Baker & McKenzie: The Status of PPPs in Russia

For many years governments throughout the CIS have been welcoming public-private partnerships. However, comparatively few projects have been implemented and there is little evidence of projects being successful throughout their full lifecycle.

Max Gutbrod
partner

Baker & McKenzie
+ 7 495 787 2700

Public-private partnership (PPP) is seen as a solution not even so much because of the scarcity of public funds, in particular not for those CIS countries where years of substantial budget surpluses have not been invested in a decaying infrastructure.

Rather, the driving force for welcoming PPP seems to more be the perception that business would be better able to manage complex projects than government and that because big business is seen as being close to government, the seamless implementation of PPP projects seemed likely. Indeed, governments have a quite impressive record of maintaining existing infrastructure throughout the very difficult years before and after the demise of the Soviet Union, but they typically have not been too good in dealing with novel challenges.

This has been compounded by practice confirming that it is technically even more difficult to formulate a PPP than direct investment. This has resulted in PPP projects foundering not because of any ideological issues but because the bureaucracy in areas surrounding the projects proved too dense and often outside the direct remit of the body trying to institute a PPP project. The following examples, all drawn from our experience, highlight the difficulties:

- In the context of working with a ministry to set some parameters for toll roads, we were asked about risks that, in international practice, would have been dealt with by properly formulated contracting standards, and it transpired that the standards for road construction that the ministry was using were primitive. Evidently the ministry, which is not directly responsible for road construction, would have had to overcome substantial resistance to not only implement standards for structuring PPP projects, but also revise current contracting standards, and in the absence of such standards there was little guidance for establishing parameters for the road to be built in the toll road project.

- As the standards for education and acceptance of private money by institutions working in education keep changing, the stability required for private investment does not exist.

- As seems to be the case in Russian universities, in museums very few of those in leading positions are younger than 60 and aware of all the options for fruitful interaction with business. Whilst existing collections have been maintained, the treasures of Russian culture and their unique history seem to be much less open to globalised tourism than elsewhere. A characteristic example: it is little known that the Pushkin Museum, a couple of years ago, made available a collection of impressionists that had been hidden in depots throughout the Soviet years. This collection is of a quality similar to the one from the NY Museum of Modern Art that lead to long queues when displayed in Berlin. Much to the pleasure of those in the know the Pushkin collection is much less crowded than comparable displays in the Jeu des Paumes in Paris, the entrance is difficult to find, the museum shop has some very erudite Russian works but little easily accessible international literature, and the cafeteria compares very unfavorably with the general standard in Moscow nowadays.

- There seems to be a lack of efficiency in serving consumers of water. However it is hard to quantify this as there is no systematic measurement of the quality of service and efficiency in using water resources, either in the internal corporate governance of water supply companies or in tariff regulation. As a consequence the access of new entrants to the market is problematic, and the use of resources that are likely to play a major role in the future is not effectively managed in day to day practice.

- When working on proposals for better use of a National Park we were faced with resistance to any kind of restructuring of the use of the territory, for instance by concluding lease agreements with restaurants and excursion enterprises that could ensure investment and compliance with the highest environmental standards. As a consequence, the existing buildings in the park continue to decay, state rules limit the uses they can be put to and the park provides comparatively few options for recreation to the population of the neighboring city.

- When structuring investment into a harbor, we were told that the municipality in which the harbor was located was to have a substantial shareholding in the proposed project. We argued that the project required financial resources that far exceeded what the municipality could attract.

When we proposed that the harbor management company should hold the real estate required for the harbor and its transport links, we were told that the transfer would be too cumbersome and time consuming. As a result, a management company was founded that had little capital of its own and, despite having renowned bureaucrats in its management, does not seem able to progress and the project has virtually been at a standstill for years.

- When asked to develop a program for investment zones we were instructed to find a solution at least equivalent to what had been done in other countries. We focused on rules that would allow the government to use standards similar to those of private investors, and created parameters and incentives for long term development of the respective sectors with the relevant legislation recently being adopted.

- Whilst highly vertically integrated companies typical of the Soviet economy have suffered most throughout the crisis and, at least in the automotive sector, are clearly recognized as being outdated, there seems to be little effort undertaken to systematically find solutions for the social problems that are a logical consequence of their vertical disintegration. In similar situations in many countries, for instance, in the former steel regions in Germany, the government takes a major role in ensuring the transformation of the economy, which, in Russia, could be linked to decreasing the dependence on raw materials. Whilst Russian regions are thinking about introducing special legislation in this regard, because of the limitations of budget and procurement legislation they are unlikely to have the room for action required to become active in this process.

- In order to promote energy efficiency, the focus of the Russian government has been on energy service contracts the intended effect of which is to fund modernization by a decrease in energy consumption. Whilst this seems to streamline the investment process from the perspective of energy consumers, it adds to the complexity of the relevant contracts because the long term allocation of risks such as theft, changes of technical and environmental standards, maintenance shortfalls, tariff regulation relating both to raw material and the energy produced has to be dealt with in the relevant contracts.

These complications are not insurmountable, but rather add and will continue to add to the complexity of projects. The complexity is also not decreased by the emergence of many know-how centers and proposed (and indeed introduced) legislation on various subjects at the federal, regional and municipal levels, because these tend to focus on describing the existing problems rather than instruments to solve them. The first airport PPPs have shown that the fragmented competencies can be overcome. Airport PPPs are comparatively simple because they are based on existing infrastructure and, for them, finding a balance between investor interest and social protection by tariff regulation is not so much of a challenge.

The structuring of the Skolkovo project is an attempt to overcome the structural weaknesses of previous investment zone legislation. Nevertheless, the Skolkovo project has a number of structural weaknesses which are being dealt with by the investment zone legislation referred to above. Whether this legislation in turn will be successful will become clear only after many years, discussions about the lessons learned and evaluating the effect of economic cycles. By way of example, the German government introduced many measures to support the economy in Eastern Germany after German unification. Most of those measures were structured in a very professional manner. If nevertheless one would hesitate to call the Eastern German experience successful it was rather because of shortfalls in economic vision. It is interesting that generally the transparency of the economy and the economic vision is rather better here than in the Germany of those days.

All of this reinforces the point that only time will increase the ability to structure complex projects, and it is to be hoped that such projects will not only be successful themselves but will also bring stability for investment at large.

Baker & McKenzie

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