Study on PPP Legal & Financial Frameworks in the Mediterranean Partner Countries

Title: Study on PPP Legal & Financial Frameworks in the Mediterranean Partner Countries

Language: English

Type: Document

Nature: Agreement, Case Study

Published: January 1, 2024

Region: Middle East and North Africa (MENA)

Country: Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia, West Bank

Keywords: PPPs by Topic *, Financing and Risk Mitigation **

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Document Summary:

Study on PPP Legal & Financial Frameworks in the Mediterranean Partner Countries

Document Details:

Purpose and structure of the Report

This is Volume 1 of the Report which is the product of a FEMIP (Facility for Euro-Mediterranean Investment and Partnership) Trust Fund Study analysing the legal and financial frameworks for Public Private Partnerships (PPP) in each of the Mediterranean partner countries. The definition of PPP for the purposes of the Report is a partnership between the public and private sectors pursuant to a long term contractual agreement and covering the design, construction, financing and ongoing operation and maintenance of an infrastructure asset. These projects are project financed, i.e. lenders take project risk and are mostly concerned with cashflows generated by the project for the payment of the loan applied to construction of the asset and with the assets of the project, rather than relying primarily on the general creditworthiness of the private sector sponsors.

PPP is a viable option for the Mediterranean partner countries

It is clear from the Study that PPP can provide, in many of the Mediterranean partner countries and sectors, a cost-efficient means of delivering infrastructure projects, with appropriate risk transfer for the benefit of the public sector. A key advantage of well structured project financed PPPs, as opposed to traditional procurement methods, is the project discipline they create. Most Mediterranean partner countries already have had some success with PPPs and others are preparing to introduce structural reforms necessary for PPPs to work. There are, however, a number of conditions which need to be satisfied and PPP is not suitable for all projects. Careful selection and delivery of projects in the context of a well understood and appropriate legal and regulatory and financial environment is essential

...And their progress along the PPP maturity curve is varied

Historically Algeria has developed a successful PPP model for water desalination and has a track-record in IPP procurement. However, relying on its hydrocarbon income, the country currently has a policy of procuring infrastructure through alternatives to PPP. While Algeria is preparing to implement a major and sustained investment programme, it does not currently actively encourage international participation.

The successful close of the New Cairo Waste Water project (NCWW) in Egypt indicates the potential for future PPP procurement. While the capacity of domestic banks to fund PPPs is limited, government support and a PPP enabling environment (including a recently enacted PPP Law), make Egypt a potentially vibrant PPP market, capable of attracting foreign investment in sectors such as waste water, transport and healthcare.

Israel has a successful track record of PPP projects developed across a number of sectors by various procuring authorities. Projects have been implemented in the roads, light rail and desalination sectors. This, combined with a sophisticated domestic banking sector with a track-record in PPP lending and the capacity of the Israeli government to commit to PPP payments, make Israel a mature PPP market.

Successful procurements and project financings of recent high profile projects in Jordan (such as the Queen Alia Airport project) have demonstrated the potential for future market development. Jordan has established PPP-specific central government institutions and is in the process of enacting a PPP law. Projects are currently under procurement in the power, roads and rail sectors. A test for the new institutional framework will be how successfully it selects and scopes future projects.

Lebanon has adopted elements of a pro-PPP policy at official level with attempts to enact a PPP law to institutionalise PPP as a procurement option. Lebanese banks could have PPP lending capacity but they as well as government institutions, lack experience of PPP. This is because there is no PPP project precedents to date in Lebanon to draw upon.

Morocco has a track-record in delivering concession based projects where the user/demand risk is carried by the private sector. The procurement of availability-based PPPs has built on that existing track-record and has successfully maintained the interest of local and international investors. Although additional support is provided by several infrastructure funds, the market would benefit from a more unified approach at an official policy and institutional level (particularly with regard to a central PPP unit and PPP specific legislation).

Syria has taken initial steps to create a PPP friendly environment. However, there is as yet no practical PPP experience in Syria. So far only two foreign currency earning privately operated port projects have been developed and no PPP (or concession-based) project experience which includes the financing of construction currently exists in Syria. The country has recently tendered its first PPP in the power sector (Al Nasserieh), and has prequalified 16 bidders which is a sign of success. Without sufficient local bank capacity, the initial phase of Syria's PPP programme is likely to be debt funded in foreign currency primarily through IFIs and Export Credit Agencies (ECAs).

Tunisia has a history of user based concession projects and a potentially attractive environment for PPP investment. While the domestic banking sector has limited capacity, long-term foreign currency funding may be a viable option for funding the projects currently being proposed in the water and electricity sectors. A stronger strategic direction with the role of PPP placed in the context of wider infrastructure priorities would benefit the development of the market in Tunisia.

