I OVERVIEW

In mainland China (China), public-private partnerships (PPPs) have been defined as the partnership between government and the social capital county or upper-level governments in charge of implementing the PPP projects within their territory. Social capital includes domestic and foreign enterprises acting as legal persons, which can be state-owned enterprises, private enterprises, mixed ownership and other types of enterprises, even for those local government 'platform companies' that have established a modern enterprise system and realised market-oriented operations, and the local government debts undertaken by them have been included in the government budget that has been properly disposed of and clearly announced that it will no longer assume the role of local government borrowing in the future can also be used as a social capital. Foreign investors' participation in PPP projects is also subject to market entry policies.

China has gone through three stages towards accepting the PPP model. The first stage was around the 1990s, which began with building power stations using the build-operate-transfer (BOT) model, and followed with investments in toll roads. The second stage began with the landmark issuance of an administrative rule in 2004 by the Ministry of Construction regarding the administration of concessions, as of which BOT, transfer-operate-transfer (TOT), build-own-operate (BOO) and other models became formally accepted in the field of public utilities such as roads, water supply facilities, sewage or garbage treatment plants and gas stations. As the beginning of the third stage, the past several years have witnessed a burst of growth of PPP in China. At the end of 2013, the Chinese government started to promote PPP in more aspects of public product and public service fields. It is encouraged to adopt the various types of PPP to provide public services in more sectors, including energy, transportation, water conservancy, environmental protection, agriculture, forestry, science and technology, affordable housing, medical treatment, public health, elderly care, education, and culture, etc.2 The requirements for PPP investment are increasing consistently. As of 30 November 2018, the Ministry of Finance (MOF)'s PPP integrated information platform project management library3 has a cumulative total of 8,557 projects, with an investment amount of 12.836365 trillion yuan.

Currently, China has no specific fundamental law on PPP. The legislative framework of PPP mainly consists of relevant laws, regulations and regulatory documents. The PPP related documents in force are relatively low in the legal hierarchy. In July 2017, the Legislative Affairs Office of the State Council has promulgated the Regulations on Public-Private Partnership in the Field of Infrastructure and Public Services (Draft for Comment), and the full text of the explanation solicits opinions from all sectors of the society, and includes the PPP regulations in the legislative work plan of the State Council in 2018. The public comments period for the draft has now closed. However, the authorities will conduct further draft and amends works based on these public comments. At the time of writing, the draft has not been formally promulgated but has been included in the legislative plan.

II THE YEAR IN REVIEW

The year 2018 saw PPPs have a great and far-reaching impact on China. Since being popularised in China in 2014, the PPP model has been widely used in various fields of infrastructure and public service, following more than three years of strong growth and rapid development. At the same time, however, problems such as the abuse of PPPs, the illegal loan guarantee of pseudo-PPPs, and non-standard problems, such as exceeding the red line of financial expenditure, have revealed a larger hidden risk in PPP projects. To rectify these problems, prevent and resolve the major risks, and promote the sustainable development of China's PPPs, 2018 and 2017 were expected by many ministries and departments to be the years of PPP reform and standards development. The MOF, National Development and Reform Commission (NDRC), State-Owned Assets Supervision and Administration Commission (SASAC) and other departments have successively issued a series of normative documents and management requirements for PPPs, and carried out the rectification and management of PPP projects, the most noteworthy of which are discussed below.

On 10 November 2017, the MOF issued the Notice on Regulating the Management of the Public-Private Partnership Integrated Information Platform of Project Databases (CAIBANJIN (2017) NO. 92), defining the new project storage standards. It stipulates that it is not suitable for adopting the PPP method, that the preliminary preparation work is not in place, that the effective payment mechanism is not established and that it is not allowed to enter the project database; and clarifies the standard of clearance and withdrawal of the items that have been entered into the project database. If value-for-money and feasibility assessments are not carried out according to the regulations, it is not appropriate to continue to adopt the PPP mode, which does not meet the requirements of standard operation, constitutes a guarantee for illegal borrowing, and clears and returns the items that have not been made public with information according to the regulations, and so on, to standardise the PPP project operation and project management, prevent the abuse of PPP generalisation and contain any hidden debt risk.

