While the deals – the Pulkovo airport, the Odintsovo Bypass and the Moscow-St Petersburg highway – closed and attracted billions of dollars in financing, they were complex and took years to finalise. Their efforts have, to an extent, masked some of the deeper problems that still remain in developing PPPs in Russia. Most ob­viously, there is doubt as whether they would have ever have been successfully procured if they had launched in the current climate.

“The projects to close were all really ambitious but it is worth remembering that they were launched when the economy was stronger,” comments Kirill Ratnikov, the head of infrastructure and PPP at CIS law firm Magi­sters. “I don’t think the government would have launched the tenders if they had been in a recession.”

Secondly, there is such limited risk transfer to the private sector, through the use of government and multilateral lend­ers, and government guarantees, that it is hard to call the deals fully-fledged PPPs. “The deals to close were not the most advanced PPPs. They did not reach the optimum struc­ture we can expect in terms of value for money, which re­mains a key driver in devel­oping such contracts for both public entities and the private market,” comments Brice Laine, a member of Egis’ business development and finance group.

Lack of appetite

There have been moves to make the legal framework for PPP more robust (see legal box below), but the financing of PPP projects on a fully commercial basis is still tough. The three recent projects spent a long time in the development dol­drums; taking years to tender, award and finance. Worrying­ly, the commercial appetite for funding them was not strong. Indeed, international bank involvement was non-existent.

“The financing for PPPs so far has not really come from the international banking communi­ty,” says Magisters’ Ratnikov. “In­stead, the debt has come mainly from state-controlled entities and that is an indication that the market has not sufficiently embraced PPPs. There were the three big projects that reached financial close in 2010, but it looks like the Russian PPP market has effectively reached capacity. There seems to be very little appetite at international lenders and investors for PPPs in the country.”

The 2010 flurry began with the Odintsovo Bypass in early April, which is now commonly viewed as Russia’s first PPP. The design, build, finance, operate and maintain deal – awarded to a consortium that in­clud­ed Gaz­prom­bank, Stroygasconsulting, Alpine Bau, FCC and Brisa – is for a road linking the Moscow Ring Road and the Moscow Minsk M1 Highway and was financed via government-backed corporate infrastructure bonds and the state-backed infrastructure fund. The Russian government guaran­teed R11 billion ($350 million) of the project’s total cost of R25.6 billion.

It was a similar story for the Moscow-St Petersburg deal, with Sber­bank and Vnesheconombank (VEB) providing a R29.2 billion pack­age, which included R10 billion of state-guaranteed bonds. The deal was awarded to a consortium led by Vinci. The other major project to close in 2010 – the Pulkovo Airport, awarded to a group that included Fraport – attracted a Eu716 million ($942 million) debt package. Once again, VEB led the deal but the financing also brought in a selection of development finance lenders, namely the EBRD, the IFC, the Eurasian Development Bank, the Nordic Investment Bank and Black Sea Trade and Development Bank. So while there is interest from international developers, such as Alpine Bau, FCC, Vinci and Egis, in Russian PPPs, international banks are limiting themselves to financial ad­visory roles and not lending.

“Commercial banks face difficulties in Russia due to the weakness of the economic environment and unbal­anc­ed revenue distribution throughout the country,” Laine ob­serves. “Mar­ket and financing conditions have to be sound enough. Debt maturities have to get longer, certainly. Un­cer­tainty remains about enforcing con­tracts and there needs to be enough stability to encourage long-term finan­c­ings with sophisticated structures.”

The financing issue has already affected other big planned transport PPPs, including the Western High Speed Diameter (WHSD). The $6 billion project was originally awarded in June 2008 to a group made up of Strabag, Basic Element, Bouygues, Hochtief, Egis Projects and Mostoodryad No 19. The deal never reached the financing stage and ultimately was postponed.

“We were part of the preferred bidder group on the WHSD but problems came with the financing,” Laine says. “There was a significant difference between the value of the contract and what was budgeted by the government, which could not be resolved. The financing was the main concern. The risk allocation was not acceptable for the private parties, as the focus was on them to take on more of the risk. This would have raised the development costs even further.”

The WHSD – a 46.6km motorway around St Petersburg – was broken down into different sections and re­tendered in October after its initial collapse. Once again, a state-guaranteed bond is earmarked for financing the scheme.

Other deals have also struggled to close. The Orlovsky Tunnel – a 1km toll tunnel under the Neva River linking Piskarevski Avenue and Smolnaya Embankment in St. Petersburg – was awarded to Vinci (the only bidder) in March 2010 but has gone quiet ever since. The $1 billion Nadzemny Express PPP (Nadex) light train system in St Petersburg was to be procured as a PPP through an availability payment mechanism. A shortlist of five bidders was revealed in 2008 before the deal was sent back to the drawing board. A new tender was launched in March 2010 but then dropped off the radar. The only other major PPP on the horizon is a waste project called Yanino (see Social Infrastructure box below).

