Note:English version for reference only,Chinese version shall prevail.
Ji Xinhua, Shanghai Municipal Finance Bureau
In the current round of PPP boom, governments at all levels and various nongovernmental investors have paid increasingly more attention to the roles of PPPs in innovating supply, stimulating market vitality and creating new sources of economic growth, and accelerated the implementation of PPP projects through relevant channels, with much help from banks, funds and other financial institutions of course. But overall, the risk management and product design of domestic financial institutions at present is not yet well adapted to the characteristics and requirements of PPP financing, and financial institutions are still cautious about PPPs, which, consequently, restrains the participation of social capital and the implementation of PPPs. On the other hand, as PPP projects have high asset values with stable and reliable project operation and expected returns, and the large amount of capital deposited in the domestic financial market because of insufficient financing demands are seeking investment targets, projects under the PPP model with huge investment scale are capable of absorbing such capital and will definitely attract attention from financial institutions; and this lays the realistic foundations for solving PPP financing difficulties. Therefore, it is necessary to better play the guiding role of policies to attract financial institutions to actively participate in PPP financing, flexibly use various types of financial instruments to provide diverse, standard and market-based profit-making and exit channels for social capital, in order to further promote the development of PPP model in China.
I. PPP Financing Difficulties in China
Since the standard PPP practice in China is still in its infancy, the business model for PPPs is not mature yet, and the supporting system covering market environment, policies and regulations is not sound, leading to the difficulties in controlling the risks arising in the long-term partnership and the limited independent financing capacity of project companies based on project assets and future cash flows; and thus, the projects cannot comply with the relevant financing requirements of financial institutions, slowing the pace of project financing facilities participating in PPPs in China at present.
1. It is difficult to predict and control the risks of a PPP project, which is the main factor that restrains financial institutions from participating in PPP financing.
The risks of a PPP project should be transferred to onto the relevant corporatepartners based on controllable risks, optimization of allocation and other applicable principles, so as to give play to PPP's advantages in risk management and control. However, as the implementation of a PPP project may last up to two or three decades, any risk from a tiny one such as a rise in the price of raw materials and a shift in consumer preferences, to a larger one such as a reform in the technique or process used by the project and a change in domestic or international political and economic environment, especially a risk regarding the government's performance willingness and capacity which concerns the nongovernmental investors most, will have an impact on actual operation and profitability of the project .
2. PPP project companies have limited capacity to carry out independent project financing.
Most corporatepartners will set up an independent project company for construction and operation of a PPP project. Because of the short time of establishment, project companies often have issues like small scale of assets and no realization of any cash flow; whether it is for the availability of financing or the minimization of costs, guarantee from one or more strong shareholders is required. In addition, the majority of PPP paid projects with good economic benefits in China have already been implemented or put on to the market, and most of projects promoted at present have indistinct cash flows, or even primarily depend on government payments or viability gap subsidies, which also restricts project companies' capacity of financing from the capital market.
3. Financial institutions are cautious about PPP financing.
Although financial institutions are actively involved in the financing for demonstration projects in different regions, they do so largely for the symbolic meaning of being first movers and the great attention form the government on the demonstration projects. Usually, a PPP project cannot comply with relevant financing requirements due to the difficulty in predicting the risks and the lack of adequate credit enhancement means; and therefore, even if the front-line marketing unit of a commercial bank actively participates in rendering loans and financing to the project, the project may not be able to get implemented due to requirements set out by superior risk control, audit or loan departments. Social security, insurance and other institutions are more cautious, setting more demanding requirements on credit enhancement for project financing than commercial banks. With respect to other financing products provided by trust, brokerage and other financial institutions, if there is no strong guarantee and other credit enhancement measures, there will a low possibility to obtain financing, and the financing costs will be higher, thus curbing the enthusiasm of the relevant organizations to involve in financing PPP projects.
