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Legal aspects of international transport related infrastructure projects in the METR Region
Olga Revzina, Partner, Herbert Smith Frehills Moscow
This article addresses key current transport development trends in Russia. These Russian trends are being compared with the situation in the rest of the METR region given the unique position and role of Russia in this area.
1. VITAL NEED FOR HIGHWAYS IN RUSSIA AND DRIVERS FOR PPP GLOBALLY
Being the largest country in the world, Russia clearly needs a developed road network. Geographical conditions and unique territorial characteristics are essential drivers for the development of transport accessibility in Russia. Moreover, the existing Russian motorway network was mainly constructed in Soviet times and is therefore a technological inheritance of the 20th century. Today Russia is facing an acute need to build new roads and reconstruct existing ones which comply with modern regulations in terms of environment, safety and quality.
Given the vital need to develop a motorway network in Russia, Russian public authorities have recently taken a step toward administrative reform. In particular, in 2009 the Russian government introduced a new authority responsible for the motorway sector – the State Company "Russian Highways" ("GK Avtodor") in addition to the existing Federal Agency "Rosavtodor" ("Rosavtodor"). The mission of GK Avtodor is to form and develop Russia’s national high speed highway network, highway infrastructure and highway services, as well as attracting investment via the Public-Private Partnership ("PPP") mechanism. In fact, both authorities are responsible for developing the highway network, but each concentrates on a different aspect: Rosavtodor largely works on developing and reconstructing existing motorways, while GK Avtodor is mainly focused on constructing new toll highways, primarily in the European part of Russia. This split of work is not absolute and is flexible, but reflects the current situation.
Generally, the attempt to develop administrative structures which better promote infrastructure problem–solving, has been a common world-wide trend. In this context, similar state companies responsible for a particular part of the overall infrastructure development process have been established in some countries. By way of example, in 1982 the Austrian Republic established ASFiNAG (short for "Autobahnen- und Schnellstra?en-Finanzierungs-Aktiengesellschaft" which is German for "Autobahn and high way financing stock corporation") a publicly owned corporation focused on planning, financing, building, maintaining and collecting tolls for the Austrian autobahns.
In an increasingly competitive global environment and in the aftermath of the global economic crisis, governments around the world are focusing on new ways to finance projects and build infrastructure. This is where PPP is becoming a popular tool to bring together the strengths of both sectors. Recently, PPP has also come to play an important role in developing highways in Russia. Whilst it is recognised that project procurement through PPP may be contractually more expensive than the implementation of projects carried out via traditional means of procurement, certain advantages make a strong case for concession-based PPP.
First of all, private sector financing of essential infrastructure needs relieves the pressure on budgetary requirements allowing Governments to spread expenditure on expensive project out over time and thus releasing currently available resources for other purposes. This mechanism can also be very helpful where there is a budget shortfall accompanied by an existing social demand on a particular infrastructure unit. A good example of such a project is the construction of Motorway 8 in Greece, a 215 km road connecting Athens with Patras. One of the main reasons for choosing a PPP scheme was the desire to procure the project without increasing the country’s sovereign debt. Moreover, most regional PPP projects in Russia have been delivered in the context of a budget shortfall.
Another advantage of PPP lies in the commonly recognized ability of the private sector to tackle inefficiency and respond more effectively to user demand. This is so, because the private sector is usually in a better position to provide greater levels of expertise and efficiency when constructing and running infrastructure projects than the public sector. Reasons for this increased efficiency include greater innovation, a commercial approach to problem solving, better governance, improved competition and more efficient management. Furthermore, the whole life-cycle approach assists in selecting the most efficient solution for the long term, rather than the cheapest solution in the short term. The private sector also imposes discipline on projects, through the motivation to make a profit, and ensures that project implementation – even for large-scale projects – is speeded up. As a result PPP offers increased value for money and presumably a higher quality of motorways along with greater certainty of outcome. For instance, the expansion of the A1 highway between Hamburg and Bremen, which is considered to be the largest PPP project in Germany, was completed after only 49 months of construction - three months earlier than originally planned.
