward to reproduce, requiring customization jointly by the public party, the investor, the project legal team and other such consulting firms based on the specific circumstances of the project.

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