On 17 November 2017, SASAC of the State Council issued the 'Notice on Strengthening the Risk Management and Control of PPP Business of Central Enterprises' (GUOZIFACAIGUAN [2017] No. 192), which regulates the participation of central enterprises participating in PPP projects as important social capital, and requires strengthening group management, strict access conditions and scale control, improving project quality, preventing increasing debt risks, optimising cooperation arrangements, standardising accounting, serious accountability, and preventing illegal business investment behaviour.

On 28 March 2018, the MOF promulgated the Notice on Regulating Financial Enterprises' Issues Concerning Investment and Financing Behaviours of Local Governments and State-Owned Enterprises (CAIJIN [2018] No. 23), which puts strict requirements on PPP financing, debt funds such as 'fake equity, real debt', shareholder loans, and borrowing funds cannot be used as capital for PPP projects; if the source of capital of the project is not implemented, the evaluation of value for money, the demonstration of financial affordability, the evaluation of value for money and the demonstration of financial affordability are not fully disclosed in PPP projects, and no financing shall be provided, etc.

On 24 April 2018, the MOF promulgated the Notice on Further Strengthening the Standardised Management of Public-Private Partnership Demonstration Projects (CAIJIN [2018] No. 54), which handles the classification of 173 demonstration projects that have problems in verification, and regulates project management from the aspects of pre-project work, procurement procedures, contracting entities, contract terms, project performance, etc., and strengthens project supervision and information disclosure.

Standardised governance leads to better development. The introduction of the above-mentioned PPP normative documents and the rectification and clean-up of PPP uncertainties by various ministries and departments of the country have made China's PPP sphere gradually stabilise, which has been beneficial and conducive to realising the long-term development of China's PPPs.

On the other hand, we have to acknowledge that in the process of consolidation and standardisation on PPPs, in some cases, departments have deviated from accepted PPP policy and implementation has been too fierce, leading to the emergence of increased quotas. As a result, approaches to PPPs have gone from aggressive to cautious, which has had a negative impact on the normal implementation and long-term development of PPPs.

III GENERAL FRAMEWORK

i Types of public-private partnership

The types of PPP mainly include operations and maintenance (O&M), management contract (MC), BOT, BOO, build–own–operate–transfer (BOOT), TOT, and rehabilitate–operate–transfer (ROT).

The type of PPP project is chosen in light of the specific conditions of each project and business or political requirement of the parties. In fact, the PPP-related rules do not prohibit the selection of other types of PPP. That said, although the build–transfer (BT) model formerly applied in some previous public utility projects, it is not deemed a formally adopted type of PPP in China in practice. Based on our understanding, this is because BT is generally prohibited in most public projects when being deemed as a disguised form of government debt raising, and second, BT does not cover the operation and maintenance of a project, and does not comply with the long-term or full life-cycle cooperation and risk-sharing nature of PPP projects, which is emphasised in China.

ii The authorities

At the central government level, ministries of the state council take charge of the guidance and supervision of PPP promotion in relevant fields according to the division of functions. The MOF and NDRC act as coordinating authorities in developing PPP in different fields by establishing project libraries, organising evaluations and approvals, and improving the relevant systems and mechanisms. Both the MOF and NDRC have issued guideline opinions on PPPs and published guidelines on PPP contracts. Both authorities have also published PPP project lists and project libraries to promote PPPs. Additionally, according to the needs of different projects, the administrative authorities for different industries, such as construction, transportation, water resources, environmental protection, health, education, culture, civil aviation, land, agriculture and forestry, are responsible for project guidance, implementation and supervision.

In practice, most PPP projects are promulgated by county, municipal or upper-level local governments. Besides following rules and policies issued by central government, the local governments are in charge of promulgating specific policies and carrying out the implementation thereof, pursuant to the existing plan and the realities of the region. Based on the provisions of the MOF or NDRC rules or other competent authorities regulations, in a specific PPP project, the competent county or upper-level government is mainly responsible for the review, organisation and coordination, as well as the examination and supervision of the PPP project.

