PPP projects in water management: Risks and solutions in the Eastern European context Roderick...

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PPP projects in water management: Risks and solutions in the Eastern European context

Roderick MackenzieSolicitorPinsent Masons

Public Private PartnershipsPractical Instruments for Regional Development

Riga21 September 2007

Quotes and Definitions

Quotes and Definitions“A concession contract is never accepted it is tolerated”

Quotes and Definitions“A concession contract is never accepted it is tolerated”Market Profile on Legal ServicesGlobal Water Intelligence – February 2005 (Page 19)

“There is an ongoing need for legal representation in the perpetualstruggle with politicians who want to be seen to gain ground against concession operators rather than complying with theoriginal contract conditions….

Indeed, given the need to build up a defence against this attitude,legal representatives are increasingly considered a “part of theteam” on concessions, where previously they had been moredistinct”

PPP is the art of allocating risk for any given service provision to theparty within a project team most suitably qualified to manage that risk

Public

Municipality

Public

Municipality

Public

Municipality

PublicPrivate

Municipality

Municipal OwnedWater Company

PublicPrivate

Municipality

PublicPrivate

Municipality

PublicPrivate

100% share holder

Municipality

PublicPrivate

100% share holder

Municipality

PublicPrivate

100% share holder

Municipality

PublicPrivate

100% share holder

The Consumer

Municipality

PublicPrivate

100% share holder

The Consumer(The man who votes for the mayor)

Municipality

PublicPrivate

100% share holder

The Consumer

Municipality

PublicPrivate

100% share holderTariff Control

The Consumer

Municipality

PublicPrivate

The Consumer

Bidder

Municipality

PublicPrivate

The Consumer

Bidder

Municipality

The Successful Bidder

PublicPrivate

The Consumer

Bidder

Municipality

The Successful Bidder

PublicPrivate

The Consumer

Municipality

The Project Co(SPV)

PublicPrivate

The Consumer

Municipality

The Project Co(SPV)

PublicPrivate

The Consumer

Municipality

The Project Co(SPV)

PublicPrivate

The ProjectAgreement

The Consumer

Municipality

The Project Co(SPV)

Sponsors

PublicPrivate

Equity

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Equity

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Equity

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

DebtEquity

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

DebtEquity

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

EPC Contract

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

EPC Contract O&M Contract

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

EPC Contract O&M ContractInterfaceAgreement

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

EPC Contract O&M ContractInterfaceAgreement

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

Term – 25 years (for example)

InterfaceAgreement

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

2-3 yr build

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

2-3 yr build 22-23 yr operation

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

Shareholders’Agreement

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

Insurance

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

Insurance

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

InsuranceSecurityBlanket

Municipality

The Project Co(SPV)

BanksSponsors

PublicPrivate

Direct Agreement

DebtEquity

Builder Operator

The Consumer

InterfaceAgreement

InsuranceSecurityBlanket

Any problems?

• The position of the Sponsors in the water sector has already been presented in the quotations at the start of this presentation.

• The Bank is getting anxious about the consumer, his relationship with the Mayor, the tariff negotiation mechanism and the impact on the availability payment.

• But what about the Mayor?

Any problems?

• The position of the Sponsors in the water sector has already been presented in the quotations at the start of this presentation.

• The Bank is getting anxious about the consumer, his relationship with the Mayor, the tariff negotiation mechanism and the impact on the availability payment.

• But what about the Mayor?PPP is the art of allocating risk for any given service provision to theparty within a project team most suitably qualified to manage that risk

The Mayor

• Not looking forward to ongoing negotiation on tariff to support the availability payment

• Constraints on public spending prevent direct contracting of capital works projects

• EU Accession requirements necessitate the proposed expenditure in order to comply with environmental directives

• Typically, any Mayor faces the need to authorise capital works on water and wastewater infrastructure of, potentially €50m to $150m

• Privatisation is a dirty word

The nature of municipal services

• Water is intensely political as a municipal service, not least owing to essential nature of water to life itself

• However, it is not unique as municipal solid waste faces similar challenges (public health, unwillingness of consumer to pay)

• District heating also faces challenges and levels of operational complexity comparable to water and solid waste

• Do nothing is not an option, as the State will be fined by the European Commission at the end of any derogations periods

• Can we find an alternative solution?

The Hybrid Lease

• Hybrid – a cross between two species• Concession form (as previously detailed)• Lease – Common Law real property concept

– Lord Templeman in Street v Mountford [1985] AC 809 at p816

• Exclusive possession (for free use and enjoyment)• for a term (defined period of time)• at a rent

• A similar concept is available in Civil Law• The French water industry is based on lease

mechanisms through the affermage contract

Municipality

PublicPrivate

100% share holder

Municipality

PublicPrivate

100% share holder

Infrastructure Assets

Municipality

PublicPrivate

100% share holder

Infrastructure AssetsPeople

Municipality

PublicPrivate

100% share holder

Municipality

PublicPrivate

100% share holder

Municipality

PublicPrivate

100% share holder

Infrastructure AssetsPeopleRevenue stream

Municipality

PublicPrivate

100% share holder

Massive capex demand

Municipality

PublicPrivate

Massive capex demandImpaired creditworthiness

100% share holder

Municipality

PublicPrivate

Municipality

PublicPrivate

Municipality

PublicPrivate

Landlord

Municipality

PublicPrivate

Landlord Tenant

Municipality

PublicPrivate

Landlord Tenant

Municipality

PublicPrivate

100% share holder

Landlord Tenant

Private Operator

Municipality

PublicPrivate

100% share holderPrivate Operator

Municipality

PublicPrivate

Municipality

PublicPrivate

Municipality

PublicPrivate

Contract?