II. Realistic Foundations for Solving PPP Financing Difficulties
Despite the above-mentioned difficulties in PPP financing, most PPPs are key projects related to the national economy and people's livelihood at the places where they are located, and the project operation and income is stable and reliable, which is conducive to keeping the confidence of financial institutions in investment. On the other hand, the large amount of capital deposited in the financial market because of insufficient financing demands are seeking investment targets, and projects under the PPP model with huge investment scale are capable of absorbing such capital and will definitely attract attention from financial institutions. Therefore, there are realistic foundations for solving PPP financing risks.
1. PPP projects have high assets value
Most of the PPP projects are in the infrastructure field. For example, in the second batch of 206 demonstration projects with a total investment of RMB 658.9 billion published by the Ministry of Finance, there are 37 transport projects, with a total investment of RMB 388.9 billion, and 18 projects boast investment of more than RMB 5 billion and the highest single project investment is nearly RMB 50 billion; 59 municipal engineering projects, with a total investment of RMB 102.7 billion, and 26 projects has single investment of RMB 1 billion; and 50 waterworks project, with a total investment of RMB 90.7 billion, and most of the single project investments are more than RMB 1 billion. Those projects in the above-mentioned categories three items account for 71% of the second batch of demonstration projects, with the investment accounting for more than 88% of the total investment. The exclusivity and natural monopoly of those infrastructure projects, as well as large upfront investment in fixed assets, lead to the fact that those projects have higher asset values.
2. A PPP project will have stable and reliable expected returns
As key projects concerning national economy and people's livelihood in various regions, the failure of a PPP project will result in financial losses much higher than the service supply cost to all relevant stakeholders, and disturb the stability of the local government in the place where the project is located; and therefore, the stability and sustainability of the public services rendered by the PPP project is the primary concern of the local government. In addition, the constant improvement in PPP rules and regulations and gradual completion of contract framework, return mechanism, government credit system and other institutional environment, is also helpful to regulate and strengthen the contract performance by the government and corporatepartners, and consolidate and stabilize expected benefits of the project, thus conducive to alleviating the worries of financial institutions.
3. The liquidity on domestic market continues to be eased while effective financing demands are insufficient
In terms of money supply, the liquidity on domestic capital market will continue to be eased, and the growth rate in credit and loans will continue to be higher than that of GDP. In addition to the traditional measures such as cutting the deposit reserve ration and interest rates, the central bank may guide the interest rates to a lower level and monetary easing through a variety of policy tools. In terms of financing demands, demands for private financing slow down against the backdrop of new normal featuring transformation of development mode and upgrading of economic structure, leading to lack of effective financing needs. Innovation and technological progress will gradually play a central role in economic growth, whereas the role of social factors in financing innovation-driven economic growth will decline; industrial restructuring, particularly the expansion in real estate, heavy industry and other sectors in need of large-scale funds, has slowed down, and the service sector has relatively limited capacity to absorb private financing. Meanwhile, due to the impact of the economic slowdown, corporate credit risks climb up; and out of the worry that asset quality may drop, banks tend to be cautious in granting credit. In particular, as government platform loans will no longer enjoy government guarantees and will not be included in government debts, commercial banks will lose some prime, almost risk-free loan demands, making it more difficult to find a financing channel effectively matching the credit requirements of financial institutions.
4. PPP financing demands on the capital market are indispensable
As an important means to support new urbanization, the PPP model can help enhance the planning and management and accelerate infrastructure development. The expected total investment of RMB 42 trillion will come from socialcapital primarily, with the majority part transformed into specific PPPs. Moreover, speeding up infrastructure construction and increasing the supply of public goods has been seen as a powerful tool for stabilizing growth by local governments. As financing platform companies undertake the financing function from the government and the scale of government debts is relatively limited, the PPP model will become the major financing channel for local governments. In addition, the functions of the PPP model to ease local government financing gaps and expand effective investment are valued by governments at all levels, and stimulate the enthusiasm in promoting PPPs in different regions. Currently, the PPP projects launched successively in various provinces and municipalities are more than 1,800, with a total investment of RMB 3.4 trillion, and will gradually be implemented in recent years. Therefore, PPP projects have the ability to absorb the huge capital deposited on the financial market, and financial institutions will try to provide support in compliance with PPP project financing characteristics and requirements.
