Risks for Two
With the current economic crisis and growing global competition for investments, the public-private partnership is becoming increasingly relevant as a means of risk sharing. This survey describes the main factors to be taken into account by potential investors when implementing PPP projects in Kazakhstan.
The implementation of infrastructure projects with the help of PPPs has been a topic for discussion in Kazakhstan for several years. There are both successes and failures, but most importantly, there is valuable experience in the field of legislation development and enforcibility in this area.
The public-private partnership used to interest only a small number of experts and officials directly involved in the process, but today the term “PPP” can be heard everywhere.
Obviously, with the lack of government funding, tight budgets of national companies and limited borrowing opportunities, the government has to attract private investment in infrastructure through PPPs. In this respect, the crisis has played a positive role, forcing us to actually look for points of contact with investors. Besides, international competition is growing. New Asian and African markets are struggling to get the investors’ attention. As for investors, the global geopolitical and economic turmoil has made them more careful in choosing investment opportunities.
Over the past 10 years, since the first concession project was announced, Kazakhstan has done a lot to attract private investment. We have something to offer investors who invest in infrastructure projects through public-private partnerships.
Kazakhstan has developed a regulatory framework: the Law on Concessions is in effect and has been updated considerably several times (amendments were adopted based on the recommendations of investors and international best practice), the Law on Public-Private Partnership was adopted on October 31, 2015, the Budget Code, the Law on Project Financing and Securitization and other regulations are all in effect ensuring successful legal protection for investors in PPP projects.
Potential investors, as well as public and private partners, will be interested to know what PPP means in today’s Kazakhstan.
Types of PPP
There are institutional and contractual PPPs in Kazakhstan. The former means joint participation of public and private partners in the authorized capital of a newly created venture. The contractual PPP, on the other hand, can be implemented in the following forms: 1) fiduciary asset management, 2) tenancy (lease) of the state property 3) leasing, 4) concession 5) contracts for technology development, prototype manufacturing, pilot testing and small-scale production, 6) life cycle contract, 7) service contract. Other PPP types not listed in the Law “On public-private partnership” can be introduced by industry-specific laws and codes.
Level-wise, PPP projects can be national or local. By the organization type, there are PPP projects where PPP agreements are concluded as a result of: 1) tenders on the selection of a private partner and 2) direct negotiations (without competitive tendering).
The level of guarantees and rights to be granted to investors may vary depending on the project level (national or local) and its nature (social purpose, significance).
Some PPP types can be used for both new construction and reconstruction (e.g. concessions, life cycle contracts). But there are certain PPP types that are not allowed for new construction and are only used for the reconstruction of the property and its subsequent operation (for example, fiduciary management).
Private partner’s rights for PPP property
The scope of the rights which the private partner will have for the property depends on two factors: 1) whether there are any legal restrictions for the disposal of the property 2) what kinds of payments the private partner expects to receive from the government.
Disposal restrictions First, there is property that cannot be conceded. The list was approved by the Decree of the President No. 294 of March 5, 2007. In addition to the recently adopted Law “On public-private partnership,” the list of property not allowed for either concession or PPP projects will be adopted soon.
Pledge in concession: the object of concession may not be pledged or alienated. The rights of the concession holder under the concession contract may not be put in pledge, unless with the consent of the concession grantor.
Pledge in fiduciary management: the property may be put in pledge with the prior written consent of the fiduciary management founder.
Pledge in other types of PPP: The law “On public-private partnership” says nothing about pledging the property, i.e. it does not expressly prohibit to put the property in pledge, leaving these matters to the discretion of the parties to the PPP contract. However, if a private partner in the contract is entitled to ICR (investment cost reimbursement by the government), then the property may be put in pledge only with the consent of the state partner.
Further, there are a number of sites whose disposal is limited by the Civil Code of Kazakhstan due to “strategic value” of the property. According to Article 193-1 of the Code, “strategic property” means property that has social and economic importance to the sustainable development of the Kazakhstani society, whose possession and (or) use and (or) disposal will have an impact on the national security of the Republic of Kazakhstan.
Such property includes: main railway lines, main pipelines, national electrical grid, main telecommunication lines, broadcasting infrastructure (industrial and technological complex of terrestrial and satellite systems for television and radio broadcasting), oil refineries, power generating facilities with the capacity of more than 50 megawatts, national postal service, international airports, seaports of international importance, air navigation and air traffic control infrastructure, devices and navigation signs ensuring marine safety, atomic energy and aerospace industry infrastructure, water treatment facilities, public roads, as well as stocks (shares, stakes) in legal entities owning such strategic property, stocks (shares, stakes) of individuals and entities that have the ability to directly or indirectly make decisions or influence the decisions of legal entities which are the owners of strategic property.
Encumbrance against strategic property from third parties or its alienation is subject to the approval of the government of the Republic of Kazakhstan, where a corresponding permit has to be issued.
Restrictions on the disposal of PPP property are also set forth in certain sectoral laws. Thus, the law “On railway transport” says that construction (reconstruction) and subsequent operation of railway lines under concession agreements is possible, unless these lines are main railway lines. Moreover, the concession holder may only have the rights of ownership and use. Which means that only Build-Transfer-Operate contracts can be signed by the concession holder in respect of the property.
Restrictions due to payments from the government: if under the concession contract the concession holder receives such payments and incentives from the government in the form of ICR, as partial compensation of investment costs for construction, co-financing (to finance the property construction), loan guarantees from the government, government guarantees for infrastructure bonds, then such property can only be provided to the concession holder under the Build-Transfer-Operate scheme. That is, the property may not be owned by the concession holder and must be immediately returned to the government once the construction is completed.
