In Reform Index focus: will the concession breathe life into the neglected infrastructure?

Before talking about the innovations of the Law, it is necessary to define the basic concepts. There are many myths surrounding the concession mechanism, the main one is the following: “Concession is a hidden privatization”. Just as the state is going to sell critically important infrastructure – roads, stations and ports.

In fact, Article 30 of the Law clearly states that the project transfer into a concession does not presuppose the transfer of ownership to the concessionaire. After the expiration of the contract, the object is returned to the principal owner – state or local community. 

Moreover, even the newly created (built) by the concessionaire property is a state or a communal ownership within the terms of the agreement. 

So, the concession is definitely not about the selling. The law defines it as a form of public-private partnership, which confers the right to the concessionaire on creation (for example, building or reconstruction) and management of the object, as well as the provision of socially significant services.

Put in simply, an investor gets a state-owned object into service, for example, road, port or station, invests money in it and then makes a profit.

There are two basic models of concession in the world: user-pay, when the users of a certain object pay money the concessionaire, and government-pay, when the state pays money. The first one is applied to high-margin (high-earning) objects, such as ports, and the second one is applied to social infrastructure.

What was before?

The concept of concession is not something new for the Ukrainian legislation. It first appeared with the adoption of the Law about Concessions in summer, 1999.

But over the next 20 years, no large-scale project of such a partnership has been realized in Ukraine. Why did it happen? 

It is easier to understand it in a specific context. The first concession agreement was signed in Ukraine between Ukravtodor and the Transmagistral consortium for the building of the Lviv-Krakovets road in December, 1999. The project had to be funded by the user-pay model: with the establishment of payment points for drivers. 

At the beginning everything was well: the concessionaire performed design work, resolved land issues, held a tender to select a contractor. But then Transmagistral needed to raise funding.

And there it turned out that the whole business model of the project was based on a contract clause, according to which the state had to compensate the investor for losses for non-achievement of expected traffic. Such mechanisms did not exist in the legislation at that time, so the guarantee was essentially void. After all, the creditors refused to provide the loan.

Another defect of that Law was the lack of clear definition of who exactly and in what order can initiate a project of concessions.

In theory, the executive and local authorities had to do that, but as a rule they had neither specialists for technical preparation of the project, nor the appropriate motivation.

The new law aimed to eliminate those defects and create new incentives for investors. Let’s try to see what its know-how is.

What has changed?

One of the strategically important norms of the  Law 2019 was the transfer of most of the operating risk to the concessionaire. This means that if the project is not cost-effective, the state will not compensate the investor for its losses.

Another fundamental innovation is that not only the public authorities, but also private legal entities, that are interested in partnership, can be the initiators of it now. They can develop a feasibility study of the project at their own expense, but then they still have to participate in the tender with other participants.

It was for the first time when the law detailed the conditions of such a competition. In particular, the possibility of holding a tender with the help of an electronic platform was envisaged. That norm was supposed to come into force on October 1, 2020, but was postponed by the deputies till January 1, 2022 due to the lack of funds for the developing of the necessary electronic system.

The Law also clearly defines the criteria of evaluating the tender bids. They include:

• internal rate of return (profitability of the project);
• reliability of financing mechanism;
• cost of investment;
• amount of possible state support.

And about the state support. The law offers quite bevy of its tools:

• purchase of a certain amount of goods or services, that are produced (provided) by the concessionaire;
• supply of goods or services necessary for the contract performance;
• building of related infrastructure facilities. For example, railways, highways, communication lines, heat, gas, water and electricity, utilities, etc. 

Another type of state support is described in detail in the section of the Law about the concessions for the building and road usage. This is a “fee for readiness “. It stipulates that the investor will reconstruct the road at his own expense and keep it in good condition, and for this he will receive payments from the state by a fixed rate. If the road does not meet quality standards, penalties will be deducted from the amount of payment.

Moreover, the concessionaire will receive payment directly from the drivers. Its secific amount will depend on the contract terms, but it cannot be higher than the maximum rate approved by the Cabinet of Ministers (determined in euros – individually for motorcycles, cars and trucks).

