UME discusses public private partnerships with Freshfields
What gets public private partnerships off the ground?
Joe Huse: I think in the Middle East the level of involvement is dictated by what is commonly termed the haves and the have nots, in relation to vast mineral and resource wealth. The countries that do not have huge dependable revenue streams have no choice but to go down the public private partnership (PPP) path. If you take Bahrain as an example, there last three major power projects have all been done on a PPP basis. A number of other projects throughout the region will probably be done on this basis too.
Charles July: The prevalence of these PPP deals will vary hugely by jurisdiction. If you take Abu Dhabi, it is experimenting with PPPs for surface transportation, with the likelihood that it will be used for the metro and integrated high speed rail link. It lends itself very well to these sorts of projects.
PPPs – which is a very flexible term – could be used in the context of wider infrastructure projects, such as a port, where the state is the landlord, and through a concession arrangement involves the private sector as a terminal operator. That’s a classic arrangement, where they have a long term agreement.
People tend to get hung up a bit on terminology, but when you dissect these kinds of arrangements, its basically the private sector building something or providing a service to the state, which the state therefore doesn’t have to finance itself. That can be for a variety of reasons, whether the state can’t afford, or doesn’t want to bear the cost of that project, or from a political perspective may want to actively encourage private sector involvement, then it is a very attractive option.
Where this will become very intriguing in the future, because it is harder to organise, is social infrastructure (healthcare, housing, education, courts and prisons). The big difference is that in these scenarios there is no product which could then be off-taken by someone. The state pays through a unitary charge for the service provided. That has its own challenges because the state has to demonstrate that it getting value for money.
The key thing is the public sector demonstrating that a privately procured PPP arrangement gives better value for money than running the project – whatever it may be – than if it was state run.
A conventional procurement can’t be easily compared to a PPP because it has to be measured over the whole life of the deal. The private sector is responsible for maintenance and servicing over the lifespan of the project, so those future costs need to be built into the equation.
What do you have to look out for in PPPs?
CJ: PPPs are very complex contracts. A large part of our role is making sure the allocation of risk through the contractual matrix is an appropriate one. A tried and tested mantra is that the risk should be borne by the party best able to manage it.
On one level we’re lawyers preparing documentation, but looking at it in a purely mechanical way and assuring the risk is in the right place is an important part of our role. However, that’s only part of the story. If we have achieved that, then putting that into the right legal framework is crucial, and therein lies the regional difficulty. In some of the jurisdictions the situation may be that the insolvency law isn’t flexible enough to deal with the stresses of this sort of deal.
Over the years, in areas where PPP deals are more developed in terms of usage then that allocation is more tried and tested. I don’t think we’re in a situation in most of the GCC where that is the case. In most jurisdictions it’s not sufficient to rely on UK precedent for example. Banks here and legal regimes need some assurance that the legal regime in its jurisdiction will always behave a predictable and reliable fashion. The level of certainty by definition isn’t very evident in this region simply because it has never been tested in this way before.
This means banks demand that the risk allocation is extremely robust. In certain projects, which have had difficulty in the financing stage, whatever the economic conditions, when you look at them it’s quite often because there was in inappropriate allocation of risk for the maturity of that market. What tends to happen in more developed market is a more detailed allocation of risk, which is perfectly logical because it reflects how the flow of negotiations would have gone between the state and private sectors. Once a few of these PPP projects get banked then those governments can start pushing back the risk towards the private sector.
How you achieve that in current market conditions may now be about gradually increasing that risk portion on the private sector incrementally as you progress, but there comes a point where conditions in financial markets may stop banks from participating simply because they can’t, or because it’s unattractive to them in financing terms.
How has the market reacted since the downturn?
Harnek Shoker: What we’re finding is that even if you have the regulatory framework in place, we are having to restructure because essentially the conditions that were acceptable in financial terms six months or a year ago, no longer are.
CJ: The goals posts have moved. This time around the banks are not prepared to absorb the same level of risk that in a very buoyant market with masses of liquidity and competition the once were. Not long ago projects in this region were getting very attractive financing and very attractive terms, and some might even say, they were getting much better terms than the risk premium justified. The financing market was overheated.