December 2013

On March 13, 2013 the Government of the Russian Federation initiated a draft federal law “On the bases of private-public partnership in the Russian Federation”, which is now at the edge of being considered by the Russian Parliament in the second reading. The draft law creates a favorable legal environment for implementing PPP projects and leaves opportunity for an individual approach to structuring each PPP project. It is a significant step toward implementing effective mechanisms for developing infrastructure in Russia. 

Reliable infrastructure is the key to successful development for Russia’s regions and to stable economic growth. Furthermore, the level of infrastructure development is among the main indicators of social welfare of the public. Traditionally resolving such issues is within the powers of state authorities who, unfortunately, are not always efficient when it comes to managing property.

For the last 25 years, the average annual expenditures on building infrastructure facilities comprised no more than 3% of the GDP. Such lack of attention to infrastructure problems has given its negative results: according to a report on the global state of competition prepared by the World Economic Forum in 2012, Russia holds 136th place out of 144 in road quality.[1]

Things are not much better in transport and social infrastructure. According to researcher data, Russia in 2013 holds 31st place out of 142 countries in railroad infrastructure quality, 93rd in port infrastructure, and 104th in air infrastructure.[2]

In addition, Russia is in dire need of education facilities: there are over 2 million small children waiting in line to get into a kindergarten, and in the last 3 years there have only been 750 children’s facilities built, which is a minute number when talking about the whole country.

Therefore, there is now a need for new ways to solve old problems.

As world experience shows, one of the ways to stimulate infrastructure development is to attract private capital and foremost based on public-private partnership (PPP). Though the PPP mechanism is relatively new to Russia, in the last 10 year, experience has been acquired in applying it, in particular when implementing transportation infrastructure projects.

Some examples are the construction of a road junction at the intersection of the Mozhaiskoe Highway with the Moscow Ring Road, construction of the highway between Moscow and St. Petersburg (based on concession agreements), implementation of the toll highway Western High-Speed Diameter in St. Petersburg and the project on reconstruction of the Pulkovo Airport in St. Petersburg (based on regional PPP legislation). In addition, St. Petersburg has experience in creating education institutions based on PPP.

Nevertheless, even though there are a few successful projects, private-public partnership in Russia still remains rare and has not gained broad application, with one of the main factors hindering PPP growth being the absence of due regulation for PPP on a federal level.

Current PPP laws in Russia

As of now, the only legal instrument regulating PPP relations on a federal level is the federal law “On concession agreements.” This law provides only for one form of PPP, when the concessionaire (private investor) creates or reconstructs the subject matter of the contract and transfers it to the concedent (public partner), with subsequent operation of the facility for the contractual term (Build – Transfer – Operate). At the same time, the law limits the potential objects of concession agreements to, for example, roads, transport facilities, utility infrastructure systems, health care and cultural facilities, etc. The law does not allow use of concession mechanism in other areas.

The main drawbacks of this concession scheme are strict requirements concerning the content of concession agreements and the procedure for holding tenders. Furthermore, the said law was adopted without due account for international PPP practice, and some of its provisions make it rather difficult to attract financing as it is less interesting for private investors.

It is also worthwhile to mention that despite the existing shortcomings of this federal law, Russian legislation on concession agreements is constantly undergoing improvement. The concession agreements law was amended in April 2012 to be more in line with global practice as well as to provide for development of concession projects involving roads and relevant structures and in May 2013 to attract private investments into the residential utilities sector.

Nevertheless, the said amendments do not resolve all the issues.

Unlike federal authorities, state authorities on the regional level hold profound interest in PPP mechanism. As of the present, approximately 60 regions of the Russian Federation have elaborated and adopted their own laws regulating PPP. However, regions are limited in their capability of law making, therefore only further development of federal legislation will result in PPP becoming a fully-fledged mechanism.