Finally, although PPP always represents a large item of expenditure, it constitutes off-balance sheet financing which does not influence a company's credit history and allows it to keep debt to equity (D/E) and leverage ratios low. This is the reason why a significant number of PPP projects contemplate the establishment of a special purpose company which consolidates the assets of the investment companies (such as Project Y in Austria and the Western High Speed Diameter in Saint-Petersburg).
Best foreign practices confirm the belief that PPP delivers a higher quality of motorways and it has already proved itself in Russia. The debutant greenfield road project was a concession in the Moscow region for the construction of the M-1 Odintsovo bypass. The concession was granted by GK Avtodor in 2009 and the toll road was successfully launched on 1 January 2014.
2. OVERVIEW OF CURRENT PROJECTS IN RUSSIA – MOVING TOWARDS GLOBAL METR TRENDS
The need for new infrastructure ensuring transport accessibility is common to all METR countries. Yet the scale of the projects needed is diverse given the different geographical conditions and technological level of existing infrastructure.
For instance in France and Spain, both the railway and road sectors are developing fast. In the Middle East, the predominant position belongs to the rail sector. In Russia, the road sector is currently most significantly underdeveloped.
Generally, local points of infrastructure development are concentrated in large cities and their suburbs (Paris, Brussels, Moscow, Saint-Petersburg, Abu-Dhabi, Istanbul), especially where the need for alternative routes to decrease heavy traffic problems is high. At the same time, public and business communities in Eastern and Western countries also demonstrate a deep understanding of how to improve transport accessibility within the country. For instance, France has established a high-quality and large-scale system of railroads across the state, Turkey has been actively promoting the construction of bridges which significantly reduce the length of journeys between its cities (eg the Gebze-Izmir motorway project).
In Russia, the pipeline of highway projects looks impressive and promising. Below we consider some large-scale highway projects.
Rosavtodor is implementing a federal concession project to construct an all-Russia truck tolling system (similar to the German one) that integrates Russian Glonass space navigation and cell networks to monitor the distance travelled by lorries over 12 tones and applies charges based on mileage. The project has crossed the PQ phase, although the bid submission date has been postponed several times so far. We also note that there are talks around restructuring this major project.
GK Avtodor runs three major PPP projects, namely the M-11 Moscow-St. Petersburg Highway, the M-4 Don Highway and the Moscow Central Ring Road and is about to start some new projects.
On the M-11 Moscow-St. Petersburg toll highway project the most recent tender was for a concession to construct sections 7 and 8. The launch of the operation is scheduled for the beginning of the 2018 FIFA World Cup, for which Russia was chosen as the host country. The M-4 Don highway project involved road development, the creation of bypasses and the implementation of tolling systems.
Another project currently being run by GK Avtodor is the construction of the Moscow Central Ring Road, which is a toll road encircling Moscow and its outskirts.
The Moscow government has also recently launched the first inner city concession project for the construction of the Kutuzovsky avenue toll bypass which is intended to improve traffic circulation in the central part of the city. The shortlisted tenderers were announced in May and the winner should be decided in September.
Finally, a widely discussed greenfield project that has recently become one of the key infrastructure targets for the Russian Government is the construction of the Kerch Strait Bridge. However, it has not yet been decided whether the state will appeal to private investors, or whether use of the bridge will be free.
As a general note, toll roads are still largely criticized in Russia, but this is no doubt one of the problems inherent to any developing PPP market. Russia is only now taking its first steps toward such a phenomena and it will take a certain amount of getting used to. At the same time, the number of on-going toll-road projects clearly demonstrates the willingness of the Russian authorities to develop in the direction set by other developed METR countries.
The majority of highway projects are still focused in Moscow and the Moscow region, however there is a promising tendency that PPP will be rolled out to other regions with some major deals – both geographically and legally. Recently, commercial close was reached for a toll bridge project in the Udmurtia region.
3. MARKET CONSIDERATIONS IN RUSSIA – MIRRORING AND OPPOSING GLOBAL TRENDS
As mentioned above, the on-going projects in Russia clearly evidence its intention to keep pace with the rest of the world. However, as is usually noted by research into any phenomena in the country, Russia has its own special path of development.
Fast growth, ambitious strategy, tough deadlines, promotion and application of the PPP mechanism as a tool, all of these factors together hold benefits, but also bring challenges to the scene. We will address some of the issues that have emerged on recent highway PPP projects.