III. Multiple Measures to Resolve PPP Financing Difficulties
Given that successful financing is critical to the implementation of a PPP project, and the financing costs directly determines the costs for the implementation of project cost and the value for money (VFM) measurement, in advancing PPPs, multiple channels should be sought to resolve PPP financing difficulties, and socialcapital should be provided with diverse, standard and market-based profit-making and exit channels, thereby mobilizing the initiative of socialcapital in participating in PPPs.
1. Paying attention to playing the support and guiding role of policies
Because PPP projects provides public goods and services, and the efficiency and quality of products or services will directly affect the public interest, the government is obliged to guide socialcapital to investment in encouraged public sectors and support a project to have easy access to financing. In particular, in the early stages of PPP promotion and when the market environment for financing deteriorates, the government should, through providing relevant policy tools, ensure successful financing and steady implementation of a PPP project.
(1) Actively playing the support and guiding role of PPP funds. A PPP financing support fund of RMB 180 billion was set up under the guidance of the central finance, and relevant support funds were put in place successively in Xinjiang, Henan, Shandong, Jiangsu and Hunan, to further play the leverage and guiding roles of financial funds, improve the availability of financing for a project, and guide socialcapital to investment in relevant industries encouraged by the governments at all levels.
(2) Exploring and implementing the policy financing guarantee. Financing guarantee is an effective way to reduce or eliminate the risks likely to arise in the financing, construction and operation of a PPP project, and policy guarantee is also a natural requirement for reasonable allocation of project risks under the current circumstance of incomplete policy framework. We should support the development of financing guarantees and re-guarantee institutions, increase government funding to expand the scale of financing guarantees, and through risk compensation, loss recovery and other measures, guide guarantors in enlarge their business scale of PPP financing guarantees, so as to effectively mitigate financing difficulties encountered by projects.
(3) Encouraging governments at all levels to contribute to and participate in PPPs. Through investing in a PPP project company as a minority shareholder, the government may be able to understand the operations and related financial information of the project more easily and comprehensively; and for corporatepartners, the involvement of government shareholders will reduce their funding pressure from the initial equity investment, help share project risks, and produce an effect of credit enhancement for financing to some extent.
(4) Further intensifying policy-based loan support. Currently, the transport, sponge city, shanty-town transformation, underground pipe corridors and other sectors where PPPs concentrate are the sectors vigorously supported by the China Development Bank; and the Agricultural Development Bank of China has also been actively engaged in ecological, pollution control, agricultural development and rural infrastructure and other projects. As policy banks can raise funds at a lower cost not for profit, they can support PPP financing through differentiated credit support, in order to better play the role in policy guidance and support.
2. Strengthening institutional constraints and support for PPPs.
As the leading department in promoting PPPs, the Ministry of Finance is focusing on improving the framework of "legal norms + policy guidance + implementation details", and under the Guidelines on Promoting the Public-Private-Partnership (PPP) Model in the Public Service Sector (Guo Ban Fa  No.42), has issued operation guidance, contract management, government procurement, demonstration of financial capacity and other supporting documents on PPP projects, particularly highlighting legal compliance, honoring promises and performing contracts, openness and transparency, as well as other basic principles, reaffirming the requirements of being just, fair and open in procurement by partners, emphasizing the financial management system under which financial expenditures of a project are included in the overall budget management, and making the industries and financial capital feel reassured in respect of the selection of social capital, the conclusion of contracts between the government and the corporatepartner based on equal consultation, government performance, etc., to ensure sustained and healthy development of PPPs.