Payments from the state budget and measures of government support
Any PPP project offers the following investment options:1) the private partner’s own funds; 2) borrowed fund; 3) government subsidies in cases stipulated by the laws of the Republic of Kazakhstan; 4) partial reimbursement of investment costs; 5) compensation of operating costs to the extent of maintenance costs for social and essential services infrastructure in a particular industry (sector); 6) fees for managing government-owned property; 7) lease payments for the property owned by the concession holder; 8) availability payment; 9) co-financing.
The government can be an investor in the project in the following ways: co-financing, compensation of investment or operating costs, fees for managing government-owned property, lease payments for the property owned by the concession holder, as well as availability payment. Let’s examine each of these options.
Co-financing is the only way of getting money from the government at the property construction/reconstruction stage. All other payments are made according to the time frame specified in the contract after the construction is completed.
Investment cost reimbursement means that a certain part of the concession holder’s investment is reimbursed, that is part of the property construction (reconstruction) costs. ICR occurs according to the time frame agreed in the contract after commissioning the property. The size of the ICR depends on whether the concession holder achieves the targets while performing its obligations. For example, in case of the concession holder’s failure to fulfill its commitments (not only in terms of the quality of services/goods/works, but also other contractual obligations), the grantor has the right to reduce the next ICR payment by the amount (percentage) agreed upon in the contract. If there are no complaints against the concession holder (in terms of technical and performance characteristics of the property, the quality of services and other contractual obligations), then it is entitled to the maximum amount of the ICR specified in the contract.
Operating Costs Reimbursement (OCR) means reimbursement of a certain amount of the concession holder’s operating costs for maintaining social and essential services infrastructure as part of the concession contract.In the same way as ICR, OCR payments:
- are made after the property is commissioned in accordance with the time frame agreed upon in the concession contract;
- are limited by the total size of concession obligations and the amount established by the law on republican budget (during the year);
- depend on the concession holder’s fulfillment of contractual obligations.
The size of annual OCR payments shall not exceed annual government payments for maintaining (including subsidies) similar property, based on standard rates approved jointly by the Ministry of National Economy and the Ministry of Finance.
Property management fees mean regular payments made in instalments during the period of using the property, provided that the concession holder maintains the property’s technical and performance characteristics. This type of payment is special, because according to the concession contract it is with the help of management fees that the concession holder has the right to compensate losses caused by the onset of the currency risk. Moreover, if the statutory limit of concession commitments is insufficient to cover this foreign exchange risk, the limit has to be adjusted during the budget revision, as stated in the budget legislature. Covering foreign exchange risks with management fees is only possible for projects of special importancewhich must meet the following criteria:
- technical complexity of the concession property (first level);
- the concession project must have a social purpose;
- the concession project will involve state property (existing or anticipated for construction), and/or the concession project will create economic benefits for two or more provinces, cities of national significance, capitals;
- the cost of building (reconstruction) of the concession property is over 4,000,000 statutory minimum rates (in 2015, one SMR was equal to KZT 1,982).
To get all three payments at once (ICR + OCR + management fee) means to receive availability payment. Only projects having a social purpose can have all three payments. Such projects are in the following areas: 1) social security, services and protection of the public, 2) health care, 3) secondary education, pre-school education and training, 4) utilities, 5) transport.
Implementation of these projects should increase the number of institutions in the following sectors:
Ÿ social security, services and protection of the public;
Ÿ health care;
Ÿ secondary education, pre-school education and training;
Lease payments for using the concession property owned by the concession holder include regular payments from the state budget made to the concession holder for as long as the property is in use in accordance with the time frame specified in the concession contract, provided that the concession holder maintains the property’s technical and performance characteristics. The amount of lease payments during the calendar year, just as the above payments, is limited by the size of concessionary obligations and amounts established by the law on the republican budget or decisions of municipal authorities adopting local budgets.
In general, the government’s obligations in respect of the above payments are part of the government’s concessionary obligations, i.e. the concession grantor’s rights and duties for the amount equal to assumed but unfulfilled financial obligations under the concluded concession contracts on a particular date. Without a doubt, the good thing here is that, according to the Budget Code, no budget cuts may prevent the government from fulfilling its concessionary obligations.
The law also provides measures of government support for concession holders: 1) government guarantees for infrastructure bonds under concession contracts; 2) government guarantees for loans to finance concession projects; 3) providing the concession holder with exclusive intellectual property rights owned by the government; 4) providing material grants in accordance with the legislation of the Republic of Kazakhstan (for example, providing a land plot for free use); 5) co-financing of concession projects; 6) government guarantees for consuming a certain amount of goods (works, services) produced by the concession holder, in case the government is the main consumer.
However, the law limits the size of certain types of government support and sources of funding: the total size of payments which have to be made according to tendering terms and the contract (ICR + co-financing + exclusive rights for the concession property + material grant + government guarantee for a loan + government guarantee for infrastructure bonds) must not exceed the value of the concession property.
As you can see, among all the above types of payments only ICR is part of the availability payment that normally has to be made in PPP projects in the health care sector.
Also, land plots are often provided as material grants. Therefore, if the land is provided to the concession holder as a material grant in addition to ICR payments, the total size of ICR + material grant must not exceed the value of the concession property. OCR and other payments, except for those mentioned above, are not limited by the property value.
Lastly, despite the fact that the size of government support and sources of funding have to be specified in the contract, in reality the maximum size of the government support, as well as types and amounts of government funding are determined at the stage of Tendering Documentation and Feasibility Study (in case of a one-stage tender), or in Tendering Documentation (in case of a two-stage tender). After that, the state partner (the tender’s organizer) sticks to them during the tender.
Head of PPP practice at Colibri Kazakhstan