Challenges of the procurement process
Due to the relative novelty of PPP schemes there is a certain gap in the capacity to hold efficient tenders. Both the public and private sectors share the view that the only purpose of expensive and timely procurement processes for tenders is to ensure true competition. In reality, achieving this goal involves facing difficulties. We address some of these below.
• Corporate restrictions on companies in the bidder's group. Tender documents ("TD") for major concession projects usually set forth high qualifying criteria related to the PPP and construction experience of the bidder. In this context, the TD usually specify corporate links that may be used by the bidder to confirm its compliance with such qualifying criteria. In countries with developed PPP markets such links vary flexibly as most PPP projects involve foreign investors who might have relations within their corporate groups that, on the one hand, are of a type completely unfamiliar to a tender-based country, but on the other hand, do not make the companies within the group any less related. In particular, relations within the group may be represented by common ownership, common directorship or any other common source of control.
The problem of excessive corporate restrictions exists within developing PPP markets where a lack of experience on the part of the tender organisers results in their unwillingness to rely on unknown foreign corporate relations.
For instance, TD for large PPP projects in Russia tend to impose restrictions on the test of corporate control and primarily appeal to "vertical" corporate links. Practically, this means that a bidder with a sophisticated corporate chart lacks the legal opportunity to meet qualifying criteria because its corporate links with other companies within its group do not fall within the scope of the TD. Thus, the corporate test implemented by the public sector in Russia for qualifying companies requires adjustments.
However, recent tenders of GK Avtodor clearly demonstrate that the approach is changing and is becoming more market-oriented.
It should also be noted that tenders all over the world are subject to very detailed scrutiny from regulatory authorities. For instance, in the European Union (EU), strict rules for open government procurement apply. In particular, several European Commission (EC) directives deal with public procurement of supplies and works, including in the construction sector. What is more important, is that the EC has authority to impose sanctions for breach of the EU competitive tendering rules in public sector procurement and construction, and, moreover, that it is very active in exercising this authority. The main purpose of such activity is to stimulate competition. For this reason, it is of the utmost importance to comply with the requirements of TD.
• Secondary infrastructure market assets. It is undisputed, that construction and operations experience is critical to understanding whether a project will be delivered on time and within budget and to ensure that the service levels required are met. For this reason, TD always contain requirements as to the experience of a potential private partner, to be evidenced by related documentation. Taking into account the long-term character of PPP projects, this issue may arise when a participant intends to confirm its experience by referencing a project that was sold by it at a later stage of project implementation.
In fact, it is not at all uncommon that at an operational stage, where a newly developed infrastructure asset is substantially de-risked, the initial developer sells the project to a longer term investor. By way of illustration, the European Services Strategy Unit Database records 281 equity transactions in the United Kingdom involving 716 PPP projects between 1998 and 2012. Moreover, the sale of secondary market funds with portfolios of PPP assets is another important way in which ownership of equity in PPP projects has transferred to new owners.
Multiple transactions of the same special purpose company ("SPC") occur for a number of reasons. Firstly, there are usually two or three shareholders in the SPC and all may sell their equity, sometimes collectively, but usually individually. Secondly, shareholders sometimes sell only part of their equity and retain the remainder, or sell it at a later date.
Thirdly, construction companies may sell equity to new infrastructure funds or joint ventures established with financial institutions, such as pension funds, or they may sell equity via the secondary market. Finally, equity may be resold for commercial or financial reasons connected with the parent company. This is why equity transactions in the PPP market are inevitable - this is the normal way of conducting business.
Among the top sellers of PPP equity in the United Kingdom in recent years are John Laing, Carillion plc, Lend Lease Corporation and Interserve plc. For instance, in 2004 Carillion plc sold 50% of its stake in Sheppey Route Limited, a company implementing the A249 Stockbury (M2) to Sheerness DBFO project to John Laing. The other 50% of this project was sold by Carillion plc to Barclays European Infrastructure in 2011. In 2012 Atlantia (one of the largest concessionaires on the Italian motorway network) sold 99.98% of its equity in Autostrada Torino-Savona to SIAS Group (Italy's main motorway operator). This transaction increased the average remaining life of the motorway concessions part of the SIAS Group from 11 to 13 years. In 2010 Aecon (Canada) sold its 25% share in the Cross-Israel Highway to Israel Infrastructure Management, which became the 50% shareholder in the project.
