The road to success in PPP toll roads - An Asia Pacific perspective

This Article first appeared in CES and was written by Geoff Roberts and Nicholas Brown of Pinsent Masons

The experience of early build, operate and transfer toll road projects has been mixed.  Many such projects, on progressing to the operational phase, were no longer commercially viable.  More creative partnership schemes between the public sector and the toll road concessionaire were required and this is understood to have been at the root of a widespread movement in recent years towards the public private partnership (PPP) model as the preferred model for international toll road projects. 

Clearly the use of the PPP model should not be considered as a panacea that will result in a guaranteed successful project.  The success of a country's PPP programme will depend on the interaction of many other factors including that country's cultural, economic and legislative framework. These other factors are explored below.

Key to using the PPP model is the principle of value for money.  The PPP model is appropriate where the commercial terms underlying the project provide value for money to the procuring government. Value for money will depend to a large extent on the cost of borrowing from the private sector.  Debt is priced based on funders' perception as to the certainty, risk allocation and the long term support for the expected revenue stream.  Evidence to date suggests that those major and complex infrastructure projects with significant ongoing maintenance requirements, where the private sector can offer project management skills, whole-life costing, innovative design and risk management skills, have been the most successful concessions.

In considering the PPP toll road concession model, as applied anywhere, and no less in the Asia Pacific, certain fundamental factors stand out.

Government push

The success of a PPP project is heavily dependant on the support that PPP's in general receive from the procuring government.  Without the necessary support and commitment from the government, the project could encounter difficulties given the significant length of time for which toll road concessions are typically granted (in Asia this ranges from 15 to 30 years).

A government may be reticent in handing over the operation and benefit of the asset for political (including labour market politics) or financial reasons.  Threats along the line, even by opposition parties, to abolish tolls on existing concessions, such as occurred on the Australian State of Victoria's Mitcham-Frankston freeway into the operational phase, do not engender confidence in the sector.

Sustainable rate of return

The concessionaire running the toll road will be looking to make a profit from its involvement in the project. Indeed without a sustainable level of return it would be difficult for a concessionaire to attract the necessary funding. Toll road concessionaires will aim to establish and maintain a financially viable toll road concession in order to maximise this return.  It is of fundamental importance to the success of the project that the host government and the procuring authority understands and accepts this.

This principle should inform all stages of the procurement of the project.  The procuring authority should ensure that tenders' bidding costs are minimised through the use of appropriately drafted invitations to negotiate or expression of interest documents.  This would include the use (as much as possible) of standardised, bankable contracts and commercial and legal guidance, together with reasonable requirements of design development and contractual documentation up to BAFO stage.

Rules of the game

The Project will have to comply with the legislative and regulatory framework in force in the host country.  The public sector must therefore give consideration to the adequacy of its legislative and institutional framework.  Does it allow for concession licences and for all the related road authority powers that will be required to successfully allow the private sector to manage a road PPP?  Are all  potential doubts as to authority vires covered off?  Does it oblige landowners to cooperate in land acquisition? – as does recent Indonesian legislation, presumably in light of the problems on the Veteran-Ulujami stretch of the outer ring road in South Jakarta.

Are the rules of the game adequately transparent to support confidence of investors both in the initial procurement and in any potential secondary transaction?  Take for example the risk of competing facilities, where policies aimed at protecting the financial model through appropriate restrictions, such as those planned under the Indian National Highway Development Programme, are highly desirable. 

Such questions merit high priority at the outset in each country's strategy everywhere, and no less in the Asia Pacific as a poorly developed legislative framework will have a significant impact on market appetite.  This has been the case in Indonesia, where recent legislative changes have increased the attractiveness of PPP Projects, albeit that project financers are likely to remain vigilant when setting foot in the market.

Stable political environment

A number of countries in the Asia Pacific still do not offer a fully stable political environment where the prospect of expropriation of a project road or land user interference could be regarded as slim.  Where there is political instability the market appetite for such projects and their success will likely need to be contractually guaranteed in such circumstances in order to be bankable.

Whilst expropriation and security issues are at the extreme end of the legal and political spectrum, the prospect of changes in law should also be considered.  New laws, particularly in relation to tax, can have an adverse effect on the toll road concession. This will have a subsequent effect on the profitability of the project for the concessionaire.  Recent examples include Australia where reticence to introduce favourable tax treatment to concession projects has slowed overall market appetite.

Contractual issues

The sanctity of the concession agreement is important.  The legal heritage of the host country and any local rules of interpretation can have a significant impact on the success or failure of a project.  Code law countries, in contrast with common law countries, will often have their own contractual or commercial codes which impose superadded obligations into the contract. Some of these countries, such as Mainland China and Vietnam, have recently restated their contract laws.  Additional due diligence is necessary to discover the existence of these codes and the existence of the codes can increase the risk of legal challenge and unforeseen expense. It is therefore most unfortunate that the mandatory law of the host country is sometimes treated as somewhat of an afterthought.

Credit Rating

The credit rating of the host government will impact on the lending terms the need for credit guarantees, and indeed the funding options, and hence the value for money of the project. For instance bond financing will generally require higher credit rating than traditional debt funding.  It is important not to overlook this simple fact and the consequential importance of good economic governance when assessing the underlying viability of a PPP toll road concession.

Tolling structure

When deciding on the tolling structure to be implemented, the political culture of the host market must be considered and reflected.  The political conditions pertaining to tolling in India for instance are quite different to that in Mainland China, and so on.

Analysing countries in the Asian Pacific region leads to the conclusion that the countries are still experimenting with a variety of tolling structures.  Various toll structures including mixed hard and soft tolling, annuity based toll revenue adopted to suit local target markets – all with and/or without government subsidies and often including performance-based claw backs are being rolled out.

In order to achieve consistent revenue generation it is important to note that if hard tolls are chosen, the toll proposed in the financial model should not be disproportionate to economic earning power and disposable income.

Toll Variation

The ability to vary the tolls will be an important issue that must be dealt with clearly in the concession agreement. The circumstances in which the toll road concessionaire may vary (increase) tolls and any current and/or future limitations on so doing, so both the concessionaire and the government can forward plan.

In some markets however, toll variations are controlled by means of public decrees, which in turn are influenced by developing political conditions and processes; witness the five-year freeze on road tariff increases in Indonesia as from in the late 1990s owing to organised political activities of end users.  Although the wider political explanation for these approaches is quite understandable, such criteria for toll adjustments do not engender investor confidence in the development of essential transport infrastructure.

Technical advances

Regarding toll road concessions the Asia Pacific region has mirrored the rest of the international toll road concessions market in witnessing electronic toll collection coming to the fore.  The regulatory framework must of course keep pace with such technical advances to ensure a joined up approach to the key problem of toll evasion.  Like underlying legislation for a PPP framework,  a due diligence exercise focused on the regulatory framework for collections needs to be carried out in each country whatever the region.

Conclusions

The PPP model is a procurement method that is spreading in the Asia Pacific.  In our opinion, the prospects look good for the future. The ultimate success of any project including an international PPP toll road concession will be dependant on a whole host of issues that are specific to that project including the way that it is structured. The issues highlighted in this article should still be considered at the macro level. They will provide valuable assistance, in the first instance, when considering an international PPP toll road concession's chance of success. 

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