Infrastructure series: Public Private Partnerships (PPP) in Indonesia
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There is a strong consensus now that the PPP model works. In the last five years the number of PPP projects increased quite exponentially. The PPP market is made up largely by local investors and local financiers. State-owned companies and state-owned banks are pioneer-investors who kick-started the PPP market. We are now seeing more and more private (local) companies team up with state-owned companies. Foreign investors have started to come but at a much slower pace.
The PPP market is already equipped with a fairly robust PPP regulatory framework, including design process, government fiscal support as well as institutional support. Institutions such as KPPIP (Committee for Acceleration of Priority Infrastructure), Bappenas (National Development Agency) and Ministry of Finance – all three at the policy level – and Indonesian Infrastructure Guarantee Fund (PT Penjamin Infrastruktur Indonesia (Persero)) and PT Sarana Multi Infrastruktur (Persero) – both at the execution level – have contributed in shaping the market into what it is today.
What is next for the PPP market? One could argue that it should be attracting more foreign direct investment, to bring in more capital and, for certain sectors, expertise. The latest change to the Investment Negative List has made it possible for 100% foreign investment in most infrastructure sectors. In order to push this further, there should be a clear objective in the project design on the type of investors that the project wishes to attract. Clearly foreign investors could not be put in the same category as local investors. Local investors’ ability to absorb local risks is generally higher. This is because local investors may be able to offset losses incurred in one investment with gains in another investment within the country, or obtain another concessions from the government in another investment for their willingness to invest in a project – this is also common in other developing countries. Compared to local investors, foreign investors have more choices of jurisdictions to which they make outbound investments, and hence the need for compelling reasons to choose to invest in Indonesian PPP projects and forgo opportunities elsewhere. Some of the key legal concerns of foreign investors are:
a. Counterparty risk: for example, sovereign payment risk and performance risk. Who the contracting agency is matters, e.g. central government versus regional government, state-owned company versus regional-owned company. Further, for foreign investors, relying on IDR revenue for expected return in another currency has also lessened their interest in Indonesian PPP although we understand some are more receptive to this.
b. Contractual rights enforcement risk: the choice between local courts and international arbitration. Bringing a dispute against a government counterpart in the local courts is likely to be unconvincing.
c. Regulatory risk: implementing or sectoral regulations are often short-lived (while concessions typically run for 25-30 years) because they are the products of the incumbent government administrations. When the administration changes, the priority agenda may change and there is a risk that the regulations would also change.
Overview of Regulatory Framework
1. Government contracting agency (PJPK)
PJPK acts as the party that signs the PPP agreement or the concession agreement with the BUP on behalf of the government. For example, the Ministry of Transportation acts as PJPK for transportation infrastructure projects initiated by the central government. For regional PPP projects, the regional government (e.g. the Governor of DKI Jakarta) shall act as PJPK.
2. Solicited and unsolicited ppp
There are two ways in which PPP projects are initiated: solicited and unsolicited. A solicited PPP project is a project proposed by the government. In contrast, an unsolicited PPP project is initiated by business entities or the private sector.
2.1 In general, PPP schemes consist of four phases: planning, preparation, transaction, and implementation.
This phase consists of activities which are mostly conducted by PJPK: project identification, preliminary study, and public consultation. First, PJPK identifies a viable PPP project from a list of projects proposed by the government. Concurrent with this, the relevant stakeholders and the general public will be consulted in order to take into account the larger impact of the project. Secondly, a preliminary study is conducted on the project. Such a study covers the form, scheme and source of financing, as well as the offer plan of the project in question.
b. Preparation phase
This phase encompasses the formulation of the pre-feasibility study, market sounding, and proposal for determination of project location. Based on the pre-feasibility study, PJPK will analyse the requirements for the land needed for the project. If land acquisition is required, PJPK will prepare land procurement documents.
In addition, PJPK may submit a proposal for government guarantee and/or support during this phase. The provision of government support may be approved by the Minister of Finance, while a proposal for government guarantee may be submitted to the Minister of Finance through PT Penjamin Infrastruktur Indonesia (Persero) prior to the completion of the pre-feasibility study.
c. Transaction phase
The transaction phase encompasses market sounding, determination of project location, procurement of BUP, signing of the PPP agreement, and financial close for the project.
BUP must obtain financing for the project no later than 12 months after signing the PPP agreement. This period may be extended by PJPK for up to a maximum of six months, if by the time the 12 months have elapsed the BUP fails to obtain the necessary financing and providing that such a failure is not a result of negligence by the BUP. If the obligation remains unfulfilled after the extension concludes, the PPP agreement may terminate.
Debt financing is deemed to have been fulfilled if the loan agreement has been signed, and parts of the loan have been disbursed to commence the construction work. If the project is divided into several phases, the financing is deemed to have been achieved if the loan is signed to fund one of the phases and parts of the loan have been disbursed to commence the construction work.
d. Implementation of agreement
After the PPP agreement is signed and the BUP has secured financing for the project, the implementation phase will commence (e.g. construction).