In Russia however, there are clear difficulties in recognising sold projects for the purposes of meeting the criteria set by the TD for qualification, despite the fact that the sale of a project does not deprive an investor of relevant construction experience, especially from a short-term perspective. Therefore, given the developments in secondary and further infrastructure investments, potential bidders should have the right to meet qualifying criteria by referring to sold projects.
• Securing of bidders obligations. Bid security is commonly used in procurement procedures as a protection for the public side against bidders withdrawing their bids prior to the end of their bid validity period or refusing to sign the contract. The amount of such security is usually calculated as a percentage of the budget estimate of the procurement requirement or a percentage of the bidder’s bid price.
Model TD developed in most European countries do not contain a mandatory requirement to provide bid security as the risk of fraudulent bidders is substantially decreased when the PPP market becomes more developed.
The Russian Law on Concessions expressly requires shortlisted tenderers to provide a deposit to secure their obligation to enter into the concession contract. Moreover, there is a tendency for bid bonds to be provided by tenderers at the PQ stage with further security being provided by shortlisted tenderers at the bidding stage.
We note that there is little legal rationale for this requirement, as the filing of an application at the PQ stage does not oblige a tenderer to submit the bid. It is only after the bid is filed that the tenderer becomes obliged to participate in the tender. Furthermore, the idea of securing the tenderer's obligations at the PQ stage actually lacks economic rationale, as preparation for PQ filing is always very time consuming and costly and so the investment of time and money in the application already represents a form of security evidencing the tenderer's good faith.
Finally, a separate problem in Russia relates to the mode of security provided for by the law. In contrast with other countries which usually accept bank guarantees as security, Russian law requires bidders to provide a deposit to the tender organizer. What makes it even more burdensome is that the amount of such deposits are increasingly large, something which automatically limits the number of investors that are ready to divert such funds out of their on-going business.
Obviously, this is just another example of the developing character of the Russian market and another area where we should consider adopting foreign countries' best practices.
• Confidentiality. It is commonly recognised that transparency is an essential principal of procurement procedure. This refers to the openness of procurement policies and practices and especially to the basis for proposal evaluation. For instance, as mentioned above strict anti-monopoly rules have been adopted in the EU. In Russia the principle of transparency has also largely been promoted, for instance by putting in place an all-Russian website which is constantly updated with comprehensive information on every tender and by imposing very strict obligations on tender organizers to make almost every single part of the tender procedure public.
At the same time, it is indisputable that while taking part in a tender bidders are often expected or even required to disclose certain information that may be sensitive to them (such as corporate structure, patents and copyrights) or that could benefit a competitor. So it is highly important for the public sector to ensure the confidentiality of the bid. At first glance, it may seem impossible to combine transparency and confidentiality. In reality, warranted confidentiality is key to a transparent procedure.
For example, in the Netherlands, the EU open government procurement rules have been transposed into even stricter national legislation. In particular, one of the principles expressly declared by the Dutch authorities is the protection of the intellectual property rights of a candidate and warranted confidentiality. As for Russia, current concession tenders lack clarity and certainty as to ensuring confidentiality, which inevitably leads to a certain degree of reluctance from the private side to be fully open with the potential public partner and this also impedes the development of PPP in Russia. There is therefore a need and duty on the public side, not only to maintain transparency but also to ensure the confidentiality of the bid process, where relevant, from the very beginning of the tender.
Infrastructure Investor: who is who
It goes without saying that PPP projects normally contemplate huge technical, intellectual and financial resources. It also goes without saying that all the resources necessary to implement a large-scale project will not be consolidated in one single company. This clearly suggests that PPP is a team game and requires collective efforts and various consortium structures. Therefore, it is of the utmost importance to gather a reliable and competitive team of financial institutions, construction companies and operators.
When this issue arises in a full-fledged PPP market, it does not cause serious difficulties as its key players have already managed to prove their expertise and reliability.
