By Ferdinand Pecson
it was 10:37 pm of March 31, 2022 when the National Economic Development Authority received from the Department of Finance, a copy of the draft IRR containing the 6th signature that sealed the approval of the new IRR of the BOT Law—the key legal framework for PPPs in the Philippines.
The new IRR had eight signatures by the time it was published in print on April 11, 2022. I was the 7th person to sign.
As one of three panelists in a World Bank webinar on PPPs last June 27, 2022, I was asked what the government achieved with the new IRR and what the response of the market was. I responded by categorizing the amendments into 3: the greens, the reds, and the yellows.
In a limited sense, project preparation and project approval could be shorter, given that the documentary requirements for proposals and the criteria for project approval have been respectively defined in Section 2.7 and Section 2.10 of the new IRR.
I say this with a caveat—the new IRR added a layer in the project evaluation process that could lengthen the project approval process if nothing else is done to streamline the process.
In line with best practice in many PPP regimes, the new IRR makes PPPs transparent to the public sector.
Section 11.4 requires concerned agencies to post in their websites and in the websites of PHILGELPS and of the PPP Center, the results of a PPP bidding that they had conducted.
Furthermore, they are also required to post in the same websites, the Notice of Award they had given to the winning bidder.
Lastly, Section 14.9 requires agencies to publish in their website, the PPP contracts that they have awarded.
The new IRR raises the bar for accountability for the results expected from the project.
First, Section 2.8 requires that the project’s key performance indicators, along with the targets, measurement, and reporting of those indicators, be among the parameters, terms, and conditions that would be approved during the project approval stage.
Second, Section 4.3 requires that the draft contract be consistent with the approved parameters, terms, and conditions.
Third, Section 12.8 imposes new rules for setting the form and the amount of performance securities during the construction phase of a project.
In Section 12.9, one will find similar new rules that apply during the operation phase of a project.
Lastly, Section 12.14 provides stricter rules for liquidated damages arising from performance lapses.
The new IRR requires the government to proactively control fiscal risks. Section 15 includes the approval of government liabilities and of the measures to control such liabilities in the project approval process.
The latter includes the approval of a risk mitigation plan for contingent liabilities. Section 14.6 requires the prior consent of the government before a private proponent agrees with lenders on matters that could impact fiscal risks.
These include conditions precedents, defaults, termination, and refinancing. To minimize the amount of firm liabilities, such as a government subsidy, Section 15.2 requires that PPP projects with firm liabilities undergo a competitive bidding.
The reaction of stakeholders to the draft IRR after the public consultation process was summed up in three words by an editorial of the Philippine Daily Inquirer titled “Regressive BOT amendments.”
By providing a restrictive definition of material adverse government action in Section 1.3, the new IRR had effectively transferred regulatory risk and change-in-law risk to the private proponent.
This is a departure from universally accepted practice of allocating these risks. The resulting sub-optimal allocation of risks severely impacts the bankability, if not increases the cost, of PPP projects.
An issue affecting project bankability is the lack transparent and consistent policies for the setting and adjustment of user charges.
Past PPP contracts mitigated this risk by including among the provisions in a PPP contract, the initial user charges, the formula for future adjustment of user charges, and a government contingent liability that would ensure enforcement of those provisions.
This risk mitigation measure previously made it palatable for project proponents to take on demand risks in BOT contractual arrangements. While Sections 12.16 and 12.18 still allow user charges and adjustments to be set in PPP contracts, these would not be enforceable unless the regulator had approved such charges and adjustments.
However, Section 12.18 disallows the previously mentioned contingent liability.
On the other hand, Section 12.22 exempts the acts and decisions of regulators from arbitration. Despite the potential for conflict of interest, the public partner is also the regulator in many Philippine PPP projects.
The market also lamented the increased bureaucracy caused by the addition of another body in the approval process. Section 2.10 creates a Technical Working Group consisting of the NEDA, the DOF, and the concerned agency.
This group is tasked to evaluate a project against the criteria for approval set in Section 2.10.
Unless the role of the ICC-Technical Board is re-defined, I can attest, as someone who had sat in the ICC-Technical Board, that the evaluation of the project against the criteria would be repeated by the ICC-Technical Board.
As both NEDA and the DOF are members of the ICC-Technical Board, this duplication of work creates somewhat of a moral hazard—can NEDA or DOF still take a different position at the Technical Board level, if they have already endorsed the project at the Technical Working Group level?
The goal of Section 5.4 c. is clear and valid—“The prospective Project Proponent must have adequate capability to sustain the financing requirements for the detailed engineering design, Construction and/or operation and maintenance phases of the project.”
Furthermore, this section maintains the use of the “capability to raise equity” as an indicator of Financial Capability. However, the new way of calculating this type of indicator confounded stakeholders during the public consultation.
As per Section 5.4 c, the “capacity to raise equity” shall be “measured in terms of the latest net worth less equity commitments to other projects.
Net worth shall be measured by deducting total liabilities from the total assets based on the latest audited financial statements of the company or each member of the consortia.”
Still another amendment that received negative feedback during the public consultation is the addition of the “adjusted rate of return” in the definition of reasonable rate of return.
As per Section 1.3—“The adjusted rate of return shall be the project internal rate of return or the internal rate of return to equity shareholders after adjusting the project’s free cash flows to reflect the value of all Government Undertakings and risks assumed by the government.”
This is one more clause that needs a healthy exchange of views between the government and the private sector.
Given the sub-optimal allocation of regulatory risk and change-in-law risk that the new IRR had effectively created, I expect that future PPPs would not be bankable unless either of two things happen:
The government takes on the demand risk and ensures certainty of revenue streams by using build-transfer or build-transfer operate contractual arrangements; or,
Regulatory bodies create transparent policies for user charges and adjustments to those charges.
The situation at local government units is different.
My fearless forecast is that unsolicited joint ventures governed by local PPP codes shall continue to dominate the pipeline of local government PPP projects.
The new administration seems to have anchored its pursuit of economic recovery, partly in building a pipelines of PPPS. However, it needs to listen to the concerns that the private sector has with the new IRR. The new administration must fine-tune the new IRR as soon as possible. It can always say that rome was not built in one day. Immediately collaborating with the private sector in addressing issues of bankability and in clarifying the IRR would send a clear message that the new administration is serious about PPPS.
My fearless forecast is that they will. It is important however that the new administration address the severe lack of skills and capacity of agencies to prepare PPP projects.
This is brought about on the one hand, by changes in leadership and personnel as the administration changed, and on the other hand, by the fact that in the last administration, unsolicited proposals prepared by the private sector dominated the PPP pipeline.
While unsolicited projects had remained unapproved due to new requirements imposed by the ICC, one must note that those projects had already undergone advanced preparation work. For those unsolicited projects that have high value for money and have compelling economic rate of returns, the new administration could consider the following options:
Continue the unsolicited project but ask the concerned agencies to restructure the proposals to be consistent with the new IRR and with government policies that are relevant to the project.
Convert the unsolicited projects into solicited projects so that this can be bid out more competitively. Doing so will increase “value for money.”
Given the time involved in preparing solicited projects (1.5 to 2 years), my fearless forecast is that the new administration would not rule out any of the above two options.
(FPecson is President, P3 Management Consultancy Services)