The West Bank has no project financed PPP experience or programme, as infrastructure development relies predominantly on grant-funding. Although there are some positive signs of private-sector participation in the procurement of infrastructure, political stability and institutional development are prerequisites to the development of a PPP market.

The political developments in 2011, affecting a number of Mediterranean partner countries, are likely to cause investors to be cautious regarding PPP opportunities in those countries, pending clarification of their outcome. These political aspects and their consequences are outside the scope of the Report. This Volume discusses how the PPP frameworks in the Mediterranean partner countries could be further developed to meet infrastructure needs and facilitate increased use of the PPP model where appropriate for the country to do so.

PPP makes new demands on the public sector

The selection of appropriate projects for development as PPPs requires an understanding of the features of, and environment required for, a successful PPP project. This may be based on experience gained within a country, but also from wider experience in other countries. Volume 3 looks at the PPP experience in England, France, Mexico, Poland and South Africa (the comparator countries). A common feature for all countries is that PPPs make new demands on public servants, as skills are needed to specify outputs, to understand complex financial structures and to allocate and manage risks in the most efficient manner. In most comparator countries this has been, or is being achieved, by the creation of a central PPP advisory unit which draws on that experience and understanding of best practice. The Report draws upon such track record and provides concrete recommendations for such units to be established and appropriately resourced with particular challenges in procurement experience in different countries demonstrates that PPP procurements must be structured so as to:

• clearly identify the output required by the authority;

• be transparent;

• rely on evaluation criteria which recognise the complexity of the authority's requirements.

Such an approach should encourage greater competition amongst a wider range of suppliers and should therefore help improve quality and deliver competitive prices. While principles of good procurement practice apply equally in 'traditional' procurement, they are still more important in a PPP. The procurement of a PPP project draws together the skills of designing, financing, constructing, operating and maintaining complex infrastructure assets. Private sector providers take the risk of not being paid until an asset is ready (and reduced revenues if there is a shortfall in performance). For this reason, issues often left open in 'traditional' procurements need to be

finalised before PPP contract signature. Box 1 below left identifies some different procurement practices in Mediterranean partner countries. and also challenges capacity in the private sector.

The development of skills within the private sector – amongst sponsors, contractors and banks – will also be important. Where international organisations are participating in a PPP programme, there may be natural transfer of skills but formal training programmes should be introduced to ensure understanding of the project finance discipline within the private sector and to ensure that the public sector takes due account of market capacity, appetite and concerns. Market soundings are needed at an early stage after project identification and project pipelines/programmes should be designed with a view to attracting both domestic and international bidders and investors, to stimulate competition and improve value for money or cost-efficiency of the project.

Legal change will often be required

The complexity of PPP projects, the interface requirements and the entrusting of private sector organisations to help deliver a public service have meant that most, if not all, countries which have successfully developed PPP programmes have changed their law to help achieve this. While it has been the practice of some countries to develop PPP projects on the basis of preexisting laws (usually concession laws), experience in the comparator countries suggests that a PPP programme will greatly benefit from the introduction of clear laws which enable PPP contracts to be entered into which are effective in delivering the expectations of the market and are flexible to accommodate changes in market practice. Box 2 provides some examples of Mediterranean partner countries who have changed or are changing their law.

Box 1: Bidding processes in the Mediterranean partner countries To enable the procuring authority to achieve a specification at the desired price, it may be appropriate in some instances (for complex projects or projects in which there is no established track record of similar transactions) to enter into discussions with the bidders. This is in contrast to procedures whereby bidders are requested simply to bid against predetermined contracts. The process of discussing solutions during a procurement process helps the authority to fine-tune its requirements and identify the solution that presents the best value for money. Amongst the Mediterranean partner countries, there is varied practice in the approach to bidder participation during the procurement process. Box 2: PPP laws in the Mediterranean partner countries The majority of the Mediterranean partner countries are civil law jurisdictions. Israel is not an exclusively civil law country and has no specific PPP law but PPP procurement is relatively advanced and has not been hindered by the absence of PPP In Algeria and Morocco, the procurement procedures do not permit the procuring authority to hold structured discussions simultaneously with rival bidders. By contrast, discussions with bidders are permitted in Israel and Egypt. In new areas / sectors of PPP, the ability to discuss project specific issues with the bidders will help the public sector to learn from the expertise of the contracting community. On the other hand, a restricted approach (where there is no active discussion) may be more appropriate where PPPs are relatively developed in a sector, contracts are standardised and issues are understood by all parties. Tender evaluation approaches will also impact value for money that is derived by the procuring authority from PPP procurement and again, there is varying practice amongst the Mediterranean partner countries. In general, a two-stage process is adopted whereby technical submissions are evaluated first and if they pass, the financial offer will be considered and the lowest price will win. This could distort the evaluation process by making the technical offer a mere filter. It is therefore important that the pass criteria are carefully considered and sufficiently robust. An alternative approach could be to evaluate the bids on the basis of the “most economically advantageous tender” (or similar) which relies on allocating weightings to different aspects of the bid, thus enabling authorities to place emphasis where required for the project in question.

