In Re (#1-2 January-February 2021)

Road PPPs and Concessions in Ukraine

by Oleg Matiusha

Despite the pandemic and related economic downturn, Ukraines infrastructure sector was among the economys most active sector in 2020. The Ukrainian government launched the ambitious Big Construction program aimed at the modernisation of the countrys infrastructure, including mass reconstruction of roads and bridges at the state and municipal levels.

The government recognises that an underdeveloped road network negatively affects the countrys transit potential and is associated with sub-optimal economic performance. It is no surprise, therefore, that the Ministry of Infrastructure of Ukraine is looking for ways to improve Ukraines road network by refurbishing, widening and extending existing roads to meet Ukraines economic needs and to capitalise on the benefits of its strategic geographical location.

According to Vladyslav Krykliy, Ukraines Minister of Infrastructure, in 2020 the government directed almost
USD 3.5 billion for the reconstruction of approximately 4,200 km of roads at the national and local levels, which is double the sum in 2019. The modernisation of an additional 6,800 km of roads has been announced among the plans for 2021.

Ukraines State Road Agency, Ukravtodor, currently uses the following key instruments to finance road infrastructure projects:

Financing from the state budget (road fund and targeted state programs);

Financing under state guarantees; and

Loans from IFIs.

However, because of a huge negative balance identified by Ukravtodor between cash inflows and cash outflows, the current model does not allow for the proper financing of planned projects without postponing the modernisation of the road infrastructure for decades. Obviously, in order to finance the countrys plans for 2021 and beyond on the resources of the Ukrainian state budget alone are not enough, and the existing model should be adjusted.

This is an area where project financing, PPPs and concessions are becoming increasingly common and may help the government to implement its plans without increasing sovereign debt, as well as enabling Ukraine to:

Spread out state budget expenses (e.g., the availability of payments to the private partner) over a longer period, instead of paying the contractors in advance and/or immediately upon completion of the construction;

benefit from the private sectors know-how and efficiency and develop Ukraines road construction and maintenance market;

pay for the quality and appropriate condition of road infrastructure, instead of just paying for the completion of roads and accepting all expenses related to its maintenance and operation;

transfer the design, financing, construction operation and management risks to a private partner.

A study conducted by the IFC and the World Bank found that PPP projects could attract about USD 2 billion in road investments from the private sector in the next 3-4 years. Although this wont entirely cover the financing gap identified by Ukravtodor, it could help significantly. At the same time, successful investments in the sector through PPPs would demonstrate the feasibility of that business model and open the door for future financing.

Perspectives

Recently the Ministry of Infrastructure successfully concluded two concession deals in the port sector. The concession of the Olvia port granted to the Qatari company QTerminals, with USD 120 million of investment into the project, became the largest concession ever awarded in Ukraine, the largest investment in Ukraines port sector, and the second-largest foreign investment in Ukraine after the privatisation of the Kryvorizhstal steel mill in 2005.

Understanding all the benefits of PPPs and concessions, the Ministry of Infrastructure of Ukraine has started, with the assistance of the IFC, to prepare six pilot road PPP projects with a total estimated capital expenditure of approximately
USD 1.52 billion. The details of these projects were recently published at
www.roadppp.in.ua/en/.

Ukraines PPP management office SPILNO should, in cooperation with advisors and the IFC, prepare the feasibility studies, structure the projects and prepare the tender terms and documentation during 2021. However, from the Ukrainian law perspective, the projects will most likely be structured as BOT (build-operate-transfer) availability-based PPPs under output-based and performance-based road contracts. Under such a model, the major part of the demand risk stays with the public party, which should be attractive for investors.

Considering the statutory terms established by Ukrainian law, the discussed projects may realistically be prepared and tendered not earlier than 20222023. In order to give an opportunity for investors to compete for several projects, tenders may start with a lag of 69 months.

Regulatory framework

Ukraine generally has a well-developed regulatory framework for PPPs and concessions, which we have managed to successfully test from the concessionaires perspective in the course of structuring and negotiating the Olvia port concession. Certain areas still need to be improved by adopting several laws and by-laws, including those to make road PPPs more attractive to investors and to improve the predictability and stable financing of such projects. Nevertheless, the existing regulations allow for the structuring and successful implementation of such projects.