The future

There is room for improvement. For all the worries about its framework for PPP, Russian’s economic power is grow­ing. PPPs are, theoretically at least, a great way for governments to deliver important infrastructure off-balance sheet. But with the meltdown in the financial markets, tighter risk allocation re­quire­ments and the still-shaky legal regime in Russia, investing in multi-billion dollar projects in a country with economic and political challenges may not be the most attractive propo­sition for credit committees.

As Russia edges more onto the inter­national stage, the anticipation is that the various legal and financial frame­works will be updated. “I feel positive for the future beyond the short term,” Laine says. “If Russia continues to develop a stronger financial model with a better business environment, and works to establish a more balanced and sound economy then offer the capacity for financing big deals, it can improve.”

Alexander Bazhenov, director of the PPP centre at VEB, believes there is also a PPP role for Russia’s vast pension funds. “Given the amount of funds available in this category of investors we believe the market of pro­jects for pension funds will develop. Current legislation allows Russian pen­sion funds to invest in project com­panies with credit ratings of not less than two grades from the national sovereign rating, and then only if the pro­ject company has three years of audited financial reports. However, there is a second alternative – the financing of concession companies. If the concessions are with the Russian government or guaranteed by Vnesheconombank there is the opportunity tto structure projects that meet the requirements of a good credit rating. In this regard mini-perm deals may also be part of the solution via a combination of pension fund long-term financ­ing with availability of construction financing.

The financings for Pulkovo air­port, the Odintsovo Bypass and the Moscow-St Petersburg PPPs have estab­lished some­thing of a benchmark for Russian PPPs. Even so, without the commercial bank debt, kinks in the legislation and problems with risk allocation, the deals have raised more questions than answers. As long as it remains quiet on the international financing front, Russian PPP may find it hard to deliver on its promising start.

BOX: ??Is the new legal framework for PPP strong enough?

Russia, given its vast size and the legacy of the chaotic post-Communist period, has vast unmet infrastructure needs, but the history of Russian PPPs is relatively short. The post-Communist era left multi-billion dollar investment gaps in vital public services, but international lenders and sponsors and banks have tended to focus on the power and oil and gas sectors rather than infrastructure. As such, the framework for PPPs has been slow to evolve.

“The main barriers [for international sponsors and banks in Russian PPPs] are lack of legal instruments necessary for isolation of project assets, giving full-scale security over project assets and flexible management of creditors’ rights,” explains Dmitriy Sobolev, a PPP specialist and associate at law firm Liniya Prava.

PPPs have only been allowed under Russian law for five years. The Federal Russian Law on Concession Agreements was enacted on 21 July 2005, and allowed assets to be procured on a concession basis in 14 sectors, including roads, rail, pipelines and energy. The legislation, although not governing PPPs per se, established a framework for procuring projects with concessions.

“PPP under concession agreements has many other legal problems specific to this instrument which will require much time and effort to resolve,” Sobolev remarks. “The market participants we know and the Ministry for Economic Development of Russia are more interested in development of legal instruments for project finance transactions in general.” 

The law permitted both build, operate, transfer (BOT) and rehabilitate, operate, transfer (ROT) structures as well as recognised concession authorities, concessionaires, contract periods and payments and a formal tender process. So PPPs have been developed under the same regulations as other project financed assets rather than having a their own framework.

The Concession Law has been tweaked since its inception (with the most recent example being provisions to provide further guarantees of the rights of the concessionaire) but there remains a gap in the PPP framework. Construction, operations, management and sales agreements in Russia would ideally be structured according to project finance market standards and there remains uncertainty about the scope of these contracts. So, despite the heavy involvement of government as lender and guarantor, existing structures still allocate too much risk to the private sector in some areas. “There is still too much allocation of risk to private partners in environmental matters and there is a move towards higher financial involvement of sponsors, specifically by requiring them to invest more equity in projects,” Egis’ Laine adds.

There has been some movement this year to improve the laws governing project liability, largely to protect creditors. A draft law, developed by the government and Liniya Prava, was to be reviewed by the end of December with the aim of becoming a statute in April 2011. Like the previous law, it governs concessions in general but now addresses PPPs. The main focus is on the treatment of creditors when projects default. For example, a new special purpose vehicle, called a special commercial company (SCC), will be introduced. An SCC will be restricted by its initial suite of contracts in the types of other agreements it can sign, meaning that additional agreements with non-project creditors will be secondary, giving project creditors contractual priority over assets. An SCC will need clearance from creditors to change the scope of this initial contract.

