Are PPPs the only choice for project investment?

By Wang Jihong and Han Jiangyu, Zhong Lun Law Firm
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Following years of promotion and application, the public-private partnership (PPP) model may just become the darling of the project investment sector, with local governments inevitably invoking PPPs when discussing the search for investors and investment for projects. Governments in some provinces have even gone as far as incorporating the scale of PPP projects and the rate of their implementation as government work assessment objectives, and using the PPP model for the implementation of all public services and infrastructure projects. But is the PPP model the only option for project investment?

Wang Jihong, Partner, Zhong Lun Law Firm
Wang Jihong
Partner
Zhong Lun Law Firm

Pursuant to relevant regulations of the National Development and Reform Commission (NDRC) and the Ministry of Finance on PPPs, the PPP model mainly applies to public services and infrastructure projects in which the government bears a responsibility for providing the same, and that are suitable for market-oriented operation. Provinces and cities should give priority consideration to using the PPP model for the construction of new projects. In such public services sectors as waste treatment, sewage treatment, etc., in which the central government provides fiscal support, either the application of the PPP model is mandatory in new projects, or the implementation of PPP model identification and fact finding is “mandatory” for such new projects.

However, the PPP model is usually required to satisfy such mandatory conditions as: “in principle, the term of co-operation may not be less than 10 years (the draft for comment of the PPP law even specifies that, in general, it should not be less than 25 years)”; “expenditures on all PPP projects each year must not account for more than 10% of general budgeted public expenditures”; “PPPs must undergo and pass a value for money assessment and a demonstration of fiscal bearing capacity”, etc. So in practice the model cannot completely match up with the demands of project construction for governments of every province or city.

For example, if the fiscal position of a certain local government is sound and it has the capacity to repay government expenditures in three to five years, although a PPP eases the expenditures of the government for that period, the compensation for all of the investor’s costs and investment returns for a period of 10 or more years will ultimately result in an actual increase of repayment costs. Furthermore, due to the fact that a PPP usually requires two to four months to complete the preliminary procedures, it cannot satisfy the pressing needs of project construction. So in some cases, governments may be more willing to adopt the build-transfer (BT) model.

QUESTIONING BT APPLICATION

BT refers to a project investment model where the government uses private funds to construct not-for-profit infrastructure. Once construction is completed, it adopts instalment payment and/or uses compensation measures to buy back the infrastructure. As the BT model presents such advantages as easing project construction funding pressures, enhancing project investment and construction efficiency, etc., it was all the rage in such project investment sectors as transportation, utilities, energy and water management before 2012. However, subsequently, in an effort to stop the rapidly rising local government debt, the state issued the Notice on Putting a Halt to Unlawful Financing Acts by Local Governments (document No. 463) in December 2012, restricting the use of the BT model.

Han Jiangyu Associate Zhong Lun Law Firm
Han Jiangyu
Associate
Zhong Lun Law Firm

Document No. 463 specifies that, “unless otherwise specified in law or by the State Council, local governments at every level and their subordinate authorities and institutions, associations, etc., may not take on government debt by such means as entrusting construction to an entity and bearing the obligation of year-by-year buy back (BT). For such projects as public rental housing, highways, etc., which, in compliance with laws or State Council regulations, may take on government debt, and which genuinely require construction by way of the construction agent system and year-by-year buy back with fiscal funds (BT), the scale of construction must be reasonably determined based on the project construction plan, solvency, etc., and a plan for repayment in yearly instalments shall be implemented.”

In September 2016, the Ministry of Finance’s Interim Measures for the Fiscal Administration of Public-Private Partnership Projects (document No. 92) specify that “the BT method may not be used for the implementation of projects in the public services sector”, further comprehensively prohibiting the BT model. Since then, it seems that the PPP model has been the only option for project investment. However, the authors argue that, under specific conditions and circumstances, there is still room for the BT model to play a role: first, document No. 463 only restricts, and does not prohibit, implementation of the BT model; it can still be used under specific conditions. This document applies only to projects that rely on fiscal funds as the source of repayment, and does not touch upon projects that rely on non-fiscal funds as the source of repayment. Although document No. 92 completely prohibits the BT model, the scope of its application is limited to projects in the public services sector, and it does not mention projects in the traditional infrastructure sector.

Second, certain local governments are more than happy to use the BT model for project construction and have issued and implemented corresponding local regulations, for example: the Administrative Measures of the Zhengzhou Municipal Government for the BT Financing and Construction of Investment Projects; and the Interim Administrative Measures of the Haikou Municipal Government for the BT Financing and Construction of Investment Projects. Such local regulations are lawful and valid, and are of reference value.

Third, given that economic development is not evenly balanced around the country, if certain regions are unable to satisfy the statutory conditions for PPPs, are they to halt public services and the construction of infrastructure? At the very least, a PPP is only an investment/financing model that is constantly improving through trial and error, and practice. So when carrying out project construction, a regional authority cannot just unthinkingly and absolutely opt for a PPP, or rashly and absolutely reject a BT; rather it should opt for what is best under the local circumstances.

The PPP model has its shortcomings and is not the sole option for project investment. Although the BT model is progressively being given the cold shoulder, it is not absolutely prohibited. Given that the state is continuously broadly supporting and vigorously promoting PPPs in terms of budgeting, taxation, project bid invitation, etc., and is increasingly tightening the regulation of BTs, the authors recommend that investors should judiciously use the BT model to reduce their investment risks.

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Wang Jihong is a partner and Han Jiangyu is an associate with Zhong Lun Law Firm

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