Lawyers live in hope that Eastern European PPP market matures
28 April 2008
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Over the past 20 years the economies of Eastern Europe and the CIS have emerged from decades of rigid state planning, leading to predictions that the private sector, and PPPs in particular, would land endless amounts of infrastructure work.
Clearly for projects lawyers working in the region, this would have been good news. But, as Eversheds projects head Jonathan Cripps points out, the masses of projects that were expected actually failed to materialise.
The reasons for this are varied, but in effect emblematic cock-ups have sullied the image of the PPP procurement model. An infamous example was Hungarian motorway project M1/M15, which initially closed in the early 1990s.
The failure of the advisers to map the traffic risk (ie that there was an alternative free road that was available for road users) meant that user volumes didn't match the figures that were initially forecast. As a result the concessionaire - a group led by Transroute International - collapsed and the road had to be refinanced.
The failure of this project comes down to a simple idea - people don't like paying upfront to use basic infrastructure, especially if there is no history of doing so.
Yet 10 years on and Freshfields Bruckhaus Deringer is advising the city of St Petersburg on its bid to launch two major road projects, both involving some type of tolling arrangements. These are the western high-speed diameter (WHSD) flyover and the Orlovsky Tunnel. Both of them, it should be noted, in a country with no experience of toll roads and large sectors of the population who simply can't afford to pay.
One Russian lawyer is immediately dismissive when asked about the viability of the projects. "Russians don't like to pay for their roads," she says.
But Michael Shaefer, the Freshfields projects partner leading on the deals, is predictably more optimistic, pointing out that traffic jams make travelling from one end of St Petersburg to the other almost impossible. Once the WHSD is up and running, motorists will be able to complete the same journey in 12-15 minutes as opposed to two hours, he says.
Shaefer is far from alone is his pursuit of road PPP deals in the region. From the magic circle to the silver circle, taking in the mid-market and US firms, Central and Eastern Europe (CEE) still firmly flickers on the radars of international projects lawyers.
Since the M1/M15 debacle, UK and US lawyers have got a number of successful road PPPs under their belts in the region, even if the quantity of transactions is not what was initially expected. These are projects such as Hungary's M6 motorway (in which Linklaters advised the government, while Freshfields advised the preferred bidder) and Croatia's Istrian toll motorway, in which Allen & Overy advised the lenders and Paul Hastings advised the Republic of Croatia on the $900m (£454.24m) phase 2A.
The latter is just one motorway project of a combined total of e15bn (£12.05bn) that Paul Hastings is undertaking, or has undertaken, since launching its London-based projects practice last year. In practically every country in the region, from Albania to Romania, programmes of this kind are being floated, and the evidence is that PPP road tolling arrangements are certainly far from dead.
"You keep coming back to the same point," says Cripps. "Either the government pays, the user pays or you go without - and that's not an option if you're looking to develop an economy."
The existence of successful precedents, combined with an ongoing need for improved infrastructure, ;means ;that opportunities are plentiful, but what are the ongoing challenges to lawyers doing work in eastern Europe? The most pressing single obstacle is the continued lack of supporting legislation. In contrast to the UK's common law model, the codified model in place across these jurisdictions makes implementing PPPs a lot more sluggish. And even when legislation is put in place, it doesn't always do the job.
"Poland has had PPP legislation, but no one believes in it, so no one uses it," points out Cripps.
Part of the reason for the lack of confidence in new laws is relative inexperience on the part of some of the local technocrats in dealing with the private sector.
Admittedly, there are more and more cadres trained at bastions of free market thinking such as the London School of Economics, but there is still a strong legacy of those who aren't. This can create problems when advising the public sector, says Paul Hastings head of European projects Jonathan Simpson.
"Many governments have bureaucrats who trained in communist governments - the basic profit motive is not as intuitive," argues Simpson.
Essentially, continues Simpson, this means these administrations could get ripped off by sponsors pushing their own view of the risk allocation. Or conversely, and potentially just as damaging, that a government might equate the cheapest with the best deal, which can often be a false economy with projects of this size.
For those advising the sponsors, sovereign risk and revenue security are major concerns. Nowhere is this more prevalent than in Russia. It is no coincidence that expert credit agencies, not commercial banks, are being approached to lead the financing by the prospective bidders on the WHSD.
One projects lawyer at a magic circle firm advising a private sector player on its bid comments: "Commercial banks aren't over the line in terms of political risk in Russia."
The other major challenge is the tightening of global lending markets. Law firms and investors alike are interested in Russia because of the mammoth size of the deals there. Shaefer illustrates the point by saying that the smallest PPP road currently on the drawing board in Russia, the Orlovsky Tunnel in St Petersburg, at around $1bn (£504.72m) is still substantially bigger than the largest road PPP in relatively mature markets such as Germany - the A1 at e450m (£361.59m).
While the WHSD dwarfs both these projects at $6.5bn (£3.28bn), its value has doubled from its initial cost estimate because of the rising price of steel on global commodity markets, exacerbated by the tariffs imposed by Russia on steel imports. However, Simpson argues that this problem could be circumvented by Russia having bought up substantial Chinese steel interests of late.
The liquidity crunch is seen by many lawyers operating in the region as a blip on their attempts to close significant deals. It may slow things down and increase the number of banks involved in syndication, but the expectation is that they should still go ahead eventually.
But CEE is no longer the only significant alternative for international projects lawyers looking to hedge against domestic downturns and take advantage of attractive returns in riskier markets.
"The challenge for the region is that PPP is now in 97 countries," says Cripps. "There are lots more opportunities for investors if CEE looks slow. There's a need for [the region's governments] to understand that they're competing for finite private sector investment. People are getting very excited about India. If you're an investor you can't wait while Poland changes its legislation."