What exactly is PPP?
The term PPP is usually interpreted in multiple ways:
- In a broad sense, as any form of interaction between the state and business to address social and economic issues. The term "public-private interaction" has also been proposed in order to avoid confusion.
- In a narrow sense, as a special form of legally enshrined cooperation between the state (or municipality) and a private investor to implement a joint investment project for a facility of public interest and control (generally, public infrastructure). Specific features of such cooperation include, inter alia, pooling of resources and highly balanced risk allocation. The latter involves, on the one hand, transfer of more risks to the private partner as compared with the transfer of risks in public procurement of goods, work or services, and on the other hand, transfer of considerably fewer risks as compared with investment-based lease and, certainly, privatization. Such a balance of risks is usually integrated into legislation in the form of specific types of long-term contracts: the concession agreement and the public-private partnership agreement. One could argue that other types of contracts should also be classified as public-private partnership; however, there is no legal reason and, consequently, no practical value for such classification.
- In an even narrower sense, as a special contractual form of the public-private partnership with a number of substantial differences from the concession agreement. States apply different approaches to distinguishing between concession agreements and PPP agreements. However, in international practice, concession is understood as an investment project structured using PPP principles, where the private partner's (concessionaire's) return on investment derives from direct collection of payment from consumers as opposed to the PPP agreement, where the private partner usually does not collect payments directly from consumers, but rather periodically receives availability payments from the state. At the same time, there are other approaches. For instance, in Russia this mechanism mainly differs in terms of ownership title to the infrastructure: under the PPP agreement such title shall be vested in the private partner, while under the concession agreement ownership always remains with the public partner (concessor).
In Uzbekistan, where there is no special law on public-private partnership, the term "public-private partnership" is used in a broad sense and includes granting of exemptions and benefits from taxes and customs duties, production sharing agreements, trust management, free economic zones, and, in the case of pre-schools, philanthropy and logistical support.
The Republic of Uzbekistan plans to adopt the Law "On Public-Private Partnership," the draft of which currently contains the more classic and narrow definition, that "Public-private partnership is mutually beneficial cooperation, legally arranged for a long-term period, of the public partner and the private partner through attracting private investment in the economy, pooling resources and risk allocation, done by concluding a public-private partnership agreement with the purpose of implementing investment, innovation, infrastructure and other projects and programs of state, social, economic, scientific and technical importance." In our assessment, the main deficiency of this definition is that it does not mention the PPP facility or public infrastructure. For instance, in the Model PPP Law for the CIS countries, the scope of application of PPP is limited to facilities of public interest and control and with respect to which the government authorities shall have the relevant powers.
In addition, it is important to consider that excessively broad interpretation of public-private partnership is undesirable, since it could confuse the notions of public-private partnership and public procurement. In this vein, the draft law envisages that the law shall not apply to public procurement, but it is unclear whether legislation on public procurement shall apply to PPP projects or not, since the recently adopted Law "On public procurement" does not contain provisions regulating this issue. Moreover, in accordance with the draft PPP law, the PPP project presupposes fulfillment of one or more of the following functions: design, financing, construction, reconstruction, production, maintenance, operation and trust management. Following the logic of the draft law, the PPP agreement may provide exclusively for design by the private partner, and thus, be essentially a public procurement agreement.
The Law of the Republic of Uzbekistan "On concessions" was adopted in 1995 at a time when PPP was just emerging. There exists a fundamental disconnect between this law and public-private partnership in contrast with the majority of jurisdictions of the world, where concession is considered one of the main forms of PPP. The matter is that the Law "On concessions" was initially aimed at attracting exclusively foreign investors to prospecting, exploration, mining or utilization of natural resources. In this regard, the Law does not contain a number of important provisions, e.g. reference to immovable property as to a concession item (instead, business activity itself is considered a concession item), provisions regulating the legal nature of the concession agreement, and investment obligations of the concessionaire.