The problem posed by investors' lack of experience in this regard is inherent to infrastructure markets that have not yet fully formed. Unfortunately, this is a real issue for the current infrastructure market in Russia where any form of multilateral cooperation between different groups of investors (banks, constructors, operators, etc.) does not give the appropriate level of comfort. This is because the relevant players are still a little unfamiliar with one another and the investment regime is not adequately well tested. Moreover, investors may also not be fully aware of how to properly meet the TD requirements and this is because the rules of the tender game are not always very clear.
Countries all over the world tackle this problem by setting up independent platforms for the consolidation of qualified market participants. The latter trend revealed itself in Russia – currently GK Avtodor has ambitious plan to establish a National Association of Operators and Investors in Road Infrastructure recently introduced to investors' community. The association will promote the formation of a national PPP market by creating a pool of construction and investment companies willing to provide equity/debt finance and having the organisational, investment and technical capabilities to implement PPP projects in infrastructure.
The benefits of such an institutionalised investors' community are relevant for both the public and private sectors. Such a community will enable the improvement of PPP regulation backed-up by the consolidated opinion and expertise of the business community. In addition, it will help to promote the value-for-money principle and the innovative development of infrastructure.
Financing: the problem of financing sources ("public-public partnership")
Despite PPP's high profile and wide promotion, current Russian large-scale highway projects rely mostly on public funding. Russia faces the problem of the "quasi" private partner. One of the main drivers for PPP is an alternative source of financing. The current problem emerging on the Russian market is that large-scale projects are often funded by state-owned companies which are only formally private entities.
This issue turns out to be inherent at the infant stage of PPP development. There are examples from the early 2000s of European project finance deals that demonstrate this. A good example of such a project is the Netherlands’ HSL-Zuid line linking Amsterdam and Rotterdam to Belgium (launched in September 2009). The project was conducted by a joint venture, 90% of which was owned by the stated-owned Dutch national railways while only 10% was owned by the private side. This is essentially only the appearance of a public-private partnership, which covers relations that are actually closer to a public-public partnership.
Risks: moving towards development of risk allocation standards
Risk allocation is another important governance challenge that both sides of a partnership usually face when negotiating the structure of their relationship. Although every road project is unique and risk allocation strategies may vary from project to project and from country to country, in general, risks that are related to the environment within which the project is implemented should be retained by the government, while the risks that are directly related to the project are mostly allocated to the private partner. Some risks that are beyond the control of both the private and public partners should be shared by both parties.
The implementation of these principles in the real world is, however, very difficult. Recent negotiations of public and private partners in Russia during pre-tender and tender procedures reveal that the potential partners may turn out to be unable to agree on risk allocation and are usually willing to shift risks to the other side. Largely the reason for such problems may be the absence of or little experience in doing PPP projects and thus the absence of a really tested understanding of how the risk materialises and who is in a better position to manage it. That is why it is highly important to be flexible and to attempt to agree on risk allocation as early as possible, as in practice, a later transfer of risk may constitute a deal-breaker for investor. Such flexibility should not prejudice the idea of balance between the public and private partners.
A recent piece of research in the UK conducted by experts in PPP showed that site availability and political risks should be retained by governments, while relationships risks, the risks of legislation changes and force majeure risks should be shared by both the public and private partners. The majority of the remaining project-related risks, risks that are directly associated with the project itself, should be assumed by the private partner. The research also found four risk factors (the level of public support, project approval and permits, contract variation and lack of experience) that could not clearly be allocated to a specific party.
Another issue relates to the proper study of traffic and the related risks which, if they materialise, may give rise to dramatic consequences. The importance of correct risk allocation in PPP was revealed in the debutant M1-M15 private toll Motorway in Hungary, which was also the first fully private funded Motorway to be built in Europe, purchased without a single penny of taxpayers’ money. The project was delivered on time and to budget by 1996. However, the investors encountered difficulties almost right from the start as the expected traffic did not materialise. The traffic projections made by the relevant authority were overly optimistic and the toll revenue collected by the private investors was not sufficient to service the debt. In addition, the timing of the project was unfortunate: a recession, the effect of rapid economic reforms and high inflation all negatively impacted the project. Moreover, the presence of an alternative road, as well as delays at the border, which more than offset the time savings, were major problems. Finally, the road was characterised as the most expensive toll road in Europe which resulted in legal action against the concessionaire to reduce tolls. Many years of protracted negotiations took place and restructuring plans were made, culminating in the nationalisation of the project in 1999. Uncertainty surrounding the on-going court challenge and the general unpopularity of tolls led the Government to choose nationalisation as the most politically expedient solution. Shareholders lost equity and the bank lenders to the project suffered. Even though the tolls were removed, traffic increased only marginally.