For the purpose of implementing a single PPP project, the government will appoint an implementation institution to be responsible for the preparation, procurement, supervision and transfer work of the project. In practice, the local government itself and functional departments or non-profit institutions appointed by the local government could be the implementation institution of a PPP project. In addition, the government will designate one or more companies as government representatives to participate in the formation of a special purpose vehicle (SPV), exercise shareholder rights and fulfil shareholder obligations on behalf of the government

iii General requirements for PPP contracts

There are two major suggestive contract forms that govern PPP projects, including the Contract Guidelines for PPP projects published by the MOF, and the General Contract Guidelines for PPP Projects published by the NDRC. Neither of the proposed contract texts requires mandatory use.

PPP contracts follow the principles of contractual legality and compliance, equal government and social capital rights and obligations, public welfare, honesty, fairness, efficiency, and flexibility. It usually contains the project participants, the purpose of the contract, the principle of risk allocation, investment construction, operation and maintenance, transfer, payment mechanism, rights and obligations, breach of contract, dispute settlement and other core and key clauses. In practice, the content of the PPP contract will vary according to the industry area, project characteristics and operation mode of each project.

IV BIDDING AND AWARD PROCEDURE

As indicated in the PPP Procurement Measures, social capital shall be selected through a legal procedure. The MOF provides that the selection of social capital should be a government procurement (PPP procurement), and provides five methods for PPP procurement, including public bidding, invitation bidding, competitive consultation, competitive negotiation, and single-source procurement.4 According to the characteristics of the purchasing demand of a PPP project, the project-implementing agency chooses the appropriate purchasing method according to law. If a method other than public bidding is proposed to be selected, the implementation institution should first apply for approval of the finance department of a certain level of government.

The NDRC Guiding Rules also provide that the social capital shall be selected through public bidding, invitation bidding, two-stage bidding, competitive negotiation, etc. However, the NDRC Guiding Rules further provide that, for PPP projects of which the engineering investigation, design, construction, supervision and supply of important equipment or materials are to be contracted to or supplied by the social capital investor itself, the social capital must be selected through bidding according to the Bidding Law.

i Expressions of interest

MOF and NDRC procedures are similar in this respect. An announcement of pre-examination of qualifications shall be released via the government procurement information release media designated by the relevant finance department at or above the provincial level (for projects listed in MOF project library) or on media appointed by the NDRC (for projects listed in the NDRC project library). The time period for submission of application documents for pre-examination of qualifications shall not be less than 15 working days from the date of release of the announcement (requirement of the MOF) or five days after the bidder issues the pre-examination invitation document (requirement of the Bidding Law). Where there are at least three social capitals that pass the pre-examination of qualifications, the implementation institution may continue the preparation of bidding documents. Where there are fewer than three social capitals that pass the pre-examination of qualifications, the implementation institution shall organise a new round of pre-examination of qualifications after adjusting the content in the announcement of the pre-examination of qualifications.

The bidding documents of a PPP project shall contain all procedural and substantive requirements of the project, and shall contain the evaluation method and criteria, draft contracts and other legal instruments for the PPP project. Among others, the bidding documents shall point out those details of the project contract that are variable during the negotiation for confirming procurement results. The PPP bidding documents shall also expressly state that the project contract must be submitted to central government at the corresponding level for approval and not take effect until it is approved.

The MOF further provides that, where a competitive negotiation or competitive consultation procurement method is adopted, the project procurement documents shall, in addition to the contents prescribed in the preceding paragraph, specify the contents that may be substantively changed by the evaluation team based on negotiations with social capitals, including the technical and services requirements under procurement needs and the terms of the draft project contract.

ii Requests for proposals and unsolicited proposals

Generally, the requirements for bidding documents are set forth in the documents calling for bids. If the selection of PPP social capital is carried out through bidding, generally the proposal of bidders will respond to the substantial requirements and conditions as provided in the documents calling for bids.5

Compared with the public bidding procedure, the other methods, especially by way of competitive negotiation and consultation, provide relatively more space for the social capitals respecting the variable details. In short, in the process of competitive consultation, the consultation group may make material changes to the technical and service requirements of the procurement and terms of the draft contract based on the consultation documents and the actual consultation situations.6 The material changes shall be effective parts of the consultation documents and be sent to all candidate social capitals. The candidates will submit a new response document accordingly.

