- Russia's need to improve its infrastructure has led to a concerted move to embrace Public Private Partnerships (PPPs). For investors looking for established methods of entering emerging markets to shelter from the credit crunch, PPPs present an attractive option. However, a number of practical, legal and financial challenges remain, which need to be addressed if PPPs are to form a significant part of the country's infrastructure financing.
- The Russian government has announced plans to spend about $1 trillion over the next 10 years on improving infrastructure. It has also made it clear that a significant part of this investment will be in the form of PPPs, to benefit from the leverage provided by the efficiency, competition and investment of the private sector.
- The Russian PPP market is potentially enormous. One of the smallest current PPP roads in Russia, the Orlovsky Tunnel in St Petersburg, at around $1bn is still substantially bigger than the largest road PPP in relatively mature markets such as Germany – the A1 at $672m. Further to the first projects being developed mostly in the transport and, to a lesser extent, the utility sector, there is also scope for future use of PPPs to develop other social infrastructure.
- The timetable for the first PPPs tendered in Russia was overly optimistic, but several projects are now under way and should provide forward momentum for PPP in Russia.
- Despite the recent volatility of its economy, the long term outlook for foreign investment in Russian infrastructure remains positive. This investment will be bolstered by the small number of stateowned banks that are likely to provide a significant portion of the financing of imminent projects.
Framework for PPPs in Russia
While they offer distinct advantages, PPPs present a number of practical, legal and financial challenges. In Russia, as in other emerging markets, the embryonic state of the legal and practical framework for PPPs means that relatively few have been implemented to date.
The situation is changing, however, and we are now seeing a drive to replace, modernise and expand the aging infrastructure, which lingers as a remnant of the communist era. In 2007-8 several high-profile PPP projects have been tendered in Russia. These include major road, urban rail and air transport projects and mark the first real test for the relatively new Russian PPP legislation.
There are currently two PPP models being followed in parallel:
- the federal government's concession law, under which the physical asset remains owned by the government, a fact that makes enforcement of bank security complicated; and
- a specific regional PPP framework, such as the one developed by the St Petersburg government, where the deal pipeline is regarded as the most advanced in Russia.
The Federal Russian Law on Concession Agreements
The Federal Russian Law on Concession Agreements (the Federal Concession Law), adopted on 21 July 2005, includes provisions on:
- entities involved in the concession granting process;
- concession facilities;
- selection procedure;
- concession agreement; and
- certain guarantees for investors and government support issues.
The law's adoption set the stage for the utilisation of PPPs in many parts of the public sector, including transportation, energy, education, health care and utilities.
For the most part, the legislation is flexible and does not impose rules on how relations between the state and private investors will be conducted during implementation of concession projects. Once a concession agreement has been concluded, regulation of the investorstate relationship is to be governed by the detail of the agreement itself.
However, some rules of the Federal Concession Law have been unusual and restrict the parties from having a tender and negotiation procedure and a concession agreement fully in line with international standards. In July 2008 various amendments to the Federal Concession Law were published with the aim of curing these defaults. Certain legal issues, however, remain to be improved, in particular as regards lenders security.
Law on the Participation of St Petersburg in Public Private Partnerships
The government of the City of St Petersburg takes an active role in developing the city's infrastructure, both in the form of projects based on the Federal Concession Law, such as the Western High-Speed Diameter (WHSD) or the Orlovsky Tunnel, and in the form of nonconcession projects, including those based on the private ownership of the facilities.
To regulate its participation in the non-concession based projects, the regional St Petersburg PPP Law was passed in December 2005. It offers a relatively flexible framework for structuring, tendering and supporting PPPs. In particular, by comparison with the Federal Concession Law, the following factors can be seen as advantageous.
- Flexible form of PPP relationships. Unlike under the Federal Concession Law, there are eight categories of permitted PPP relationships, including those involving private ownership of the assets, such as 'buy-own-operate-transfer' (BOOT) structures.
- Better framework for structuring the robust security package. The law does not impose restrictions on pledging or assigning rights out of the PPP agreement. Under a BOOT-type structure, pledge or other encumbrance of the asset for the benefit of the banks may also be possible.