Dispute resolution mechanisms must be fair

Furthermore, any legal system should provide an effective, transparent and impartial forum for the resolution of disputes with the experience of resolving complex commercial differences. In many cases the preferred forum will be arbitration operating under international rules although in some comparator countries, arbitration under local rules (England) or Court decision (France) are the norm and lenders' legitimate requirements recognised.

Experience of both successful and unsuccessful projects in the comparator countries and some of the Mediterranean partner countries shows that there are certain key features of a PPP contract which the legal framework should permit. These include:

• absolute clarity as to an authority's legal power to enter into the contract;

• the ability of the Project SPV to grant effective security over its assets, shares and revenue streams;

• the ability of funders to step into the project and rescue it;

• payment of appropriate compensation on termination;

• the ability of the State to guarantee the contractual obligations of a contracting authority, should this authority not have sufficient creditworthiness on a standalone basis;

• certainty as to contractual rights (including liquidated damages and termination rights).

The appropriate laws exist in most of the Mediterranean partner countries although developing standard contract approaches would improve a country’s ability to achieve required objectives.

Risk allocation is central to PPP

Any contract must allocate risk and experience demonstrates that the temptation to allocate too much risk to either the private or public sectors, when they cannot properly manage those risks, will not provide best value for money or costefficiency and may lead to project failure. Worldwide, the project finance PPP market is well enough established for there to be a good deal of certainty about how key risks are allocated in successful PPP projects. These international norms should be applied in the Mediterranean partner countries in order for successful PPP programmes to be established and maintained with a focus on the management of risks by those best placed to do so.

Not all risks the private sector partner cannot control should be allocated to the public sector. Thus, where an event occurs outside the private sector's control, it could be fairly compensated (in time and money), by defining principles such as "relief events" or "compensation events" in the contract or identifying relief which the parties agree should be available in the event of the application of the civil law concept of "imprévision" (economic rebalance). The private sector partner can often manage its risks through insurance – for this reason, the availability of insurance on commercial terms is a key requirement for an active PPP market. Related to this, the public sector should take great care before conceding unnecessarily wide definitions of force majeure in PPP contracts – again, international standards and norms are a useful guideline here but specific regard should be had to insurability.

The payment mechanism underpins risk transfer

While all PPP projects place the risk of performance largely on the private sector partner, the allocation of demand risks and the payment mechanisms to remunerate the delivery of an output or service vary. There are two basic types of payment mechanisms: availability based and demand based. The availability based mechanism has been used in the comparator countries in many sectors. In this system, the public sector and there may be important sectoral differences in what is appropriate.

Box 3: Dispute resolution in Mediterranean partner countries In the Mediterranean partner countries, contracting authorities should consider using international arbitration as this is likely to be a key requirement for foreign investors and lenders. They will seek to be satisfied that the ultimate dispute resolution forum is able to deal with the complexities of PPP contracts. To date, project contracts in Algeria, Morocco, Jordan and Tunisia have selected international arbitration (under rules such as International Chamber of Commerce (ICC), London Court of International Arbitration (LCIA) or United Nations Commission on International Trade Law (UNCITRAL)). This has encouraged international private sector sponsors, contributing to increased competition during bidding. In Israel and Egpyt, the more common approach is to make disputes subject to domestic arbitration. In Syria, international arbitration has been identified as the preferred final resort of dispute resolution. If PPPs are to be pursued in Lebanon and the West Bank, it is recommended that international arbitration rules apply to the contracts. specific legislation. The other countries, where the legal tradition is to rely on written laws, would benefit from a specific PPP law if PPP procurement is a priority. The recent enactment of a PPP specific law in Egypt and initiatives to introduce PPP laws in Jordan, Lebanon and Syria reflect this approach. PPP laws should address key issues such as procurement processes and the ability to issue sovereign guarantees if/when needed, to cover the contracting authority's payment obligations, and further detailed regulation can be in the form of secondary regulation (for example, implementing decrees to detail procurement procedure stages and time periods), but laws should not “over-legislate” by providing the detail of matters that are typically set out in PPP contracts where they can be more finely attuned to the particular transaction. Morocco and Tunisia have “concession laws”, but their applicability to PPP projects where the private sector does not take demand risk lacks the certainty which international funders are, as a rule, likely to seek. Should these countries wish to continue pursuing alternative PPP models (i.e. those based on availability payments), introducing clear laws applicable to these structures will benefit investment as they will provide greater certainty as to the ability of the public sector to make payments during the operational phase of a project. Given the relatively early stages of PPP in the region overall, the enactment of PPP laws can be a means of demonstrating political commitment to PPPs. However, this is not essential where the current legal framework is clear and comprehensive and has proven itself to work in practice (as is the case in Israel, for example).