Municipality

PublicPrivate

Contract?

Management ContractsUseful first step

Municipality

PublicPrivate

Contract?

Operation and Maintenance ContractsLimited transfer of risk to the private sector

Municipality

PublicPrivate

Contract?

Operation and Maintenance ContractsLimited transfer of risk to the private sector

Municipality

PublicPrivate

Municipality

PublicPrivate

100% share holderPrivate OperatorDivestiture?

Municipality

PublicPrivate

Privatisation is a dirty word

Municipality

PublicPrivate

Privatisation is a dirty word

Municipality

PublicPrivate

Lease?

Municipality

PublicPrivate

Lease?

No divestitureShares remain in public ownershipMunicipality has privatised nothing

Municipality

PublicPrivate

Lease?

No divestitureShares remain in public ownershipMunicipality has privatised nothing

A recipe for a happy Mayor!

Municipality

PublicPrivate

Municipality

PublicPrivate

Municipality

PublicPrivate

Assignment of certain rights over shares fora fixed term

Municipality

PublicPrivate

Assignment of certain rights over shares fora fixed term

• Dividend• Right to appoint directors• Right to contract• Right to enter loan agreements

Municipality

PublicPrivate

Assignment of certain rights (possession) over shares for a fixed term

• Dividend• Right to appoint directors• Right to contract• Right to enter loan agreements

Municipality

PublicPrivate

The Lease

Can contain covenants in relation to:

• Creditworthiness• Improvements including capital works

Municipality

PublicPrivate

Assignment of certain rights (possession)Covenants for improvement

Municipality

PublicPrivate

Term – 10 to 15 years

Municipality

PublicPrivate

Term – 15 years

Year 0-3:Creditworthiness

Municipality

PublicPrivate

Term – 15 years

The Cash Injection

Municipality

PublicPrivate

Term – 15 years

The Cash Injection

Vanilla Loan Agreement

Municipality

PublicPrivate

Term – 15 years

The Cash Injection

Municipality

PublicPrivate

Term – 15 years

The Cash Injection

Loan repayment15 years

Municipality

PublicPrivate

Term – 15 years

Builder

Municipality

PublicPrivate

Term – 15 years

Year 3-5Build Period

Builder

Municipality

PublicPrivate

Term – 15 years

Builder

Municipality

PublicPrivate

Term – 15 years

Builder

Municipality

PublicPrivate

Term – 15 years

Builder

Question:What happens now?

Municipality

PublicPrivate

Term – 15 years

Builder

Answer:Depends on the deal struck betweenthe Mayor and the Bank

Municipality

PublicPrivate

Municipality

PublicPrivate

Direct Agreement

Municipality

PublicPrivate

Direct Agreement

Sets out the conditions for Re-Leasingthe property (Company) at the end ofthe term of the first lease on similar termsand to a suitably qualified and competent operator

Municipality

PublicPrivate

Direct Agreement

Sets out the conditions for Re-Leasingthe property (Company) at the end ofthe term of the first lease on similar termsand to a suitably qualified and competent operatorOR repay all outstanding sums.

Municipality

PublicPrivate

Term – 15 years

Builder

Municipality

PublicPrivate

Term – 15 years

Builder

Competition time!(In line with European ProcurementDirectives)

Municipality

PublicPrivate

100% share holderPrivate OperatorRe - Lease

Term – 15 years

Builder

Term – 15 years

Municipality

PublicPrivate

100% share holderPrivate OperatorRe - Lease

Term – 15 years

Builder

Term – 15 years

Subject to existing loan agreement

Why the Hybrid Lease?

• A cross between– a lease contract (for the company); and– a concession contract (for the procurement of capital

works)• There is no privatisation• Dramatic transfer of risk to private sector with

minimal political risk• Similarities between this form of PPP and the

French water industry – a civil jurisdiction with the longest standing municipal service sector engaging in PPP in the world!

Caveats• Clearly, not all companies will be in the right shape to enter a hybrid

lease and simpler forms of PPP (i.e. management contracts) will be required as a first step

• Suitability criteria clearly need to be considered (e.g. population served per employee, ratio between billing and collection) as these issues influence creditworthiness

• There is the need to check primary legislation within any jurisdiction to determine whether assignment of certain rights over publicly held shares is permitted

• Careful consideration is required in relation to which rights over shares are assigned in order to make hybrid leasing work while remaining politically acceptable

• Ultimately dependent on the vires of the Direct Agreement between the Municipality and the Bank

Who’s Happy (1)?

• Bank– Has either an existing loan covered by a new leasing

arrangement or been paid out at the end of the first lease term

• Operator– 15 years happy operation of a utility– Paid by the fee for running the company and by

dividends received on shares

• Contractor– Reduced time for procurement cycle– Deals directly with the utility

Who’s Happy (2)?

• Mayor– Because the much of the political risk associated with

privatisation has been removed– Tariff negotiation risk has been reduced into the

bidding process on Re-lease– The competition for the Re-lease acts as a natural

economic market regulator thereby improving regulation of the market

– The overall cost of procuring a project is massively reduced

Who’s Unhappy?

• Lawyers

Thank you

Any questions?

PPP projects in water management: Risks and solutions in the Eastern European context Roderick...

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