PPPs and Risk, Part 1

In a speech delivered during the PPP conference last 18 November 2010, the President revealed that his administration’s approach to promoting partnerships between the public and private sector (PPPs) is to protect investors from “regulatory risk,” to wit —

Let me show you how we are taking your concerns to heart in terms of certain specifics and opportunities to which we are already responding.

If we are truly interested in a square deal for all, then what we shake hands on, should be what endures. To this end, what we will be doing in so far as solicited projects are concerned is to minimize your risk in a meaningful and fair manner.

The government will provide investors with protection against regulatory risk. Infrastructure can only be paid for from user fees or taxes. When government commits to allow investors to earn their return from user fees, it is important that that commitment be reliable and enforceable. And if private investors are impeded from collecting contractually agreed fees – by regulators, courts, or the legislature – then our government will use its own resources to ensure that they are kept whole.

The specifics of such protection will be part of the contracts to be entered into between government and winning bidders of PPP projects. Each project will be looked at differently, and the government will use independent financial advisors to study each project carefully before it is bidded out, to determine what protection is necessary. It is important to note that this protection will be limited to regulatory risk.  Commercial or market risk, which you are in the business of determining, will be borne by investors, as it should be.

Let me provide you an example of how regulatory risk protection may work: A contract between the government and a private entity building a road or a bridge may specify a formula for rate adjustments. If for some reason, a court decision threatens the adjustment, the government will compensate the private concessionaire for the difference between what the tariff should have been under the formula, and the tariff which it is actually able to collect.

This is different from previous contracts where the government provided politically difficult guarantees to investors against market risk. For instance, with power supply contracts in the past, the government committed to buy power output regardless of what the actual demand was.

I am not certain how exactly the President wanted this to be received, given that for the most part, it represents a downgrade from previous approaches which guaranteed both commercial and regulatory risk.

Whatever he had in mind, it is not clear what  mechanism will allow “the government  … to ensure [contracted fees] are kept whole” in the event that “private investors are impeded from collecting contractually agreed fees – by regulators, courts, or the legislature.”   Indeed, it seems legally impossible to conceive of any sort of  indemnity clause which will survive the effects of a court mandated invalidation.

Finally, opening the floodgates to indiscriminate government guarantees is short-sighted and counter-productive.  At the end of the day, the increased cost of a government guaranty against regulatory risk will be borne by  tax payers not now but down the road.  Since most PPP contracts will outlive President Aquino’s administration, he should be wary about putting his signature on a piece of paper which will doom his successor (and the one after that) to additional fiscal  burdens, especially where the benefit is not clear or the need is not immediate.

In my view, the President would have been better off explaining  that the perceived risks of dealing with the Philippine government are not inherent to government per se. They are rather simply the just desserts of dealing with a corrupt Arroyo administration specifically.  You play with fire, you get burned.

Ultimately, the solution to the risk issue is a political one, rather than a legal one.  The so-called regulatory risk is a function of perception regarding government’s credibility from both sides of the rubicon — the consumers on one hand and the investors on the other.  Thus, to minimize regulatory risk, one has to first make the process supremely transparent to ensure that all possible stakeholders are given the opportunity to register their objections.  To this end, the jargon has to be simplified and contracts standardized (for there is comfort in the familiar after all). Finally, the selection process should be strengthened to weed out all but the determined and capable.

More in Part 2.

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