A PPP project can be proposed by both the government and social capitals, but is usually proposed by the government. The recommendation of potential PPP projects by social capitals shall be made to the financial departments (PPP centre) in the form of a project proposal. The Administration Measures on Public-Private Partnership (PPP) Project Database in the Traditional Infrastructure Field (Trial) issued by the General Office of the NDRC provided that a PPP project can be filled in and submitted by industrial departments, public institutions and various types of enterprises to the project database so as to be listed in the PPP project library.

iii Evaluation and grant

A legally established evaluation team shall be responsible for pre-examination and bid evaluation. The members of the evaluation team shall sign the qualification pre-examination report and the evaluation report.

The implementation institution shall establish a special working group responsible for the negotiation and confirmation of the final bidding results according to law.

The public body and the bid-winning social capitals to conclude transactions shall enter into PPP project contracts within 30 days after the notice of winning the bid or concluding transactions is issued.

Public notification and public announcements are requested for each step above.

V THE CONTRACT

i Payment

There are three main kinds of payment mechanisms in PPP projects in China: government payment, user charges and viability gap fund (VGF).

The three mechanisms apply to different kinds of PPP projects. Public transportation such as highways, bridges and subways and public infrastructure for water and heat supply usually takes user charges. VGF refers to the economic subsidies the government provides to the project company to fill the gap for those PPP projects in which the user charges cannot cover the input cost and reasonable profits.

In practice, VGF can take different forms such as investment subsidies, equity investment, concessional loans, grant of other developing and operating rights and interests related to concession projects.7 In some projects applying the VGF mechanism, the government takes partial payment responsibility during the operation period.

The principle for the price of public utilities includes cost compensation, fair return, resource conservation, high quality and high price, and equitable burden sharing. In practice, the price is decided during the PPP procurement procedure, but is also subject to the restriction by the government. For PPP projects applying the government payment mechanism or VGF mechanism, the proposal of PPP projects including a payment or subsidies arrangement must pass verification of fiscal capacity before the project applies the mode of PPP. For PPP projects applying the user charges mechanism, the price shall be subject to the approval of the price administration bureau, if it is listed in the catalogue of prices fixed by the government.8

Both the guidelines for PPP contracts of the NDRC and MOF confirm that the parties will provide the adjustment of price in the PPP contract. The adjustment of price will be according to the project execution situation and performance evaluation results. A public hearing will be held before the price is adjusted.9

The General Contract Guidance on Public-Private Partnership Projects (2014 edition) (the 2014 General Contract Guidance) provides that the contracts of PPP projects shall specify the method by which private capitals will obtain payment. According to the nature and characteristics of the specific projects, the sources of income of the projects mainly includes user charges, the combination of user charges and government subsidies and government procurement for the services.10

ii State guarantees

According to Chinese law, the government is prohibited from providing a guarantee.11

The relevant rules provide that the minimum requirement risk of a PPP project may be taken by the government side. The measures for the government to take this risk in a project will be provided in the project proposal prepared by the implementation institution, among others, by making a payment to the SPV for the margin between the guaranteed usage and the actual usage.

The payment made by the government is subject to the government fiscal budget. In practice, the most popular method for local government to ensure its payment to the social capital according to the PPP contract is, although not of a guaranteed nature and not 100 per cent without risk, to confirm to the social capital that the expenditure of the PPP project will be listed in the local annual budget of the pay year. Previously, the confirmation was generally in the form of a comfort letter, which has the risk of being deemed as invalid.12 The current system construction work for PPP shed light on listing the government payment and subsidy under the PPP contract into budget in a formal and more controllable way. China will set up systems to guarantee sustained and healthy development of the PPP model by including operating subsidies, correct operating charges and other considerations in the annual budget and medium-term financial planning, reflect and manage the same in the financial reports of the government, and report to the people's congress at the same level or its standing committee. The Concession Measures also provide that the payment or subsidy by the government in VGF concession projects shall be linked up with the government's annual budget and mid-term fiscal planning to ensure the requirements of fund appropriation.

iii Distribution of risk

Risks are allocated between the government and the social capital according to the principle of risk allocation optimisation, risk return equivalence and risk controllable, and upon overall consideration, the management capability on government risk, the project return mechanism and the management capability on market risk. In principle, the commercial risks, including design, construction, finance, and operation and maintenance of the project, shall be borne by the social capital, and the risk of laws, policies and minimum requirements shall be borne by the government. Force majeure and other risks shall be borne by the parties jointly on a reasonable basis.