The $1bn Pulkovo Airport concession and the $1bn plus Nadzemny Express light rail project are the most high-profile examples of PPP projects that are not being done under the Federal Concession Law, but are BOOT structures under general civil law and the St Petersburg PPP Law.
In November 2005 the Investment Fund (IF) rules were adopted by the Federal Russian government, signalling another move towards PPP. The IF is intended to be one of the state's primary PPP funding sources and to act as a catalyst in attracting private investment. For 2008, the IF's volume has reached $3bn. Investments to be made from the IF may take the form of, among others:
- funding up to 75 per cent of total capital project costs as equity investment or financing certain assets in exchange for an ownership title to the assets; or
- a guarantee on 60 per cent of the borrowings for the purposes of the project.
To qualify for IF support, an investment project must comply with public sector priorities, generate social benefits, have a negative stand-alone net present value (NPV) justifying state support for implementation and generate economic profit if support is provided (creating a positive NPV).
In May 2007 the Federal Law on the Russian Bank of Development (Vneshekonombank, VEB, which is a banking institution fully owned by the Russian state) was assigned with promoting Russian infrastructure, including via financing or otherwise supporting PPP projects. VEB is currently considered as one of the institutions that will play a key role in the further development of Russian PPPs. One of the recent moves to confirm this perception has been creation of a PPP task force within the bank to study, standardise and promote PPP practices in Russia.
Business issues for potential investors
Transparent legislative frameworks and tender processes are essential to attracting high-calibre applicants to bid on tenders. In this respect the current framework for PPPs in Russia has a number of drawbacks.
Restrictions on the concessionaire's ability to grant security over the project assets or rights under the concession agreement. Under the Federal Concession Law the parties are not allowed to pledge the asset or the rights under the concession agreement and a security assignment over such rights is only limited to a period after the asset is completed. Although alternative security instruments are available in Russia, such as a pledge of shares in the concessionaire, the limitations on the agreement and asset related securities makes finding lenders and structuring a security package more difficult. Under the St Petersburg PPP Law this is not an issue.
- Exclusion of the PPP models that incorporate ownership of assets by private sponsors (for example, BOOT). Under the Federal Concession Law, assets built under the concession agreement are owned by the grantor on their completion, with the concessionaire granted only a long-term lease and concession rights. This reduces the range of PPP models that may be used to implement a project and limits flexibility for the grantor. Unlike the Federal Concession Law, the St Petersburg PPP Law does not include such restrictions and allows for multiple forms of PPPs.
- Negotiability of bid documentation. While bid procedures under the Federal Concession Law have recently been amended to facilitate post-tender negotiation of key terms, in particular to give parties more flexibility to amend the time schedule to close the deal, there are still certain procedural imperfections that need to be cured. The St Petersburg PPP Law is more flexible in this respect.
- Concerns in relation to the truly independent forum for dispute resolution. Russian policy favours Russian court jurisdiction in disputes over international arbitration yet there are doubts about the independence of the Russian court system. In a number of the current projects the grantor decided for an internationally recognised arbitration.
- No specific federal legal framework for non-concession based PPPs. Although the regional PPP laws may in some cases be more reasonable than the Federal Concession Law, the risk of using such laws is that the correlation between the federal and regional law in this area is not fully clear from the legal perspective and has not yet been tested in practice.
Current PPP projects in Russia
The majority of current PPP projects in Russia are in the transport and infrastructure sector. The potential volume of private investment in transport infrastructure has been estimated at €12-15bn per year.
The Western High Speed Diameter motorway (WHSD)
The WHSD is a high-speed motorway linking St Petersburg's trade seaports, including the Grand Port, with the national road network. To the north it will provide a connection to the 'Scandinavia' motorway. It will connect the north-western, central and southern parts of St Petersburg and play a vital role in the city's development as a major world transport hub.
- Construction started in September 2005 and is expected to be completed in six to seven years.
- Mostly eight-lane with an overall length of 46.6km.
- Total project contract value estimated at around $9bn.
- Approximately 50 per cent of construction costs contributed by the Federal government.
The winning bidder, announced in June 2008, was the WHSD-Nevskij Meridian consortium, which includes Strabag, Basic Element, Bouygues, Hochtief, Egis Projects and the Russian construction firm Mostoodryad No. 19.
