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China – New Concessions Regime Will Encourage Private Sector Participation In Projects, Says Expert.

21 May, 2015

 

Legal News & Analysis – Asia Pacific – China –  Energy & Project Finance

 

New rules governing concession agreements in China will allow for private sector involvement in a much wider range of public sector infrastructure projects and utilities, an expert has said.

 

The Regulation on Infrastructure and Public Utility Concessions will come into force on 1 June 2015 and replace the existing concession regulation, which only applied to urban utilities, following state council approval. It aims to consolidate and encourage private sector participation in the financing, construction and operation of infrastructure and utility projects, and explicitly applies to energy, transportation, water resources, environmental protection and municipal works projects.

 

Infrastructure law expert Ellen Zhang of Pinsent Masons said that the new regulation left open the possibility that investors would be able to use non-standard concession models or enter into agreements running for longer than the current maximum of 30 years. However, they should prepare for longer discussion with the government to agree  non-standard models in practice, she said.

 

“The regulation lists Build-Operate-Transfer (BOT), Build-Own-Operate-Transfer (BOOT) and Build-Transfer-Operate (BTO) as three main concession models but leaves the possibility for other models that are allowed by the State to be used,” she said. “This ‘catch-all’ is very characteristic of PRC regulations, however investors should not view is as promising that other models can be proposed and will be accepted by the government without challenge.”

 

“The regulation retains the current regime’s maximum term of 30 years but has provided an exception for ‘large scale investment projects’, for which the government and concessionaire may agree a term longer than 30 years. However there are no rules to specify what criteria a project must meet in order to quality as a large scale investment project. Again, investors should be extremely cautious in assuming that longer terms will actually be approved in practice unless there is considerable active, high level central government support for the project,” she said.

 

The Chinese government has announced its intention to promote public private partnerships (PPPs) in certain sectors including transport, environmental protection and healthcare. At a State Council meeting this week, Chinese premier Li Keqiang said that increasing the use of PPP would increase competition, expand the supply of public products and services and provide reasonable returns to private sector investors.

 

The new regulation will allow the public sector to permit a private sector operator to charge fees to end users of public assets, and also allows the government to provide ‘viability gap funding’ to concessionaires on projects that are economically justifiable but struggling to obtain funding. Under article 3 of the regulation, the public sector will be allowed to enter into concession contracts with both domestic companies and those incorporated “outside the PRC”.

 

“This seems to suggest that a foreign sponsor may not need to incorporate a project company within the PRC to enter into the concession contract and undertake the project,” said Ellen Zhang. “However, in practice, there might be practical difficulties for non-PRC concessionaires to acquire the necessary land rights, import equipment and goods and handle taxation. More generally, the fact that the project is a concession will not exempt it from any of the regulations governing foreign investment into China.”

 

The regulation specifically allows the Chinese government to make certain types of commitment to private sector operators. These include non-competition covenants, in which the government would promise not to undertake any “unnecessary” projects that would compete against or otherwise impact on the concession project; covenants requiring the government to provide ancillary services and facilities to the concession; and subsidies. However, government bodies will not be allowed to guarantee fixed investment returns to the private sector operator.

 

“It remains to be clarified what will be deemed as guaranteeing fixed investment returns – would an availability-based payment which shifts the market risks back to the public sector be treated as guaranteeing fixed investment returns? We hope not as the concessionaire still keeps the performance risks of the lifecycle of the project” said Zhang. “Investors also need to monitor the implication of this mechanism – there are risks of cautious government bodies insisting on overly one-sided contracts because of a fear of being seen to offer such guarantees. Investors should seek legal advice on this particular issue sooner rather than later in any process,” she said.

 

Pinsent Masons

 

For further information, please contact:

 

Ellen Zhang, Partner, Pinsent Masons

ellen.zhang@pinsentmasons.com

 

Homegrown Energy & Project Finance Law Firms in China 

 

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