From the perspective of the planned availability-based road PPPs, it is important for potential investors to understand the legal status of the availability payment, the procedure for its calculation and source of financing in Ukraine. Ukrainian law treats the availability payment under a PPP or concession agreement as one of the forms of state assistance, which, however, is different from state assistance in the meaning of the Law of Ukraine On State Aid to Business Entities. Essentially, this is a payment from a public to a private party, made upon putting an object into operation. The amount of the availability payment depends on the fulfilment of various qualitative criteria specified in the PPP or concession contract, e.g., the condition of the road in the winter and summer periods. We highlight key issues regarding the availability payment below:

The public party would pay the private partner only after a road is put into operation and only for so long as, and to the extent, it is available for use and complies with the qualitative criteria. In case of a road concession, the availability payment is paid only when the concessionaire is unable to receive full compensation of its investments from road tolls.

The amount of the availability payment depends on performance indicators defined in the contract and achieved by the concessionaire. Road availability will generally be determined based on two main criteria: physical availability of the road for use (subject to the exemptions such as planned maintenance) and the condition criteria, meaning compliance with the quality requirements for the road and its service. If these criteria are not satisfied (either fully or partially), that would lead to the deduction of penalties from the amount of the availability payment.

Availability payments shall not exceed investments by the concessionaire related to construction, reconstruction, large-scale repair and road maintenance. However, the payment for the use of roadside infrastructure is an additional source of income. The total amount of the availability payments shall be determined by the public party during preparation of the project.

Availability payments will be paid from the Road Fund, which is a special fund within the state budget for the respective year.

Notably, the existing regulatory framework in Ukraine is appropriate for the structuring and preparation of PPP projects in line with key bankability requirements and enables:

the pledge of all proprietary rights under a PPP and concession contract;

the execution of a direct agreement between the operator, creditor and the grantor;

clearly defined procedures for the creditors stepping-in and substitution of the operator in default;

the waiver of sovereign immunity by the public partner at the request of the private party or a creditor against a court decision or an arbitral award, an interim injunction or enforcement action in the PPP/concession agreement or direct agreement;

the enforcement of pledges;

stability of law guarantees (grandfathering);

choice of governing law by the parties to the contract;

stability and predictability of cash-flow/income.

At the same time, the possibility for long-term budgeting is a key issue to be resolved by the Ukrainian government to improve the stability and predictability of cash flow prior to the commencement of road PPPs.

Unlike common international practices that provide for mid-term and long-term budget planning, Ukraines budget system has until recently provided only for short-term (one-year) planning. In practice this has limited the possibility of long-term budget commitments in investment projects, such as availability-based PPPs. Ukraine has made good progress over the past three years in implementing reforms to strengthen medium-term (three-year) budget planning. However, the mechanism of availability payments under PPP projects with a 3050-year lifecycle will be essentially blocked until budget legislation is changed to allow long-term budgeting (10-50 years) for such projects. The Cabinet of Ministers of Ukraine recently approved the draft law on amendments to the Budget Code of Ukraine enabling the public party to take a long term financial obligations under the PPP and Concession projects and establishing the relevant procedure. Once the law is approved by the Parliament, this should significantly improve the predictability and stability of financing of the PPP and concession projects, enabling long-term planning and almost all types of state support instruments for PPPs and concessions envisaged by Ukrainian law.

Another important step towards improving the stability of the operators income in the availability-based road PPPs may become an amendment to the Budget Code of Ukraine and Law of Ukraine On Sources of Financing of the Road Network aimed at (i) making availability payments a priority payment compared to some other expenses of the Road Fund and (ii) to establish registration of the state financial obligations under the road PPP projects to prevent an excess of state financial obligations on the available resources of the Road Fund.

Toll roads prospects

Once contracts for the above six pilot PPPs have been successfully concluded, the government is expected to proceed with the next 1519 projects planned for 20232030 as tolling concessions. However, to enable such projects, various changes to Ukrainian law are required, including those enabling the collection of tolls by the concessionaire.

Nevertheless, the government is moving in this direction. Under the Law of Ukraine On Concession, the toll is determined by the investor in accordance with the concession agreement and taking into consideration the tariffs for a single trip on the motorway for each kilometre travelled. On 23 December 2020, the Ukrainian government approved EUR-denominated tariffs for passage through roads constructed under concession agreements. The tariff is now determined based on the category of vehicles and for each kilometre of the motorway travelled.

If the government doesnt slow downand based on the political will already demonstrated by the president, Parliament and the Ministry of Infrastructure and with the existing unprecedented level of assistance of IFIs such as the World Bank and IFCwe expect to see the first toll roads in Ukraine in 45 years.

Oleg Matiusha, ounsel, Head of Infrastructure, Construction and Property at Kinstellar Kyiv

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