Creditors will have greater ability to claim security over a project’s property and moveable assets. Under the present regime, a project’s assets have to be thoroughly outlined in a pledge at the start of a contract. Asset values can change greatly from financial close to project completion and operation. Instead, future asset rights will be described in general terms; making it easier for creditors to assess the real value of assets.

Inter-creditor agreements will be allowed, so creditor decisions will be binding even if one creditor is not in favour of a certain decision, preventing banks from pulling out of arrangements. For the first time, a collateral manager can be appointed by creditors to exercise their security rights and creditors will have security over the cashflows of a project, which can be placed in a dedicated account separate to the special purpose vehicle.

“The draft law eliminates the main barriers for the development of PPPs because it gives developers, creditors and governmental agencies legal tools that are market standard for project finance transactions,” explains Sobolev. 

Box: Social Infrastructure

?The three PPPs to reach financial close were, like many PPP pilot projects, in the transport sector. Payments based on tolls or landing fees tend to be easier to justify than pure availability deals. In Russia, questions remain over the ability to deliver PPPs for schools, prisons or hospitals, for which there has not been a single major project launched. Contracts governing these assets are often more complicated and harder to deliver, especially where they feature complex availability and performance payment mechanisms.

“The burden is still on the government and that will affect the flow of projects into the Russian regions,” Egis’ Laine says. “The transport PPPs that have been completed have taken a long time to close and involved a steep learning curve. Without the support of the financial markets, it will be difficult to extend PPPs.”

The government is not looking to tender very many big concession contracts in the short term and the emphasis will be on making the current deals successful before more projects are undertaken (work was suspended on the Moscow-St Petersburg motorway in August over environmental issues that have arisen during construction). Few observers are confident that a promised shift of PPPs to the Russian regions will translate into the social infrastructure programmes seen in Western European markets. While several regions have taken the lead from St Petersburg and developed their own local concession laws, experts are hesitant that the relative success of the transport deals can be transferred.

“I question whether social infrastructure PPPs will ever happen,” Ratnikov remarks. “For example, there is no legislation that would allow for a prison PPP and the Ministry of Justice would not be very keen. There is some political support but, looking from a professional standpoint, the deals are too complicated and there are not enough legislative and financial structures in place to be successful.”

The closest Russia has come to a social infrastructure PPP was the proposal to develop the $1.3 billion Rosa Khutor Alpine Ski Resort in Krasnaya Polyana as a PPP. The concession is for the development of a sports complex and related hotels in anticipation of the 2014 winter Olympics. As with the other PPPs in the country, VEB was in line to provide the lion’s share of the debt.

Dmitriy Sobolev, an associate at Liniya Prava, reckons that because PPPs made under a concession agreement are optimal for, and usually designed for, debt finance, the structure is only suited to large-scale projects, such as road construction, rather than regional deals such as schools, prisons and hospitals. “Projects in social infrastructure are smaller in scale and usually made under a public procurement contract,” he remarks. “Such a structure is based on budget receivables which can be pledged, along with other property of the project company, as security on flexible terms to raise finance in local or international loan markets.”

The most notable non-transport prospect is the Yanino PPP waste processing plant concession, developed by the St Petersburg government and VTB. The 30-year design, build, finance, operate and transfer concession involves building a 350,000 tonnes-per-year waste processing plant. The tender was announced in November 2009 with three bids – led by: Strabag; Helector and Aktor; and Keppel Seghers Engineering, shortlisted in April. The winning bidder was scheduled to be named by the end of 2010. The likely financing was going to come from a mixture of state-backed debt and the EBRD, which was earmarked to contribute part of the scheme’s Eu200 million capital costs.

Alexander Bazhenov, director of the PPP centre at VEB, remarks: “We see the project pipeline as consisting of few water concessions in major cities, new construction of regional waste management infrastructure, and the provision of utility and transportation infrastructure for industrial parks or new districts dedicated to affordable housing. Most of these developments are in the tender preparation phase.”

There is even hope that PPPs may also spill over into the wider CIS region, because Russia’s neighbours have looked at the structure. A tender was due to launch in late 2010 for the Eu130 million multifunctional national stadium in Vilnius, Lithuania and the $1 billion 301km Almaty-Khorgos road concession in Kazakhstan has recently been awarded to a Impregilo-led consortium, with the concession agreement due to be signed before year-end. A further batch of Kazak road concessions was expected to be tendered during 2011.

“The next step will probably be outside of Russia and into the CIS,” Ratnikov concludes. “Places like Ukraine and Kazakhstan have shown interest in PPPs and that is where activity could pick up.”