iv Adjustment and revision

Generally in practice, the PPP contract contains a general term saying that the contract can be revised or modified by the parties through mutual agreement and the revisions shall be in writing and formally signed by both parties. Even though the PPP contract does not have this term, the revision of contract by both parties through mutual agreement is a right under contract law. The Consultation Draft of the PPP Law requests the parties to sign a supplementary agreement through negotiation when it is necessary to make an alteration during the cooperation period. And the material change to the cooperation agreement shall be submitted to the original approving authority for approval.13

The parties may also provide in the PPP contract conditions or restrictions for the revision of contract on a specific issue. Of course, the conditions and restrictions can be abandoned through negotiation.

v Ownership of underlying assets

The transfer of the ownership of the underlying assets depends on the different type chosen (e.g., BOT, BOOT and TOT) and the terms of the PPP contract. In some types of PPP projects, the ownership of the underlying assets is not necessarily required to be transferred to the social capital together with the transfer of occupation (e.g., O&M). Some types of PPP projects do not have the necessity of ownership transfer, such as BOO. But most types of PPP projects have one or more asset ownership transfer step. For example, in a BOOT project, the social capital (in most cases through its SPV for the project) builds the project asset, owns the asset and operates the same in the cooperation period according to the PPP contract. Upon the expiry of the contract or early termination, it will transfer all the facilities, rights and interests therein (land use rights, etc.) to the government or the institution it appointed.

Transfer includes the transfer of occupation, and the transfer of ownership. Some PPP contracts do not emphasise the ownership of underlying assets, but owning assets during an operation could be important for projects having an asset-backed securities plan by the social capital. PPP contracts generally prohibit the asset being used as security for other projects. Besides the above, competent authorities generally use the performance test to ensure the perfect function of the assets and the validity of the IP rights and technical documents.

vi Early termination

PPP contracts allow early termination in the following situations:

  1. by the social capital owing to the default of the government partner;
  2. by the government owing to default of the project company;
  3. the government partner unilaterally terminates the contract under specific circumstances according to its legal power, which shall strictly follow the law and accompanied by adequate compensation;
  4. any party may terminate the contract because of force majeure incidents that last so long or accumulate to some extent; or
  5. a mutual agreement is reached to terminate upon negotiation.14

VI FINANCE

Besides traditional bank loans, financing PPP projects with new financial methods is encouraged. Social security funds, insurance funds and other public funds are permitted to support the project financing through debt, equity investment and other ways. Further, SPVs are encouraged to conduct structural financing and issue, among others, project-earning bonds, PPP projects special debts, project-earning notes and asset-backed notes.

In April 2017, the NDRC issued the 'Guidelines for the Issuance of Special Bonds for Public-Private Partnership Projects', which encourages and supports PPP project companies or social capital parties to issue special bonds for PPP projects to broaden the financing channels of PPP projects and raise funds for the construction and operation of PPP projects. Subsequently, Guangzhou Zhujiang Industrial Group Co., Ltd., Shanxi Construction Investment Group Co., Ltd., Meishang Ecological Landscape Co., Ltd. and many other companies have raised funds through the issuance of PPP project special bonds.

In addition, asset securitisation is also an important financing method for PPPs. In February 2017, the Shanghai Stock Exchange and the Shenzhen Stock Exchange issued the 'Notice on Promoting Asset Securitisation of Public-Private Partnership Projects in the Traditional Infrastructure Sector' to encourage the support of PPP project enterprises to actively develop the PPP project asset securitisation business. In June 2017, the MOF, in conjunction with China Securities Regulatory Commission and the People's Bank of China issued the 'Notice on Regulating Issues Related to Asset Securitisation of Public-Private Partnership Projects', encouraging PPP companies to carry out optimised financing arrangements for asset securitisation. Despite incomplete statistics, up to now, there have been more than 40 PPP asset securitisation projects landing or ready to land.

