Market Know-How: Reviving Concessions

A sphere where the scheme could be applicable is the housing and public utilities sector. For the time being, the government is struggling to raise funds barely necessary to maintain the worn-out utilities system in a more or less working condition (let alone, overhaul the sector) by pushing up the rates continually and, thus, triggering protests by ordinary Russians who have every right to complain they are being overcharged.

Concessions in Russia

In the years 1922 to 1927, when Russia was pursing the New Economic Policy, or NEP, the country received over 2,000 concession offers, of which nearly 10% were accepted. Several thousand enterprises in the European part of Russia operated under concession agreements, mostly in heavy industry and the energy sector. Concession holders contributed to implementing the historic GOELRO plan for nationwide electrification.

The idea of concessions was revived in Russia more than a decade ago. A draft law on concessions was submitted to the State Duma (lower house). Sergei Yashechkin, board chairman at the Eurasian Water Partnership, recalls that the draft came into being at a time when the country urgently needed radical steps to overhaul its transport and housing infrastructure. But each of the industries involved in the work on the draft law “began to rewrite the bill to suit their own ends”, says Yashechkin, and the parties concerned failed to agree on the concept. The bill was shelved for many years.

A new draft bill “On investment agreements in the public utilities sector” was submitted to the lower house in 2004, as part of the package of bills aimed at building an affordable housing market in this country. The bill tentatively approved in the 1st reading focused on involving private investors operating and developing municipal housing and utilities infrastructure, engineering work and development of plots of land allotted for housing construction. The bill never made it to the second reading, however, as MP Georgy Boss suggested that instead a large framework, legislation governing concessions in all sectors of the economy should be elaborated and adopted.

In the year 2005, a new draft law on concessions appeared. That bill, says Dmitry Khomchenko, head of the Municipal Economy project at the Institute for Municipal Economy, differed greatly from the initial variant of 10 years ago but was not applicable to all spheres of economy, focusing only on 14 spheres, to which private investors would be granted access. Those included roads and transport infrastructure, sea and river ports, airfields, waterworks, public utilities, etc. Nevertheless, the law “On concession agreement” was promptly adopted by the State Duma in July 2005, shortly before the summer break.

“Not all of the provisions initially stipulated in the law on concessions in 1995-1996 (an analogous law was passed by the RSFSR Supreme Council as far back as 1993 only to be vetoed by the president of the RF) were included in the final text,” Khomchenko says. “On the whole, perhaps, that was for the better, although certain issues were disputable. In principle, the move to pass the law can be considered an act of political will because debates on each disputable provision could have continued for years.”

Meanwhile, the government needs to take urgent measures to tackle the mounting problems in the housing and public utilities sector. Vladimir Germanenko, deputy head of the Federation Council budget committee, puts the cost of the project at 3 trillion rubles. “Local self-governing bodies were given a free hand in the housing sector,” he says. “As a result, for nearly 15 years we have put nothing into the sector.”

Yuri Tyrtyshov, deputy chairman of the Federal Construction and Municipal Economy Agency (Rosstroi), believes that in the future the federal government should let private investors take over the financing and maintenance of the sector.

Investors, however, responded to the new legislation by saying that the move pursued ends of a political, rather than an economic nature. “The government’s intention to have private investors involved in the sector remains more a slogan than a legally valid offer,” says Yashechkin. “Private firms will not benefit from that law. That is why if the government plans to earmark some funds for the development of housing and public utilities, we will appreciate it. If not, we will continue to work on our own as we did before.”

“Some laws set targets that are too far out of reach for those who have to enforce them,” says Konstantin Aprelev, member of a working group for the nationwide project ‘Affordable and comfortable housing for Russian citizens’. “Not all municipal authorities, for example, are ready to enforce the law on concessions as they should. Moreover, not every municipality takes an interest in the law. Creating incentives for officials is a challenge and, as a result, there are still no necessary instruments for enforcing the law.”

The Russian government has still not approved model concession agreements, which means that even if some company expresses a readiness to sign a deal, it won’t be able to do so as nobody knows how such contracts are to be written in the first place. Yet, this is hardly the biggest problem. “That is a technical problem, it can be solved,” says Khomchenko, “although the procedure of securing approvals from various government agencies is quite time-consuming. What is important is to prevent abuses and find a balance between the interests of private investors and the government.”

Investors and lawyers, for their part, doubt that the adoption of a model agreement applicable to all sectors can help solve all the problems that may arise. “Such an approach is rather mechanical,” Yashechkin is convinced. “You cannot apply the same scheme to every industry. How can transport concessions compare to those in the water supply sector? Elsewhere, a concession agreement is a special contract signed by the parties.”

The main drawback of the law, holds Yashechkin, is that it deals with individual assets, not with a set of measures required to maintain the entire system in a working condition. “In the housing sector it is important to create concessions not for individual properties but for the entire infrastructure. For example, as regards the water supply system, it is vital to develop the entire system, not just a single water plant.”

Vladilen Prokofiev, head of the Competitive Relations Development section at the Municipal Economy Institute, says the main goal pursued by the law is to create incentives for municipal governments to overhaul infrastructure, by forcing officials to get private investors involved in the process. Yashechkin claims the law provides no instruments that will secure the government’s obligation to concession holders.

