China’s PPP reforms leave investors wanting more

There have been some successes in the two years since China introduced public-private partnership (PPP) schemes, but there have also been problems, including unqualified projects that some local governments used as a front for borrowing.

To regulate the market and give investors more confidence Beijing has issued a series of rules in the past six months, ranging from stricter requirements for projects included on a national PPP database to guidelines on monitoring projects and resolving disputes.

However, for some industry experts these don't sufficiently address core investor concerns, which centre more on having greater clarity around questions of ownership and better legal protection when things go wrong.

Despite some earlier individual projects and trial programmes, PPP was officially ushered in China in June 2015, when the central government issued a set of rules to allow private entities to participate and invest in public infrastructure and utility projects, including energy, transportation, water resources, environmental protection and municipal services.

The market has since grown fast. As of end October, there were 6,806 planned PPP projects in China, with total investments estimated at Rmb10.2 trillion ($1.53 trillion), according to a national database compiled by China Public Private Partnership Center (CPPPC) under the Ministry of Finance (MoF).

But it's not been without its hiccups as some local authorities used PPP inappropriately, creating some unease within the finance ministry and a public rebuke just 18 months later.

Institutional investors

Local institutional investors have been encouraged to participate in PPP schemes. For example, the China Insurance Regulatory Commission (CIRC) started allowing insurance companies to invest in PPP projects in July 2016. It issued a circular again on May 4 this year to encourage insurers to support the development of the real economy, including PPP projects. 

As of end August, China's insurance companies had allocated more than Rmb4 trillion to support the construction of “big real-economy projects”, CIRC said. 

But overall the PPP market is still dominated by state-owned enterprises (SOEs), with third-party private-sector developers and investors accounting for just over one third of all demonstration projects as of end-June, according to a Moody’s report published on October 23. Demonstration projects are what CPPPC showcases to promote best PPP practices.

So it would seem that the authorities are proceeding with caution, wary of allocating resources inefficiently and exposing insurers to undue risks at a time when local governments' access to alternative sources of funding is being curtailed. 

CIRC issued a set of guidelines on May 5 that narrowed the PPP projects insurers could invest to those in the PPP project database compiled by National Development and Reform Commission (NDRC) or MoF. It also specified that they should be key projects at a provincial or national level and involve contractors who were industry leaders, had credit ratings either AA+ or higher and publicly issued bonds in the past two years. 

The fiscal expenditure accountability borne by local governments must also have been written into their annual fiscal budgets and the return mechanism must be reasonable and able to generate stable cash flows, the guidelines stated. 

“Taking the risks into consideration, indeed, we have to rule out many choices,” a senior executive at a major Chinese insurer in Beijing told AsianInvestor, on condition of anonymity.

Nagging concerns

To further address investor concerns, three government entities—the Legislative Affairs Office of the State Council, NDRC and Minisry of Finance—jointly issued a consultation paper on July 21 on how best to improve PPP regulations. The draft covers five major topics including project requirements, origination, implementation, regulatory monitoring, and dispute resolution, Moody’s summed up in a report.

But the new guidelines and thrust of the consultation don't far enough around the issue of ownership and downside protection, the Hong Kong-based head of insurance research at an investment bank told AsianInvestor on condition of anonymity. 

“The ownership is a bit unclear in China, especially after the construction starts to operate,” she said. The ownership relates to various rights such as the decision-making power. 

For example, take a tunnel project: if it doesn't fare as well commercially as expected after completion, would private investors be able to raise tolls? Under Chinese PPP arrangements that's not at all clear, the executive said. 

In contrast, in Hong Kong, insurance companies would be more easily able to invest in such projects as members of the project company because they would benefit from more specific terms and conditions, such as more autonomy on pricing for the first few years of a project's operation, she said. 

Getting greater downside protection is also key for PPP investments because they are very long-term investments and things can change a lot in that time. “How can insurers actually protect their rights if things go sour?" the executive asked. "Can they go to the court for example to sue the local governments?” 

Such misgivings are echoed in the October report by Moody’s in which the rating agency said the private sector was being held back from participating in Chinese PPPs because of the lack of a well-defined legal and contractual framework that could effectively govern the risk allocation between regional and local governments (RLGs) and project companies.

There is also lingering uncertainty over whether RLGs would honour their commitments to meet their contractual obligations over a long project life.

The silver lining is that the proposed regulations in July would penalise RLG leaders if they reneged on their PPP duties. This new enforcement mechanism may help provide more confidence to long-term investors in PPP projects, Moody’s said.