As an important guarantee for the smooth implementation of a project, a PPP contract defines the rights, responsibilities and interests related to the public-private partnership, and in the contract, the most critical terms are those on the payment mechanism of the project, which directly related to the allocation of risks and benefits and returns of the PPP project, and in turn, determines the bankability of the project. In particular, it should be noted that the agreements between the government and a corporate partner under a partnership contract on the setting of minimum users under the government payment mechanism, the calculation methods for government subsidies under the viability gap funding model, the uniqueness clauses under the user charge mechanism, and the price adjustment mechanism for the services provided by corporate partners, all will produce direct impacts on the income level of the socialcapital; therefore, the government and the corporate partner shall carry out full communication and negotiation on the above-mentioned clauses, which shall be specified in the contract and implemented strictly.
3. Encouraging financial institutions to participate in PPPs through multiple channels
The understanding and attitude towards PPPs held by financial institutions as intermediaries for currency credit activities, may determine the financing scale of a project; so regulators should guide financial institutions to proper identification, measurement and control of risks, and local governments should intensify financing guarantees, interest subsidies and other loans support to encourage all types of financial institutions to increase PPP financing.
Project loans provided by commercial banks will continue to be the main source for PPP financing, whereas overall considerations shall be given to the stability and public goodness of PPP projects, as well as responsibilities and obligations of the government in PPPs, to create financial services compatible with the characteristics of the PPP model, implement sophisticated and differentiated classified management, and actively provide easy financing support for PPPs.
At the same time, we should actively explore the direct financing channels for funds and securities firms, so as to broaden the sources for PPP financing and reduce financing costs of a project to a certain extent; moreover, social security and insurance agencies should be encouraged to innovate and employ debt investment plans, equity investment programs, project asset-backed schemes and other means of participate in PPP financing; local governments should guide and support commercial guarantee and re-guarantee institutions, in expanding business related to risk management and credit enhancement for financing, to improve the availability of financing for PPPs.
We should also actively introduce various foreign financial institutions: on the one hand, we can learn from the experience in financing management and risk control measures of foreign mature projects, and on the other hand, we can make full use of overseas funds which have low interest rates to expand the financing channels and sources for PPP projects.
4. Flexibly using all types of financing instruments on the capital market
As a PPP project has a long life cycle, and the conditions of cash flows and risk levels are optimized continuously from the formation of the project company, early-stage construction, initial operation, to the period when operation is stable, we should, depending on the differences between asset quality in different stages of a PPP project, flexibility use various types of instruments on the capital market to broaden the financing channels and give full play to the advantages of different products.
During the formation of a project company, the government and the socialcapital may make contributions and obtain equity according to agreements between them, and attract industrial investment funds, industrial venture capital funds and equity products under insurance funds to directly invest in the project for equity.
During the construction and initial operation of a project, the investment is large while the cash flow is small, and in terms of convenience for financing, project loans from banks will continue to be the major source of funding; the funds raised through project income bonds and PRN which take the stable cash flows generated based on the underlying assets in subsequent stages of the project as the main sources for repayment, can be directly invested in fixed-asset investment, and as they have long duration, they can desirably satisfy the financing demands of the PPP project during the whole investment cycle; and insurance debt investment schemes featuring large amount of funds, long term, low cost and flexibility, is suitable for the debt financing in the construction stage of a PPP fund project and to replace other high-cost and short-term financing instruments upon completion of construction.
During the period of stable operation to the final transfer, cash flows of a PPP project cash is clear and predictable, and through asset-backed securitization, asset-backed notes, insurance asset-backed schemes and other instruments, the boundary on the financing scale of the project company can be broken, and even low-cost financing may be obtained at a rating higher than that of the principal part; and corporate bonds, private debt financing instruments, medium-term notes and perpetual notes may be used to replace the bank loans in the early stages and supplement working capital; in addition, financial leasing and other approaches may be applied to address funding needs more flexibly.
It should be noted that although there are many products suitable for PPP financing, for the profit-seeking capital market, products with high uncertainty often mean higher risk premiums; and thus the cash flows and guarantee for asset-related interests of a project are always the focus of attention of various products. Therefore, the government or the socialcapital or a project company, may give full play to the advantages of the above-mentioned instruments only after putting in place the allocation of risks and the guarantee of returns in a PPP project, so as to truly facilitate project financing.
Note:English version for reference only,Chinese version shall prevail.