It is more common for demand risk to be taken in the transport sector although in many cases the authority provides a minimum payment guarantee thus absorbing all or some of the demand risk. Most of the Mediterranean partner countries have experience of procuring independent power projects using capacity/availability payments where output is purchased at a specified tariff per unit with long term purchase agreements to provide security of revenue flow. Availability payments have also been usual in a number of Mediterranean partner countries, notably in the water treatment and desalination projects in Algeria, Egypt and Israel.

How projects are funded will also impact on risk allocations

The capacity and depth of capital markets in most of the comparator countries permit projects to be funded in local currency (with the exception of Polish projects which tend to be funded in Euros (EUR) and the earlier Mexican projects which were funded in United States Dollars (USD)). However, in the majority of the Mediterranean partner countries (other than Algeria and Israel) local currency capital markets are not sufficiently deep to fund a substantial portion of potential PPP programmes. As a result, in most cases and especially for larger projects, PPPs in the Mediterranean partner countries are likely to have to be funded predominantly in foreign currency, with the procuring authority absorbing exchange rate risk. This is mainly due to the difficulty for the private sector to hedge this risk in the market at a reasonable price. However, having foreign currency denominated debt, such as in EUR or USD, interest rate risk can be transferred to the Project SPV which can hedge this risk in the market. Domestic inflation risk (on the domestic cost element of delivering the services during operations) is likely also to remain with the authority, since bidders and investors see this risk being outside their control, being primarily a macroeconomic or policy-determined variable.

....with use of international funding sources (especially from international financial institutions (IFIs)) bringing benefit of knowhow.

Box 4: Exchange rate risk allocation in PPP – general principles: To the extent that a project has raised debt or equity funding in foreign currency, the authority is likely to have to bear exchange rate risk in the payment mechanism in order to maximise costefficiency of the project. In such cases, project payments (other than to cover any local currency costs or local currency funding share) need to be adjusted for exchange rate variations, either by denominating project payments directly in foreign currency, or through indexation of payments in local currency. In all Mediterranean partner countries, there is no market in which the Project SPV can hedge local currency exchange rate risk for the duration of the project. Bidders and lenders will see this risk as outside their control, being a largely macroeconomic or policy determined variable, particularly when exchange rates are centrally managed or controlled, as is the case of many Mediterranean partner countries.

The international project finance community has considerable experience which can be applied to assist in developing optimal funding structures and risk allocations, and in transferring know-how to domestic financial institutions. IFIs and ECAs act as important catalysts for attracting other funders to support projects, since their rigorous requirements regarding open procurement, economic viability and risk evaluation, help create confidence in the creditworthiness and robustness of the projects.

And it is clear that some changes will be needed to make PPP an effective delivery method.

The viability of PPP in many Mediterranean partner countries can be enhanced so as to improve the delivery of infrastructure to meet social and economic needs by concentrating on relatively few key requirements. These would most notably include: • the development of local financial markets so that local funding is sustainable (alongside foreign currency lending);

• the establishment of clear PPP laws which meet international norms;

• the establishment of institutions to develop best practice, ensure consistency and ensure a pipeline of projects as part of a sustained programme;

• the development of an approach to risk allocation which ensures value for money for the public sector by allocating to the private sector only those risks which it is best able to manage;

• addressing lenders' requirements for security packages and protection of their investments, for example by permitting and recognising lenders' step-in rights and providing sovereign guarantees of authority obligations when there are concerns regarding the latter’s creditworthiness.

The key to an effective PPP project is partnership, in which both the public and private sectors recognise their shared interests. A well-designed, comprehensive project that is part of a wider country strategy; transparent and competitive procurement; and balanced contract risk allocation are all crucial factors for a successful PPP project.

For more PPP lessons, please visit PPP Benefits and Risks / Lessons Learned

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Updated: October 13, 2024