Current obstructions for implementing PPP projects in Russia

Close analysis of the largest PPP based projects in the Russian regions reveals the following key risks, which can be mitigated only on the national level:

• PPP agreements concluded in accordance with regional laws can be reclassified to concession agreements or state contracts and as a result, either be voided in full or certain provisions could be disputed.
• Legislation in effect does not preview procedure for provision of land plots adapted for purposes of PPP projects. At present, in addition to the PPP tender, a separate auction for lease of relevant land plots must be held.
• Antitrust legislation sets mandatory need for holding tenders for transfer of right to possess and/or use state or municipal property to private entities.
• Flaws in the tax legislation as pertains to taxation of the private partner’s activity in the course of implementing PPP projects.
• Current laws concerning state budget do not provide grounds for the public partner to take on and execute financial obligations under a PPP agreement,

The above problems substantially decrease interest in PPP mechanism for implementing investment projects.

At the same time, there is positive development as PPP law is being elaborated on the federal level. Draft federal law “On the bases of private-public partnership in the Russian Federation” (hereinafter the “Draft Law”) initiated by the Russian Government on March 13, 2013 was drafted by competent federal authorities in collaboration with regions and municipalities, which have experience in implementing PPP projects. In addition, leading legal and financial consultants, international experts and representatives of business community were invited to express their opinion.

Main points of the Draft Law

The main benefit of the Draft Law is that it creates a legal environment that is favorable for implementing PPP projects without burdensome regulations and leaves opportunity for an individual approach to structuring each PPP project. The Draft Law is of a framework nature and establishes the basic principles for interaction between public and private partners. It is aimed at removing current restrictions and at expanding possible forms for implementing PPP projects.

An obvious benefit of the Draft Law is that it does not limit use of PPP to any specific areas and neither sets restrictions on the possible PPP forms. Besides the list of obligations of the parties given in the Draft Law is non-exhaustive, which affords flexibility in structuring and preparing specific investment projects.

The Draft Law also establishes the opportunity to enter into so-called direct agreements – trilateral agreements between the public partner, the private partner and its creditors, with such agreements determining the mutual rights and obligations of the parties in the event the private partner does not fulfill or unduly fulfills its obligations to the public partner or to creditors. The Draft Law does not contain any restrictions in respect of such agreements, which gives the parties to the PPP agreement and the financing organizations a reasonable share of freedom in structuring their relations.

Another achievement of the Draft Law is that there is clear delimitation of powers between the Russian Federation, its regions and municipalities when participating in PPP relations. Regions are allowed to independently adopt legislation that sets procedure and principles of their participation in PPPs, which decreases the risk of signed agreements being disputed, as well as the risk of PPP laws being adopted beyond the powers established by law.

It is also worthwhile to mention that the PPP projects already in progress based on regional laws will not be adversely affected if the Draft Law is adopted, since the latter establishes that agreements signed before its entry into effect shall be implemented on the initial terms. At the same time, regional  laws will need to be brought in line with the national law.

The Draft Law also provides for relevant amendments to relevant federal laws. In particular, land legislations is amended with provisions under which land plots for PPP purposes can be provided without holding a separate auction. Amendments shall be made to antitrust and procurement legislation.

All said demonstrates growing interest in Russia toward stimulating investment relations between state authorities and private investors, and up to positively affect PPP development in Russia.

Though in the course of elaborating the Draft Law, the lawmakers have attempted to use a multi-faceted approach to resolve issues tied to implementing PPP mechanism into the Russian legal system, yet it appears that the proposed changes may not enough to resolve all the problems.

Thus, it might be needed to introduce amendments in laws governing certain institutions (privatization etc.) as well as particular industry branches, for example, the federal laws “On auto roads and on road activity in the Russian Federation …,” “On appraisal activity in the Russian Federation,” “On heat supply,” and so on.

To sum up, despite the described flaws of the Draft Law, the Russian Parliament (the ‘Duma’) considering the Draft Law is making a significant step toward positive change and implementation of effective mechanisms for infrastructure development. Adoption of the Draft Law will ascertain legal status of PPP agreements, which will increase interest of private investors, including foreign ones, for participation in PPP in Russia.