However, although PPP projects have these multiple financing options available, since 2018, owing to uncertainty caused by the state's rectification and clean-up of PPP projects, and the identification of the government's implicit debts for the PPP project by the Central Document No. 27, financial institutions are wary of PPP projects, and the loans to PPP projects have been tightened and in some cases even stopped. At the same time, the 'Guiding Opinions on Regulating Asset Management Business of Financial Institutions', jointly issued by the People's Bank of China, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission and State Administration of Exchange Control in April 2018 also explicitly prohibits the cash pool, term mismatch, multi-level nesting, restricting the investment of stock bonds, breaking the rigid redemption, etc., all of which has a major impact on PPP project financing.

VII RECENT DECISIONS

According to the Administrative Litigation Law and the Explanation of the Supreme People's Court regarding the Administrative Litigation Law, a concession agreement is an administrative contract, and lawsuits against the government's failure to perform the concession agreement, or illegally modify or terminate early on the concession agreement, should be heard by the court in accordance with the Administrative Litigation Law.

In the relevant PPP provisions of the MOF and NDRC, where the project- implementing agency, successful bidder and social capital have disputes in the performance of the PPP project contract and cannot reach a consensus through consultation, they may apply for arbitration or file a civil lawsuit. In the Public-Private Partnership Regulations (Draft for Comment) on Infrastructure and Public Services issued in 2017, it stipulates:

Disputes arising from the implementation of the cooperative project agreement may apply for arbitration or bring a lawsuit in a people's court in accordance with the law . . . with regard to specific administrative acts related to the implementation and supervision and administration of cooperative projects undertaken by relevant government departments, if the social capital party considers that they have infringed on its legitimate rights and interests, it shall have the right to make representations and arguments, and may file administrative reconsideration or administrative proceedings in accordance with the law.

Therefore, there should be appropriate dispute resolution depending on the type of dispute.

VIII OUTLOOK

Looking back over 2018, with the tightening of the PPP regulatory policy and the rectification and clean-up of PPPs, China's PPP sphere slowed to more stable levels. In 2019, PPP projects will land at a slower pace than ever before, but develop more regularly.

At the same time, local governments need to pay fees or subsidies to social capital as PPP projects implemented over the past four years have entered the operational phase; however, as the domestic economy enters a downward channel, the growth of government revenue is weak, and the ability of local governments to pay their finances and credit is being tested. It is expected that PPP contract breaches will occur in the future and there will be more disputes regarding PPP projects. In addition, the process of PPP legislation has also been further accelerated; at present, the Regulations on Public-Private Partnership in Infrastructure and Public Services (Draft for Comment) has been closed for comments and included in the annual legislative plan, and is expected to be officially announced soon. The promulgation of these regulations will effectively improve the conflict of PPP policies between the NDRC, the MOF and other departments, and PPP projects will be better regulated and guided.


Footnotes

1 Jihong Wang is a senior partner, and Jiangyu Han and Juan Miao are senior associates at Zhong Lun Law Firm.

2 See the Notice of the General Office of the State Council on Forwarding the Guiding Opinions on Promoting the Public-Private Partnership Mode in Public Service Field.

3 See Notice on Regulating the Management of the Public-Private Partnership (PPP) Integrated Information Platform Project Library (CAIBANJIN (2017) NO.92), which stipulates that all projects are under preparation, procurement, implementation and transfer phase should be included in the project library.

4 See the Measures for Administration of Government Procurement in Public-Private Partnership Projects (Cai Ku [2014] No. 215) (the PPP Procurement Measures).

5 See Article 34 of the Implementing Regulations of the Government Procurement Law.

6 See Article 20 of the Interim Measures for the Management of Competitive Consultation in Government Procurement.

7 See Article 17 of the Concession Measures and the definition of value for money in the MOF Guidelines.

8 See the Price Law of China.

9 See Article 10 of the Guiding Opinions.

10 See Article 8 of the 2014 General Contract Guidance.

11 See the Guarantee Law of China.

12 Government organs are now prohibited to issue this kind of comfort letter. See Notice of the MOF, the NDRC, the People's Bank of China and the China Banking Regulatory Commission on Deterring the Illegal Financing Behaviour of Local Governments (2012).

13 PPP Law of the People's Republic of China (Consultation Draft), Article 32.

14 The Guide on Contracts for PPP Projects (30 December 2014, MOF) mentioned the first four occasions.