Banks should be attracted to the project by the number of wellestablished sponsors involved. Among other commercial banks, HSBC and Gazprombank are seen as interested in the project.
The WHSD is important for the Russian Federal government, which is keen to use it as a flagship for implementing PPPs, despite concerns over the project's complexity.
The first section of the Moscow to St Petersburg motorway
The first 58km section of the toll motorway linking Moscow and St Petersburg (a total of 650km) aims to relieve congestion on one of the busiest highways in Russia.
- Estimated value of up to $2.1bn.
- Includes the construction of five bridges, eight junctions and 21 flyovers.
- Is estimated to take five years to complete.
- Half of the funding is expected to come from the state with the remainder to be covered by private sources, including international banks and companies.
The Northwest Concession Company of Vinci and one of the Russian transport majors Ntrans, have been announced the preferred bidders. Under the current timeline the parties are to close the deal in six months.
The Orlovsky Tunnel
This 1km-long tunnel under the River Neva in St Petersburg will open inland shipping to international transport. It will also increase the general capacity of the Volgo Baltic Waterway and is therefore beneficial to the federal transport network. It will also significantly improve the traffic situation in the adjacent areas of the city.
The government of St Petersburg is the project's grantor.
- In August 2006, the project was allocated more than $300m from the IF with the balance of the funding to be provided by the St Petersburg city budget.
In December 2007 its was announced that four bidders had made it through pre-qualification. These are: Nevskaya Concessionaya Companiya (led by Vinci); Nevskij Tonnel (featuring Strabag, Basic Element and Egis Project); Boyuguesproekt Opereiting (led by Bouygues); and Neva Traverse (led by Hochtief).
Pulkovo Airport in St Petersburg is arguably the most important part of the transport infrastructure in north-western Russia and it is fast developing. The City of St Petersburg will take the lead in its improvement following an authorisation by the Russian cabinet in early 2008 for the Federal Property Agency, jointly with the Air Transport Agency, to hand over the federal property of Pulkovo Airport to the city administration.
- $1.5bn is to be invested, through a special-purpose vehicle, to upgrade the airport, enabling it to accept long haul flights.
- The official target for announcing the winning consortium is March 2009, with the contract to be signed by the end of June.
- The concession agreement is likely to last for 30 years.
On 12 August 2008 it was announced that seven bidders had been shortlisted. These are: GMR Infrastructure; Petroport (Leader Asset/ Vienna Airport Group); Nevsky Airport (Basic Element, Changi Airport and Strabag); Financial-Industrial Company 'Farvater' (VTB Bank, Fraport and Copelouzos); Nevsky Sky (Macquarie Airports and Macquarie Renaissance); St Petersburg International Airport (Renova and Hochtief); and TAV Airports Holding Company.
Beginning at Baltic Pearl in the Krasnoselskiy district, this 26.5km rail line will pass through five southern city districts, ending at the Obuchovo metro station. The project will also encompass a 22km extension of the system to Pulkovo Airport and a further 22km extension to Petrodvorets (Naukograd).
- The successful bidder will be required to design, build, part finance and maintain the system, which will have 16 stations and 30km of track.
- The project has an availability payments structure.
- The concession will run for 30 years.
In April 2008 it was announced that five bidders had been shortlisted. These are: Mitsui; a consortium of Ansaldo Transporti Sistemi Ferrovanti, Soares da Costa Grupo SGPS, ATM Azienda Transporti Milanesi and `koda Transportation; Yuzhny Express, comprising Alstom, Bouygues, Tranadev and Mostootryad 19; Strelna-Express, comprising Bomardier and Vinci; and Express-Severnoy Stolitsy, comprising Strabag, Siemens and Basic Element and VTB Bank.
Risks for potential investors
Despite clear political and financial commitment to developing PPPs from both the federal government and the government of the City of St Petersburg, the existing legal and administrative frameworks place a number of hurdles in the way of investors. Of particular concern are laws governing budget regulation, tax issues, licensing and antimonopoly regulation.