Guarantees for the investor

The law would guarantee compensation for investments and losses (ie, lost profits) for the investor if the contract was terminated due to the fault of the state partner. Instead, the 1999 law guaranteed lost profits only. 

Any disputes related to the contract may be resolved in international commercial arbitration – if the relevant term is included in the concession agreement.

The norm of Article 32 is undisputedly positive. It stipulates that the land required by the concessionaire for the project must be formed before the establishment of a contract, and the state partner covers the expenses on the land management documentation. In particular, the formation of the land involves determining its area, boundaries, size, and entering information about it to the State Land Cadastre. The establishment of a contract automatically guarantees the cession of this land to the concessionaire. 

Individual rights are provided for lessees of state and communal property. They can transform their lease into a concession without a tender, by concluding a direct contract. The main condition is that the concession term should not exceed the lease agreement term.

Guarantees for the state

According the new law, the state also receives additional guarantees for the successful realization of the project. In case of repudiatory breach of the contract by a private partner, the concessionaire has the right to find a new partner.

However, this only concerns those projects for which funding has already been raised. In this case, the state partner applies to the creditor, and within 180 days the creditor looks for a new concessionaire (investor) who could take on all the rights and obligations under the contract. An additional contract is concluded with such an investor, and there should be no changes or deterioration of the original contract terms in an additional contract. 

The law defects

Despite the numerous advantages of the Law, experts are talking about a number of disadvantages. For example, only legal entities, the residents of Ukraine, can become the concessionaires. Foreign companies have the right to participate in the tender, but to enter into a contract, they must establish a representative office in Ukraine.

The provisions of Article 36 of the Law, according to which the concessionaire may have special or exclusive rights related to the implementation of the project, are problematic. However, the Law does not clearly define what these rights are.

Another defect is about the environmental impact assessment procedure, that every project should be reviewed. According to the law, such a project assessment happens AFTER signing the contract. This may lead to the blocking of the existing concession contract because of “the environmental considerations”.

There is the greatest risk in the Article 36 of the Law. According to it, the state must apply to the investor the current law from time of the contract establishment. This is a logical norm, that is aimed to ensure stable rules of the game.

But the guarantees do not cover changes in the legislation on issues of “defense, national security, peacekeeping and environmental protection”, etc. Considering that these items can be interpreted very extensively, in fact, the investor is not insured against negative changes in Ukrainian legislation. 

The first fruits

The grant to concession of two seaports Olvia (for 35 years) and Kherson (for 30 years) became the first practical consequence of the Law signing for the state. Under the terms of the contract, investors assure that they will invest UAH 3.4 billion and UAH 300 million, respectively. The Ministry of Infrastructure has the following plans: to put other ports out to tender in the next 4 years – in particular, Chernomorsk and the passenger complex in the Odessa port. This is in line with international practice, as 94 of the world’s 100 largest ports are in a concession. 

The concession of roads is also a priority for the government. The potential investors were provided with a portfolio of 6 roads with a total length of over 1,300 km (Kharkiv-Dnipro-Zaporizhzhia, Boryspil-Poltava, etc.) in October, 2020.

The Ministry of Infrastructure plans to grant 7 railway stations, including Kyiv-Pasazhyrskyi station to consession. The concession of airports, for example, Lviv airport, is also planned.

The world experience

The practice of concession agreements is extremely widespread in the world. 1,749 such agreements were implemented just in the European Union at a total value of 336 billion euros between 1990 and 2018. Probably the most well-known example of a concession is the English Channel Tunnel, which is operated by Getlink company.

India modernized its largest airports with the help of private investors, Turkey built hospitals, Brazil built schools, and Palestine organized waste processing. Public-private partnership projects are supported by the World Bank through the International Finance Corporation (IFC) at the international level.

Conclusions

The new concession law can help to attract investment to Ukraine, but the critical condition for this is the functioning work of the justice system. Let us recall that the Kherson port, one of the first concession projects, was almost at risk of breakdown because of a court decision. In the end, the tender was unblocked in the Supreme Court. But considering a general non-reforming of the justice system, it can be expected that the beneficiaries of corrupt practices of state properties will continue to try to prevent the independent investors.

Thus, the reform of concession legislation (as well as any other legislation) cannot be considered separately from other structural changes in the Ukrainian economy and public administration system.