There are no hard rules for risk allocation standards. Practice combined with careful analysis gives the answer to the most negotiable question arising between public and private partners – who is in a better position to mitigate the risk?
4. FUTURE OUTLOOK – RUSSIA AND METR
The market particularities and difficulties described above give rise to obvious obstacles in the way of developing Russian road infrastructure. However, more important and notable, is that a closer look at the situation reveals a very solid platform for the successful development of the sector. In particular, this is evident when one assesses the variety of on-going projects and those in the pipeline.
This trend, combined with the boost given to the infrastructure sector by preparations for the 2014 Winter Olympics in Sochi and further growth expected in light of preparation for hosting the 2018 FIFA World Cup, creates numerous opportunities for both the public sector and domestic and international investors.
The need for modernisation and broadening of a road network with improved quality in challenging economic conditions, appear to be the key drivers for the development of road infrastructure in Russia.
Russian governmental agencies responsible for the development of this sector demonstrate constant proactivity, readiness to co-operate and openness for dialogue. The overall positive attitude is supported by a strong project pipeline, in particular for the development of toll roads in the European part of Russia.
The successful completion of construction stages and the gaining of experience in subsequent operation and maintenance activities on major pending projects such as the Western High-Speed Diameter in St. Petersburg, the M-1 Odintsovo bypass and the M-11 Khimki bypass, are expected to demonstrate market readiness for a stable flow of projects. Additionally, the near future should reveal customers' reactions to the developments and their ability to utilise the projects. The Asian part of Russia remains more focused on achieving social goals and the development of complicated territories rather than the implementation of commercially attractive projects, however specific opportunities might be found in this region as well.
The current pipeline includes the preparation of tenders for the construction and operation of several sections of the Moscow Central Ring Road, the continued construction of the M-11 Moscow – St. Petersburg highway, the creation of the first Moscow intercity toll road and the implementation and operation of a global Russian heavy truck tolling system.
Despite the fact that currently the number of players in the market is limited to a relatively small group of investors, financial institutions and contractors, is it notable that both the market and the project pipeline require capable newcomers and the popularity of project pre-launch events demonstrate that the opportunities are unlikely to be left untaken.
Under these circumstances, those who will be able to bring best practices and expertise to the Russian market on the one hand and, on the other hand put forth real flexibility in competing with existing strong players, will reap the rewards and benefit from implementing road projects in Russia.
With stagnancy and project preparation periods in Russia a thing of the past and European road developers and financiers searching for new receptive markets worldwide, Russia's ambitious road development plans reveal challenging and future-oriented opportunities both for private businesses and the public sector.
Similar trends exist in other METR countries. Across the GCC, there are ambitious plans underway to implement the GCC integrated rail project which would link Kuwait, Saudi Arabia, Bahrain, Qatar, the UAE and Oman by rail. Many Middle Eastern countries are also developing their own domestic rail networks. In the UAE, Saudi Arabia and Qatar, the leading countries in rail sector development in the Middle East, some significant projects are already underway. Since winning the 2020 World Expo, Dubai is fast-tracking its metro expansion plans while Abu Dhabi is expected to go out to tender and further work for the Abu Dhabi Metro project this year.
In 2013 Turkey advertised a number of incredibly ambitious infrastructure projects in the lead-up to 2023, the 100th anniversary of the founding of the modern Turkish republic. Some of the most attention grabbing in the infrastructure sector are the Canal Istanbul project, the much-needed third bridge over the Bosporus, an underwater tunnel and a national network of high-speed rail lines.
From the overview provided in this article and notwithstanding differing transport developmental targets in different countries, it is obvious that METR countries are currently focused on the development of internal transport infrastructure based on an understanding of the importance of the benefits that developed transport systems can give and their key role in developing the economy.
Ultimately, the implementation of ambitious projects in this region is likely to boost connectivity in the METR region, demonstrating that historical transport routes maintain their importance and key role, irrespective of the historical period.
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