Current trends in public-private partnerships in the Middle East

July 2013 | SPECIAL REPORT: Infrastructure & project finance

Financier Worldwide Magazine

The regional infrastructure market faces a number of challenges. A combination of the Arab Spring and the global financial crisis continues to have a three-fold effect in the region: a number of governments are concentrating on national security rather than infrastructure investment, some governments have faced significant constraints on their ability to borrow to fund infrastructure projects, and the reduction in liquidity in the international debt markets generally means that those projects that have survived the squeeze are finding it increasingly difficult to get the required senior debt in place.

These issues have placed particular additional pressure on procurement of infrastructure projects through public-private partnerships (PPP). In addition, there are increasing concerns that, when compared to direct capital funding, PPP structures do not produce the ‘value for money’ required to outweigh the perceived drawbacks ofPPP. Moreover, in the Middle East (as elsewhere), the tender processes required to procure PPP projects have been criticised as being overly complex, leading to drawn-out procurement periods, delays to projects and excessive utilisation of bidders’ resources (both time and money). There are also particular concerns expressed about PPPs in the Middle East regarding perceived insufficient ‘buy-in’ from public authorities, in terms of the understanding of the PPP structure, its advantages and its limitations, and in terms of the alignment of separate public sector interests to enable effective implementation and proper management of projects.Regional governments have, however, been working hard to address these issues.

As a result of these factors, the use of traditional PPP models in infrastructure investment in the Middle East is under increasing scrutiny. At the same time, however, demand in the region remains undimmed, driven by rising populations and increasingly ageing infrastructure portfolios. Middle East governments have expressed the view that private sector financing and expertise must inevitably play a crucial role in meeting this demand.

What, then, are the current trends in the PPP market that governments in the region can follow in order to make PPP more effective as an infrastructure investment delivery model?

Risk allocation

Whereas in the past the public sector tried to transfer risks to the private sector which it was not always best placed to manage, there is a growing realisation within regional governments that aggressive transfer of risk increases the price of projects and may even lead to failure to deliver the project and, ultimately, affect the success of future PPP projects (for example, by deterring prospective bidders). In some jurisdictions, a more equitable risk allocation, whereby risks that sit best with the public sector are retained, is becoming more and more acceptable. Since the Arab Spring, country risk is also more of an issue, however otherwise bankable projects should be able to attract private sector support through the application of specific risk mitigation instruments, such as government guarantees and political risk insurance.

Streamlining procurement processes

Solid public sector procurement methodology is critical to attracting the right quality and quantity of private sector developers. Governments in the region recognise this and have worked hard to ensure that bid processes are transparent. In the Middle East, rationalising the structure and complexity of tender requirements, particularly in the number of bidders selected to continue at different stages in the process, will also be a key priority. There is a recognition generally that private sector participants have limited desire to expend substantial resources in competitions where they may have limited chance of success. Governments in the region can also be expected to seek to maximise coordination of various departmental interests as far as possible so as to ensure that bidders are faced with a harmonised and consistent procurement program.

Increasing stakeholder buy-in

Regional governments are realising that it is essential to establish a central PPP unit which, as well as standardising the principles applied across different sectors and ensuring a viable pipeline of projects, can act as a conduit for the various public sector interests and ensure an alignment of these interests and a consistency of approach. Examples of this include Egypt’s central PPP unit, housed within the Ministry of Finance, and the Partnerships Technical Bureau in Kuwait.

Government as shareholder

Compulsory government shareholding in the project company of a PPP project (or the ‘joint ownership’ model) is a relatively new phenomenon in the UK, however the Middle East is already accustomed to this type of public sector investment. Abu Dhabi has an established policy of joint ownership of PPP projects. Other jurisdictions such as Kuwait have only just introduced such a concept, while others, such as Bahrain, are now considering this approach. There are some risks for the government on a joint ownership model, however, as the UK’s new joint ownership approach indicates, it is a method which seems to be gaining more widespread government support.

Attracting finance

Given the insufficient liquidity in the international commercial debt markets, governments and sponsors are increasingly being required to consider alternative methods of financing infrastructure investment.

Some of the methods which are growing in popularity are:

Islamic finance.There is real opportunity for Islamic finance to support the development of PPP projects, particularly social infrastructure in the Middle East, given that Islamic banks have tended to fare better than their conventional counterparts in the global financial crisis. The development of suitable Islamic finance structures is already well advanced.

A successful example of Islamic project finance is the recent US$1.2bn financing of the expansion of Madinah Airport in Saudi Arabia, comprising a commodity Murabaha equity bridge facility, procurement facility and working capital facility, all Shariah compliant and primarily denominated in Saudi Riyals. This project was the first full PPPproject in Saudi Arabia and one of the largest infrastructure projects in the Middle East in 2012. The successful completion of the Madinah Airport expansion PPP should see an increased use of the PPP model, particularly in the airport sector. By way of example, it is expected that Taif Airport in Saudi Arabia will come to the market later this year and will most likely adopt a PPP structure. Islamic financing is sure to play a crucial role in this development.

Finance from institutional investors.Institutional investors such as pension funds have increasingly been courted to provide funding as infrastructure projects are seen as long-term investments matching funds’liabilities, which can assist in diversification and potentially be used to hedge against exposure to increased inflation. In particular, the health and education sectors in the region are now viewed by institutional investors as separate asset classes in themselves, which are simultaneously seen as ‘safe’ while generating returns which would normally only be seen in riskier investments in more mature markets.

Capital markets.International capital markets are being looked to in a bid to plug funding shortfalls, with more equitable risk allocations, the introduction of mezzanine finance and first loss instruments, as well as the provision of government support, all being considered as ways of making infrastructure investment more attractive.

Joanne Emerson Taqi is a partner and head of the Bahrain office, Paul Mansouri is a partner, and David Johnston is a lawyer, at Norton Rose Fulbright. Ms Taqi can be contacted on +973 16 500 214 or by email: joanne.emersontaqi@nortonrosefulbright.com. Mr Mansouri can be contacted on +971 2 615 1729 or by email: paul.mansouri@nortonrosefulbright.com. Mr Johnston can be contacted on +973 16 500 244 or by email: david.johnston@nortonrosefulbright.com.

Joanne Emerson Taqi, Paul Mansouri and David Johnston

Norton Rose Fulbright