Such limitations make it hardly possible to use concession for the purposes of public-private partnership. The Law "On concessions" does not provide a legal framework for implementing PPP projects, as evidenced by the fact that within 20 years after adoption of the Law there has been no legislative act envisaging the implementation of PPP projects by means of concession. Nevertheless, a number of recently adopted legislative acts demonstrate that, despite the foregoing limitations, Uzbekistan authorities still consider concession as one of the forms of PPP. In particular, the Resolution of the President of the Republic of Uzbekistan "On measures for further promotion and development of the pre-school education system" provides for concession to be used as one of the forms of PPP projects in respect of pre-schools. What is remarkable is that this Resolution contains a different definition of "concession" which excludes the mandatory requirement of foreign investor participation. Moreover, the recently adopted Resolution of the Cabinet of Ministers "On the establishment of a centralized clinical diagnostic laboratory on the basis of public-private partnership" envisages the conclusion of a concession agreement with Single Clinical Diagnostic Laboratory LLC, which is not a foreign investor. Therefore, in the context of developing Uzbekistan's PPP law, it is essential to amend the Law "On concessions" to adapt it to today's requirements or to combine this law with the PPP law, creating a single legislative framework for all forms of public-private partnership.
PPP provides an opportunity to structure various—but not any—infrastructure projects
Public-private partnership is quite a flexible legal instrument which allows the implementation of projects in various spheres of public infrastructure. The exact sectors of infrastructure or items of the agreement may be stipulated in the national legislation in either an exhaustive or a non-exhaustive way. The most advanced approach is an open-ended list of infrastructure spheres in respect of which a PPP project may be implemented; however, this approach assigns to the state greater responsibility for controlling the efficient expenditure of public resources (budgetary funds, land and other state property) involved in such projects.
The draft law "On public-private partnership" developed in Uzbekistan envisages exactly such an approach. In particular, the draft law lists areas where it is possible to implement PPP projects and stipulates that PPP may also be implemented in other areas, if it is not prohibited by law. At the same time, it is to be borne in mind that PPP is a mechanism for developing public and municipal infrastructure and not an instrument of state support for private commercial projects. For this reason, certain regulatory restrictions on the scope of acceptable PPP projects should be set. Otherwise there is a high possibility of abuse cases resulting from exercise of granted rights, exemptions, budgetary funds and real estate for construction of private facilities that are not public infrastructure.
In this regard, for the legislator it is important to understand what exactly should be a PPP facility. Thus, in a number of countries, including Russia, one of the mandatory requirements of both the PPP agreement and the concession agreement is generally that immovable property be constructed or reconstructed by the private partner. Movable property can be only part of the agreement (together with one or more immovable properties) and only when it is technically connected to the immovable property and is intended for the same activities envisaged by the agreement. This does not imply that movable property cannot be involved in the activities under the agreement; however, the availability of budgetary funds for its creation (or purchase) by the private partner will be significantly limited.
At the same time, at the economy's current stage of development, such an approach should be considered unsustainable for the purposes of transitioning to a post-industrial society. This approach jeopardizes opportunities to implement a significant number of projects in such areas as IT, public transport and all other projects to create and operate high-value movable properties. The balance of resources and risks allocated in PPP projects is largely determined by the functions to be performed by each party to the agreement. The following functions are mentioned most frequently: design, construction, reconstruction, financing, ownership, management, operation, maintenance, leasing, and transfer of ownership.
These functions may be used as an erector set to create different PPP models (BTO, BOOT, ROOT, BOLT, BOO, ROO, DBTO and many others). However, it is not unusual for the national legislation to radically reduce the number of models that can be built either in the form of PPP agreements or in the form of concession. Such reduction is intended to prevent abuses and intermingling of PPP with public procurement, and especially with privatization.
In particular, in Russia the mandatory elements of the concession agreement include: construction/reconstruction of the facility (except for information technologies) by the private partner (concessionaire), full or partial financing of the facility's construction and operation by the private partner, the public partner's (concessor's) ownership of the facility, the private partner being granted the right to possess and use the facility to operate it, and operation of the facility by the private partner during the term of the concession agreement. Therefore, it is impossible to conclude a concession agreement without the private partner's obligation to construct or reconstruct the facility, unless it is an IT object for which it has recently become possible to conclude concession agreements and PPP agreements without the need to construct or reconstruct any immovable properties. It is also impossible to envisage transfer of ownership title to the private partner even for a short period, and the private partner cannot be released from the obligation to operate the facility even if the private partner has an obligation to maintain it. In any case, the private partner shall conduct activities (e.g. education, health activities, public transportation activities) using the infrastructure. Market participants often criticize Russian lawmakers for this.
