In 2020, Ukraine’s government awarded the first two concessions in the history of Ukraine – 35-year concessions of the assets of Kherson and Olvia, two significant ports on the Black Sea. Building on this success, in October 2020, the government made a media splash by releasing a roadmap for further public private partnership (PPP) projects and held various promotion events since then.
The government’s infrastructure pipeline consists of a number of potential concession projects in relation to sea ports, airports and other infrastructure facilities such as railway stations, as well as other PPP projects concerning, in particular, motorways. In the past, Ukraine's government was mulling over the toll-based concessions for some of the motorways. While the government would be most happy to proceed with an output-based arrangement that places the revenue risk with the private party, it has been largely accepted now that, in the absence of long-term traffic data in addition to the general country risk, road concessions in Ukraine are unlikely to attract private sector interest and, therefore, availability-based PPPs are more viable.
In more developed economies, there currently seems to be a growing disenchantment with the availability payment structures as these can be significantly more expensive when compared to straight government debt and less flexible, e.g., cannot be refinanced in recessionary times. In the context of Ukraine, in the opinion of financial experts, these concerns can be easily balanced out by minimising cost overruns and delays by using private sector expertise in relation to not only construction but also long-term operation and maintenance.
Terminology: PPPs, PFIs and Concessions under Ukraine law
Ukraine has generally adopted the international terminology in relation to PPPs, however, not without a twist. A conversation around Ukrainian infrastructure opportunities with a potential investor or financier often starts with sorting out the basic definitions – PPP, PFI and concession.
Under the Act of Ukraine on State and Private Partnership 2010 (PPP Act), a public private partnership may take form of a concession, “an arrangement for management of an asset that provides for investment obligations of the private party”, a joint venture, or other forms. The second form may be seen to resemble what is commonly referred to across Europe as private finance initiative (PFI). This said, in the absence of a concise notion, experts in Ukraine casually refer to projects that are not concessions as PPPs, although, strictly speaking, concession is also a type of PPP under Ukraine law.
Concession has been set aside from other types of PPPs in Ukraine because of the different legal framework. As mentioned, concession is regarded a type of PPP under the PPP Act. However, it is primarily governed by different law – the Act of Ukraine on Concessions 2019 (Concession Act) which provides that the PPP Act applies to a concession “only when expressly provided by the Concession Act”. There is only one instance where this is actually the case.
Public Sector Contribution to a PFI Project
Similar to other jurisdictions, the public sector contribution to a PFI project will be primarily in the form of availability payments, i.e., regular payments made by the grantor to the private party once the piece of infrastructure has been commissioned into operation (i.e., has become “available”). Recognising the importance of a robust legal framework for availability payments, in May 2021, Ukraine's parliament adopted in the first reading a bill on amendments to the Budget Code of Ukraine to provide for medium term budgeting for availability payments and allow changes to the state budget for the current year to accommodate any extraordinary liabilities such as termination payments. These amendments are expected to be voted on by the end of 2021.
Under existing Ukrainian law, the state or a municipality may also make its contribution to a PFI project by other means, referred to in the law as “state support”. In addition to availability payments, the grantor may commit to certain other actions, including (a) making other payments to a project company from the state or municipal budget that may include milestone and completion payments during the construction period, (b) purchasing of a pre-determined amount of services provided by the project company, (c) supplying goods and/or providing services to the project company (potentially, on terms that are better than otherwise available in the market) and (d) constructing or upgrading the adjacent infrastructure (such as rail tracks, communication lines and utilities network), which is not part of the project but is “necessary for the performance of the PFI agreement”. Also, importantly, the state support may be theoretically provided in the form of a state or municipal guarantee.
While the law is not elaborate on this point, a guarantee would make the most sense as an instrument securing obligations of the project company under the credit documentation for financing of the project. At present though, such a structure would not work because of special rules on state and municipal guarantees under the Budget Code of Ukraine.
Public Sector Contribution to a Concession Project
A concessionaire would seek an agreement that provides for availability payments if user charges are not sufficient to pay the anticipated project costs in full, as well as to achieve the private party’s targeted return. The Concession Act addresses, in particular, a situation when a concession project first relies on availability payments in the early stages in addition to the user charges. Later on, when the project starts generating larger revenues, the public party stops making availability payments and the concessionaire makes reverse concession payments to the grantor.
A concession project in Ukraine may also benefit from state support in the form of (a) purchasing a pre-determined amount of services provided by a project company, (b) supplying goods and/or providing services to the project company and (c) constructing or upgrading the adjacent infrastructure at the state’s or municipality’s cost. Unlike the PPP Act, the Concession Act does not list a state/municipal guarantee among the forms of state support for a concession project though. While this makes sense in the context of a revenue generating brownfield concession project, it is probably a shortcoming in relation to a concession project that relies on availability payments, as discussed above.
A PFI project may be fully financed by availability payments under Ukrainian law. A concession project may benefit from availability payments only to a certain extent. As can be concluded based on several provisions of the Concession Act, the amount of availability payments (combined with the state support in other forms, if any) may not exceed the amount of the concessionaire’s investment and cover the larger part of the operational risk, including the demand risk. Therefore, a concession project must generate revenue in the form of user charges that, over the lifetime of the project, must be at least equal to the amount of the availability payments. Based on the foregoing, the concessionaire’s debt services expenses and profit would need to come exclusively from the user charges.
At the moment, the Ukrainian government is working on feasibility studies for the concession and PFI projects that will be granted via competitive tenders in 2022, as well as on changes to Ukraine’s Budget Code that would address concerns related to the government’s ability to make availability and other payments during the lifetime of the project. We hope that the government will keep up the momentum and other PPP projects will follow the successful seaport concessions of 2020.
By Andriy Nikiforov, Partner, Redcliffe Partners