2.2 Unsolicited PPP
The process of an unsolicited PPP project consists of three phases: approval process, procurement of BUP, and transaction phase.
a. Approval process
A business entity may initiate a project by submitting a letter of intent and a study on the project. The study may be submitted in the form of a pre-feasibility study or a feasibility study. Depending on the choice of the initiating entity, the approval process will occur through one of these two scenarios:
i. If the business entity opts to first submit a pre-feasibility study, PJPK will evaluate the pre-feasibility study. If the pre-feasibility study is approved, an approval letter will be issued by PJPK, allowing the entity to proceed to prepare a feasibility study. If the feasibility study is also approved by the PJPK, the PJPK will issue an approval letter and announce the entity as project initiator.
ii. If the business entity opts to submit a feasibility study, it is not required to obtain a pre-feasibility study approval letter. If the feasibility study is deemed adequate, PJPK will directly issue an approval letter and announce the entity as project initiator.
Once the PJPK approves the proposal, the project will be procured under the PPP scheme. The initiating business entity may be compensated in the form of:
i. additional 10% points in the bidding process;
ii. the right to match to the best bid; or
iii. purchase of the project (i.e. the intellectual property) by the PJPK or the winning bidder.
The form of compensation shall be clearly set out in the approval of PJPK.
b. Procurement of BUP
Procurement of BUP in an unsolicited PPP project will be performed in the same manner as a solicited PPP project.
c. Transaction phase
Signing, financial close, and implementation of PPP agreement will be carried out in the same manner as a solicited PPP project.
3. Procurement of BUP
PJPK organises the procurement of BUP during the transaction phase, after the location of the project has been determined. Procurement of BUP consists of a preparation phase and an execution phase. The preparation phase is carried out by the procurement committee formed by PJPK, while the procurement phase comprises two activities: prequalification and selection of BUP.
A business entity that meets the prescribed criteria issued by PJPK would be eligible to participate in the prequalification phase.
3.2 Selection of BUP
Procurement of BUP may be performed through a bidding process or by way of a direct appointment. The business entity selected through either of these processes will be required to form a special-purpose vehicle (which is the BUP) which will execute the PPP agreement.
a. Bidding process
The bidding process may occur in one or two phases. A single-phase bidding process is used for projects with clear output specifications and which do not require a discussion with bidders in order to optimise the bid. However, if such a discussion is required and the minimum requirements of the project are undecided, the bidding will consist of two phases.
For the two-phase bidding process, bidding documents provided by the participating business entities shall use a grading system to evaluate the most beneficial offer based on the technical and financial aspects of the offer. For a single-phase bidding process, participating business entities might also be evaluated based on the same grading system, or through an elimination system. An elimination system is implemented by putting in place a threshold of technical and financial standards based on the return on investment.
b. Direct appointment
Procurement of BUP by way of direct appointment may be possible if:
i. the pre-qualification process results in only one candidate;
ii. the project is for infrastructure which has been constructed and/or operated by the same BUP;
iii. the project may only be executed using novel technology, and the appointed party is the sole holder of such technology; or
iv. the BUP has acquired most or all of the land required for the project.
4. Investment returns for BUP
PJPK sets the form of return on investment which covers capital and operational costs as well as profits of BUP. The returns could originate from a user fee, availability payment, and other forms allowed by laws and regulations.
This is based on a tariff collected from public users of the infrastructure.
Revenues of BUP will be from the amount (relatively fixed) paid by PJPK to BUP, instead of from the user charges. This in effect protects the BUP against demand risk. The components of availability payment are capital cost recovery (being debt and equity) and operating/maintenance costs.
The regulations define an availability payment as periodic payments made by PJPK to BUP for the infrastructure services. In order for PPP projects to benefit from an availability payment the following requirements must be satisfied:
a. the projects must be economic and social infrastructure which benefit the community or users;
b. investment return is not derived from user charges; and
c. procurement of BUP is carried out through fair, open and transparent selection stages, and healthy competition.
Further, PPP agreements for availability payment projects shall contain at least:
a. output and performance indicators for infrastructure services;
b. agreed formula to calculate the amount of availability payment; and
c. an effective monitoring system of performance indicators.
PPP agreement can also set an incentive and penalty system for PJPK and/or BUP, in order to maintain the quality of service provided by BUP to its users.
The availability payment is paid during the operational stage of the project, in accordance with the terms and conditions set out in the PPP agreement. The fund will be paid for the first time after the infrastructure has finished construction and is declared ready to operate based on the indicators set out in the PPP Agreement.
Availability payments cannot be given to PPP projects which have been granted Viability Gap Funding or VGF.
Availability payments may be granted for both solicited and unsolicited PPP projects.
5. Government support for PPP projects
The PPP regulatory framework is designed to help develop more bankable projects to attract private participation. There are a few government supports or guarantees available for a PPP project across all infrastructure sectors, namely:
i. IIGF Guarantee
a. This is a guarantee issued by PT Penjamin Infrastruktur Indonesia (Persero) or Indonesian Infrastructure Guarantee Fund (IIGF). IIGF is a wholly owned subsidiary of the Ministry of Finance.
b. The guarantee mainly covers termination payments due to political risks, delay in tariff adjustment and delay in land procurement. Based on precedents, there is typically a cap on the amount being guaranteed by IIGF (i.e. beyond cap is not guaranteed) and the term of the guarantee is normally up to 15 years.
c. There will be guarantee fees (upfront fee and recurring six-monthly fee) payable to IIGF.
ii. Viability Gap Funding (VGF)
a. Only user-charge based projects can benefit from VGF. It is not valid for Availability Payment projects
b. VGF is essentially an upfront State contribution to fund up to 49% of the construction cost, and therefore reducing the total project cost. The Ministry of Finance is the approving authority for VGF.
c. Availability Payment (as explained in paragraph 4.2 above)