By contrast, under PPP agreements, the private partner can only maintain (and not operate) the facility the possession and use of which shall be transferred to the public partner for operation, and the private partner should hold ownership title (at least during the period stipulated in the agreement). As in the case with concessions, it is the private investor who should be at least partly responsible for financing the creation of the facility, indicating that PPP is an alternative mechanism for attracting private investment in public infrastructure.
It is noteworthy that under the draft law immovable property is not a mandatory element of the PPP project. However, only state-owned facilities may be the subjects of PPP agreements. This provision significantly limits the range of possible PPP projects and decreases the potential of this instrument. In particular, the draft law does not take into consideration the possibility of creating new facilities to be subsequently transferred into state ownership or being privately owned by the private partner, or the opportunity to transfer facilities into the private partner's ownership, which is possible in many countries, including Russia and Kazakhstan, and, for instance, is necessary to implement PPP projects according to the BOT model. The situation is different in pre-school education. In accordance with the Resolution of the President "On measures for further promotion and development of the pre-school education system" it is possible to transfer ownership title to the private partner provided that at least 25% of pupils are from families in need of social assistance. Moreover, privately owned property may be the subject of a PPP agreement.
How is PPP better?
One may ask what the alternatives are and why to choose PPP instead of other forms of private co-financing of public infrastructure. This can be discussed at length, but the point is that in contrast to investment-based lease or privatization, PPP usually provides the public partner with many more intervention instruments and bargaining chips, much more control over performance of the agreement, and with the opportunity to transfer the facility to the private partner's ownership (under a PPP agreement) and to leave the facility in state/municipal ownership. In addition, PPP makes it possible to structure the creation of the facility and its operation by the private partner more flexibly, effectively allocating responsibilities for operation of the infrastructure and its maintenance.
Given the appropriate level of legal regulation, a private partner is interested in PPP primarily due to the availability of co-financing through the state or municipal budget, as well as attracting low-interest loans (financing of PPP projects is considered low-risk financing, which is positively reflected in the national regulation in terms of banks' reserve requirements). Besides, PPP provides the opportunity to transfer some of the financial and operational (in the case of PPP) risks to the public partner, including obtaining certain guarantees and preferences which are provided by the legislation in this sphere to protect the investor from unscrupulous practices of the public partner, from the adoption of new legislative acts which change the rules of the game or from any other substantial change in the conditions for implementation of the project (in particular, the opportunity to include in the agreement the public partner's obligations to ensure the private partner's guaranteed minimum income, financial guarantees in case of termination of the agreement, etc.). In addition, investors are attracted by clearly regulated and very tight deadlines for response and approval by the state authorities, as well as the hypothetical possibility to acquire a land plot or facility for reconstruction without competitive bidding if so-called "unsolicited proposals" are used. This mechanism should also be integrated into the national legislation. For example, the draft law of Uzbekistan does not provide for such a mechanism and, therefore, there is no motivation for the private partner to initiate the PPP project. At the same time, in the case of PPP in pre-school education any initiative by the private partner leads to a tender in which the initiator of the project is not given any preferences to obtain the rights to implement the project.
PPP is an essential element of the regional development strategy
Currently both Uzbekistan and Russia have a difficult socio-economic situation which leaves the governments with virtually no choice but to promote all possible mechanisms of attracting private investment in public infrastructure. And priority should be given to PPP, since this instrument makes it possible to retain control over the facility, implementation of the project and provision of the public service, and involves using the private partner's experience and the effective management methods and technologies contributed by the investor. At the end of the day all these factors should ensure lower project implementation costs as compared to public procurement.
In Uzbekistan, public-private partnership is referred to in the Strategy of Action for Five Priority Areas of Development of the Republic of Uzbekistan for 2017-2021 as a necessary tool for reforming the state management system, improving the social protection system and deregulating the economy. In Russia, PPP has priority in regional development strategies, as evidenced by the requirement to include PPP in a regional investment plan as a mechanism for implementing infrastructure projects. The plan must be developed in accordance with the Standard for Activities of Executive Bodies of Members of the Russian Federation for Ensuring a Favorable Investment Climate in the Region approved by the Agency for Strategic Initiatives. Thus, the implementation of PPP projects has become an indicator of regional officials' effectiveness, which is why the executive authorities immediately became interested in this mechanism.