“The law says that the title to a property built by a concession hold is taken over by the municipality,” Yashechkin says. “It transpires that the government ‘stimulates’ officials to find a pretext for rescinding the concession agreement once the new top-quality facility is completed. What is there left for the investor to do? Listen to the authorities assuring him that they remember him and will pay him as soon as they have money, and… file for bankruptcy?”

The law “On concession agreements” has direct effect, providing, in particular, a detailed tendering procedure. Potential investors believe tender criteria need to be revised. Few countries have legislation regulating the tender process in such detail, experts at the Municipal Economy Institute note.

“Investors are warded off by the enormous amount of data they have to submit for the tender,” says Maria Minskova, a lawyer at Gide Loyrette Nouel. “They are not afraid to divulge that data, no, it is just that the cost of the bid can run up to 30% of the total cost of the project, while there is no guarantee they will win.”

“We welcome transparency,” says Yashechkin. “But for some reason, the criteria for selecting a winner do not include qualification requirements for the would-be concession holder. That is why some obscure fly-by-night firm with a meager capital of several thousand rubles can offer better terms to the landlord, i.e. the municipality, and beat a major corporation with a huge turnover and extensive experience in the field. And no one will ask whether the upstart is able to honor his commitments.”

“Investors are interested in concessions,” maintains Olga Revzina, a lawyer at Gide Loyrette Nouel. “There are companies wanting to work under that scheme. But not under that law.” In her opinion, the law fails to protect private investors. Concession holders are unable to invite the municipality as a long-term co-investor in the project because the municipal budgets are adopted on an annual basis, while a concession agreement is usually signed for a term of 20 years; nor are they authorized to mortgage the conceded property, Revzina says.

Furthermore, as of Jan. 1, 2006 federal law No. 210-FZ on tariff regulations came into effect enabling municipal bodies to set rates independently for investment projects in their locality. The law also sets restrictions on those rates; in certain cases, however, even the maximum possible rates can be raised, and are to be revised annually. Prokofiev believes that the law on tariff regulation has effectively shut down water supply and drainage facilities for concession holders.

Market experts agree that, in theory, concessions are attractive for businesses. “Working under a concession deal is more profitable than, say, under a tenancy agreement,” says Prokofiev. “Concession holders do not have to pay the rent and may charge depreciation costs, instead of, say, withdrawing funds from the profits for further growth. Finally, different tax regulations apply to concessions.” For the time being, unresolved legal issues prevent investors from taking up concessions.

Alternatives

Martin Shakkum, chairman of the State Duma committee for industry, construction and high technologies, told a session of the lower house: “It is good that major companies find ways to evade our laws.” The deputy was referring to the notorious federal law No. 214-FZ “On participation in shared construction…” but he might as well be speaking of any other sector of the Russian economy.

Today, companies interested in concessions are working under lease agreements and additional agreements with local governments. Sergei Yashechnkin explains the scheme as follows: “progressive private operators are building their relations [with authorities] in the framework of existing legislation and the Civil Code, which enables them effectively to do the same, i.e. establish concessions.”

The Eurasian Water Partnership has signed an agreement on strategic cooperation with the city authorities in Omsk, as well as a lease agreement for the local water supply facility and an investment agreement. As a result, the financial situation of the water supplier has improved. The investor assumed the debts of the municipally-owned water supply company of Omsk. By the end of 2005 the Water Partnership had fully repaid the company’s debts, Yashechkin says. The partnership financed the acquisition and installation of new water pumping and electricity consumption control equipment, etc. Last year the company spent nearly 400 million rubles on the project – more than twice as much as the local water supplier had been receiving in previous years.

A similar scheme has been adopted by the company Novogor-Prikamye that has taken over maintenance of the Perm water supply facilities. Mikhail Nikolsky, general director at Novogor-Prikamye, says a concession deal would be far more convenient for the company than a lease agreement, but under the existing law it is impossible.

In addition to the lease deal Novogor-Prikamye has signed a number of other agreements, effectively creating a real concession. “One of the most important documents we have signed is the investment agreement with the governments of Perm and Perm Region, featuring a detailed program for the comprehensive development of the housing and public utilities infrastructure,” Mikhail Nikolsky explains.

He admits, though, that the scheme is far from perfect: “Unfortunately, it is hardly acceptable for our partners and investors, which include major organizations such as the European Bank for Reconstruction and Development. Financiers use the term ‘bankable’. An enterprise is bankable, i.e. fit for financing if it meets a number of requirements. The package of deals utility operators are forced to sign reduces their bankability in the eyes of foreign partners.”

Concessions could prove successful in the transport system, Olga Revzina says. A number of projects for the development of road infrastructure are currently being actively discussed, Khomchenko has reported. The government plans to get private investors involved in the construction and overhaul of the national road system and in the development of toll roads on sections of the Moscow–St. Petersburg motorway, or the outer ring road in St. Petersburg (the so-called Western Diameter Highway). But a law on toll roads has yet to be adopted in this country.