The recent dramatic devaluing of Russia's stock market has undoubtedly raised general concerns over market volatility. Similarly, currency exchange risk is currently a cause of anxiety. Russia's foreign currency rating is currently BBB+ (Fitch and S&P). On 23 October, S&P announced that its outlook on Russia had been downgraded from stable to negative as a result of the cost to the Russian government of its bank rescue plan. In addition, investment in Russia is still affected by concerns over sovereign risk and revenue security, and by the perception that its commercial banks carry political risk. One result of these uncertainties is that export credit agencies are increasingly being approached by bidders to finance or underwrite PPPs.
Other, more general concerns include:
- the geographical concentration of the major projects;
- the potentially negative attitude of consumers to being charged for services that used to be free – eg the toll roads; and
- a considerable level of corruption at federal, regional and municipal levels.
Financing and the 'credit crunch'
While the liquidity crisis is undoubtedly having a global impact, the outlook for infrastructure investment in Russia is complicated and conclusions difficult to draw. Some analysts believe that the recent deterioration of Russia's stock market may reflect a growing pessimism on the future of its economy. However, what is fairly certain is that Russia will not experience a repeat of the events of 1998. It is in a far better position to manage this downturn due to tighter regulation, stronger capitalisation and accumulation of the world's third largest foreign exchange reserves.
Infrastructure projects are, by virtue of their long term nature, notoriously robust in times of economic downturn. Although the completion of deals may take longer and the number of banks involved in syndication may increase, the sentiment is that the projects will be completed eventually.
Some factors particular to Russia do count against it as a preferred country for foreign investment. One is the vast size of the projects, such as the WHSD and the Moscow to St Petersburg motorway, which are being carried out at the same time and competing for liquidity. On the other hand, the momentum and demand for investment opportunity that has built up behind projects such as Puklovo Airport are likely to spur on their development.
In terms of Russian investment, a number of small, state-owned banks still dominate the Russian banking system and even the leading private banks are not strong enough to become serious players in the upcoming PPP deals. In fact the main effect of the credit crunch on the Russian banking system has been to further widen the gap between the largest banks and their smaller competitors. For the time being, stateowned banks, such as VTB Bank, Sberbank and Gazprombank, as well as Vnesheconombank, will play a vital role in providing a significant part of the funding for infrastructure deals.
In addition, a number of special infrastructure funds are being created in Russia to encourage equity investment and it may be that a lack of projects rather than a lack of available money may prove to be the problem. By comparison, capital markets are not expected to become a serious source of infrastructure financing in the near future.
By the end of July 2008, the IF had approved 12 projects with a total value of $38bn. It has also been announced that the Russian Ministry of Regional Development will review a number of new regional projects by September 2008.
The European Bank for Restructuring and Development and the Russian Development Bank recently agreed to explore the possibility of co-financing projects in certain areas and in February 2008 a memorandum of understanding was signed. Their priority sectors include transport infrastructure, energy and municipal services and those with significant environmental and energy efficiency potential. With the help of other interested organisations, the two institutions will also consider setting up a unit to help manage the project preparation process for PPPs in infrastructure, a move that could be extremely beneficial in attracting investors.
Short term, private investment in Russian infrastructure is bound to suffer as a result of global market uncertainty. However, the federal government has not indicated any weakening of its commitment and expectations for the long term development of Russia remain optimistic. The speed at which infrastructure projects are completed should accelerate once the concession law has been tested with the first project to come to closing.
The success of the city of Sochi in winning the bid for the 2014 Winter Olympics will stimulate much infrastructure rejuvenation in the area. One major proposal is for a new offshore terminal in Sochi's port to allow cruise ships to dock. The proposed terminal would have a 3,000-passenger capacity and would be completed in time for the 2014 Winter Olympics.
To ensure that the area is ready for the Games, the Federal Target Programme for the Development of Sochi was initiated in 2006 and will run until 2014. The Krasnodar regional government plans to spend $11.7bn on development projects and the programme is being co-ordinated by the Russian federal government. It is expected that many of the projects will be completed using PPPs.
Whereas most PPPs in the pipeline in Russia focus on transportation, airports and ports, in coming years it is anticipated that this form of project finance can be adapted for use on social infrastructure projects.
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