PPP is not a panacea
Indeed, PPP has many advantages for the public partner, but does this mean all sorts of investment projects should be modelled on this mechanism? Even if the infrastructure facility is on the lists of PPP (concession) facilities envisaged by the legislation, does this automatically imply that the project must be implemented according to the PPP model? The answer is no, it does not. PPP is neither a universal instrument nor a panacea. This mechanism involves various participants (state authorities, state/municipal enterprises, banks, investors, builders, operators, consumers, the public) in development and implementation of the project, consideration of the various views and interests, as well as clearly balanced allocation of risks and resources. In fact, public-private partnership is a complex and expensive instrument, which, if incorrectly handled, can lead to bankruptcy of the private partner at best and destroy the region's economy at worst. Alternatively, in the right hands, PPP can effectively solve a complicated infrastructure problem, create hundreds or even thousands of jobs and attract billions in private investment, not to mention cases where PPP is simply the only available solution to the problem. Let us focus on those purely practical aspects which should be considered in choosing PPP to implement the project.
PPP is a commercial project and not a social burden
In preparing a PPP project the state authorities often forget that the project should be efficient, first of all, for the investor, and the latter has to compare it to other simpler mechanisms that don't involve such a close tandem with the state, for instance investment-based lease. Lease offers easily understood allocation of investment and operational risks: they are fully borne by the investor, which is controlled by the public partner to a much lesser extent. If the investor needs just the land and does not need a public partner, then possibly this is a telltale sign that PPP is not the best option for the project. Certainly, the public partner may insist on using PPP if the infrastructure is crucial for the territory and the public partner doesn't want to lose control over it. In such cases the project should be reliably efficient and profitable for the investor; its cost-effectiveness has to be calculated with greater room to spare so the project will not become a social burden for the private partner and the private partner will always be optimistic about and interested in further participation in the project, and seek to keep the facility's operation sustainable and efficient.
Ensuring this is the task (risk) not only of the private partner, but also of the public partner, therefore, the latter has to pay serious attention to this issue while preparing the project and to analyze properly all components of its financial model. The benefits envisaged by the Resolution of the President "On measures for further promotion and development of the pre-school education system" are a clear example of ensuring efficiency and profitability for the private partner. In particular, this resolution provides for opening a special account of the Fund for Financing of State Development Programs dedicated to concessional lending of entrepreneurs involved in activities related to pre-school education. Notably, entrepreneurs may obtain credit at the rate of 1% per annum for the term of 15 years and with a three-year grace period. The refinancing rate of the Central Bank of the Republic of Uzbekistan is currently 14%. However, given the fact that this resolution was adopted prior to the adoption of the Law "On public-private partnership," it is unclear whether such benefits will be applied in other spheres where PPP mechanisms may be widely implemented. At the same time, the granting of such benefits may be linked to a high social value of the projects for developing pre-schools in view of the considerable shortage of kindergartens in Uzbekistan. Moreover, the public partner also assigns social obligations to the private partner due to the mandatory requirement to educate a certain number of children from families in need of social assistance.
Risk matrix
PPP should be employed where, firstly, a state (certain region or city) is in clear and objective need of a certain infrastructure project and, secondly, the budget lacks funds to implement the project without attracting private investment. If sufficient budgetary funds do exist, it is easier and cheaper to hire a private operator using the outsourcing model of public procurement (including, if applicable, life-cycle contracts). And, if there is no clear interest, sooner or later the private investor risks not receiving the initially contracted benefits (e.g. budgetary financing, guarantees, assistance, other incentives) from the public partner, since the state authorities may easily lose incentive and interest in the project. Considering the long-term nature (usually, 15-30 years) of PPP projects, due regard should be paid to rotation and alternation of power in the region (municipality).
Thirdly, for PPP to be worthwhile, the private partner should have clear reasons for transferring some of the risks to the public partner. Usually, the project's financial and legal models indicate it is necessary to partially transfer to the private partner the financial risks and/or revenue risks for implementation of the project, which results in provision of capital and operational grants, ensuring minimal guaranteed income (subsidy) and provision of sovereign guarantees. The allocation of risks between public and private partner is reflected in a detailed risk matrix for the project and the respective parties' obligations are set out in project agreements (mainly concession agreement, PPP agreement, and direct agreements between public partner, private partner and financing organization).
