Correction and refashioning: PPP projects after Document No. 92

By Wang Jihong and Yu Li, Zhong Lun Law Firm in Beijing
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In recent years, Public-Private Partnership (PPP) projects have been developing at a ferocious pace, but various means of circumventing policies and illegal operations have also been a constant. In November 2017, the Ministry of Finance issued the Notice on Regulating the Administration of the Comprehensive PPP Information Platform Project Database (Document No. 92), which requires “prompt rectification of the wide abuse of PPP, further promotion of the compliant development of PPP and an effort to drive PPP back to its roots as a mechanism for the innovative supply of public services”, and stringent control and prompt removal of PPP projects. This foreshadows the formal entry of PPP projects into a corrective and refashioning period.

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

Return to the roots. Currently certain regions only treat PPP as a government investment/financing tool to mitigate their difficulty in directly raising debt financing – this attitude runs counter to the original intent of reforming the supply mechanism. PPP has taken on a number of functions besides financing, e.g. transformation of government functions, reducing the whole life project costs, etc., yet, ultimately, their roots lie in the reform of the mechanism for supplying public products and services, and the full utilization and leveraging of the proper function of private capital and energy in public products and services.

Stringent control. Document No. 92 sets forth stricter criteria for new projects entered into the database and “supports on a priority basis existing projects and prudent development of government fee payment type projects”. It also sets forth when entry to the database is to be denied:

(1) Projects not appropriate for implementation with the PPP model. Currently the projects for which the PPP model is appropriate are mainly infrastructure and public service projects in which the government bears a supply obligation – they require substantial investment, stable demand over the long term and flexible price adjustment mechanisms, and should be substantially market-oriented. Purely commercial projects, such as real property development projects, should not be included as a PPP project. In future, projects that do not fall within the field of public services, the bearing of which by private capital is not appropriate or only involve project construction without operation thereof may not be entered into the database.

(2) Preliminary preparation work has not been carried out. Currently, many initiated PPP projects have commenced PPP project procurement and implementation work without the preliminary procedures having been carried out. Document No. 92 emphasizes that projects for which such procedures as project approval, state-owned property rights transfer, etc. have not been carried out may not be entered into the database.

(3) Failure to establish a pay-for-performance mechanism. The determination of the fee payment mechanisms for PPP projects has been quite chaotic in practice. In some projects, in order to avoid the direct payment of fees by the government, a user payment step is forcibly grafted onto a project with no operational and fee charging basis. In some other projects there is an imbalance of payments that not only causes government expenditures to increase sharply at a certain time, but also causes the private party to incur early funding costs and bear relatively heavy repayment pressures, which is not conducive to using funds or other such means to optimize the project investment/financing structure. Accordingly, Document No. 92 requires that all returns be linked to performance evaluations, additionally, government expenditure obligations should be continuously and steadily paid throughout the project cooperation period, without fiscal expenditure pressures spiking sharply at any time.

Concentrated removal of those already characterized by irregularities. Document No. 92 requires that the review and removal work for those projects already in the database be completed by 31 March 2018. The following deserve particular attention. Firstly, the difficulty in implementing PPP projects remains an issue. Following Document No. 92, any project on which no substantive progress has been made within one year of its entry into the database faces the risk of removal.

Secondly, in practice, the late stage fiscal expenditures on certain projects account for far more than 10% of general public budgeted expenditures, a clear fiscal expenditure risk that buries a latent debt danger. So projects that have not yet entered the procurement stage but the current and future annual fiscal expenditures for which have already exceeded the redline have also become removal targets.

Yu Li Associate Zhong Lun Law Firm
Yu Li
Associate
Zhong Lun Law Firm

Thirdly, the BT model saw enormous growth in the past as a convenient financing instrument, but also led to high local government debt levels, making the BT model no longer good for infrastructure construction and the government debt situation. Limitation on its use therefore satisfies the Ministry of Finance’s requirements. However, we have found that many places still refashion the BT model through such means as stretching the repayment period, fabricating an operating period, etc. and packaging them as government fee payment type PPP, divorcing them from the essential nature of PPP. It is likely that such projects will be cleared in future.

Lastly, although the NDRC expressly requires that project capital not be debt funds, there nevertheless continue to exist instances where debt funds are used as capital. Such a practice is bound to have an impact on the structural financing of the projects, increasing their financing costs. In future, if local governments continue to insist on reducing project return levels, this will be a major test for private parties and financing parties.

In China, the main participants in PPP projects remain state-owned enterprises. It is our opinion that, after Document No. 92, particularly in light of the State-owned Assets Supervision and Administration Commission of the State Council’s opinion on the need to control the total number of PPP projects of enterprises under the central government, the high tide in PPP project development has reached its peak and will enter an adjustment period. We hope that, during this period, PPP project investment returns and the cooperation models will become more reasonable to genuinely attract more private capital and return to the roots of public-private cooperation.

Also, given that PPP regulation is becoming more stringent and that ongoing projects are also facing the risk of rectification, and, in particular, that removed projects will additionally face such issues as contract termination, compensation or modification, handling the upcoming clearing and rectification will undoubtedly lead to a series of subsequent legal issues for such participants as local governments, private investors, financial investors, etc.

Wang Jihong is a partner and Yu Li is an associate at Zhong Lun Law Firm in Beijing

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