It must be understood that every decision has its side effects. In the case of PPP the side effect is that the private partner/investor loses a significant part of its autonomy, it becomes subject to tight control by the public partner, which, due to the transparency of the project, and access to the documents and financial data, is able to look at the project and the private partner "under a microscope" and take prompt action. For this reason, PPP is far from being an ideal business model, but rather is a compromise mechanism intentionally complicated to enable effective allocation of different risks between the parties and for creating a system of checks and balances, which prevents the parties from deviating from the initially intended cooperation model. For the private partner this is not always convenient or good, and it is a difficult decision, which, however, should always be obvious.
PPP projects are the most complicated ones
Overall, one cannot say that PPP mechanisms are always effectively applied in some sectors of infrastructure or, conversely, are a priori ineffective in other sectors. Indeed, there are facilities which, due to the lack of budgetary funds or the investor's reluctance to "donate" infrastructure to the state, cannot be constructed other than by using the concession or PPP model. But in other cases, as practice shows, depending on the exact conditions and circumstances of the specific region, the same mechanism applied to the same type of infrastructure may be more or less applicable and effective.
It is safe to state that any public-private partnership is a big medley composed of participants in the project—stakeholders, including the state authorities, state/municipal enterprises and institutions, investors, contractors, operators, banks, consumers, households and non-governmental organizations—and of their interests, various economic, political, social and natural conditions and the related risks which should be taken into account, hedged against and allocated. It is indeed hard work. This work requires, firstly, the investor's and operator's experience in implementing projects in the infrastructure area in question and, secondly, the involvement of highly-qualified legal, financial and technical advisors. Thirdly, there is the public partner's ability to provide an experienced project team and, fourthly, a significant amount of money and time (at least four to six months) to prepare for the project. Not to mention that the complexity of the project predetermines its high value: for the project to be profitable and outweigh the costs of its development in the foreseeable future, usually we recommend to consider PPP as an option only for projects with investments of at least US15 million in investment.
This is quite illustrative; however, there is an exception to every rule. For instance, we are aware of successful regional and local PPP projects with a value of up to US$5 million, but all of them have been prepared by highly-qualified regional teams already experienced in this sphere and willing to transfer their experience to smaller-scale projects.
Key to success
Thus, a PPP project's success is largely predetermined by quality preparation, which includes identifying all potential problems and risks for the next several decades, determining and considering the interests of all project participants (the aforementioned stakeholders, including consumers and the public) that could affect implementation of the project, and preparing informed technical and operational decisions, a precisely calculated financial model with room to spare, developing clear, well-balanced risk matrices and project agreements. However, even with appropriate preparation, the human factor remains decisive. In this regard, the investor's (operator's) experience, qualifications and reputation, and the public partner having a qualified project team are crucial.
Finally, in order for such capital-intensive infrastructure projects to be sustainable it is necessary for the state to have unambiguous and harmonized legislation in this sphere, which should include all essential guarantees for investors and banks, as well as a stable economic and political situation in the region and in the country as a whole. Moreover, it is necessary to have the proverbial favorable investment climate, which heavily depends on business trusting the local, regional and central governmental authorities.
The key to success in this area is to maintain a dialogue between the state and a wide range of national and international investors and advisors with due regard for their opinions on legislative and project initiatives.
In this regard, we hope that development of the draft law of Uzbekistan on PPP will continue in line with the already initiated and quite productive multilateral discussions of the draft law and attraction of highly-qualified national and foreign experts in PPP.
Thus, the Ministry of Justice of the Republic of Uzbekistan jointly with Dentons Tashkent held a round table to discuss the draft law on PPP in Tashkent on June 26, 2018. Representatives of various ministries and agencies of the republic, foreign investors and invited lawyers of Dentons Russia and Kazakhstan participated in the event. The round table was a good opportunity to discuss different approaches, the potential and development of PPP in Uzbekistan. Foreign experts presented their recommendations on improving the draft PPP law based on the experience of foreign states.
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