Iraq Housing PPP
We have outlined in this paper a summary of how a Public Private Partnership (PPP) might be structured in Iraq for the delivery of new housing for rent.
The UK Approach
With the current very high demand for housing in Iraq, it may now be an appropriate time to look at new housing solutions that do not rely upon the public sector alone. The UK has faced similar challenges in the past and decided to implement a number of policies to dramatically change the basis upon which housing solutions are delivered. The philosophical shift is that the UK Government has moved to a more limited role of policymaker and regulator in the sector. It also provides certain grants, financial support and subsidies to make the sector appealing to private sector developers and lenders. It does not, however, get involved directly in the design, procurement, construction and project management, financing and delivery of new housing facilities. This responsibility has largely been passed onto the private sector.
Housing in the wider MENA Region
Most MENA Governments have already started to move away from the traditional procurement model in sectors such as power, water, waste and transportation. The BOO/BOT/BOOT/BTO models that we now see being used for infrastructure and utility projects can also be extended for use in the housing sector, although there are a number of important differences that must be recognised and built into a housing concession. Infrastructure assets and public utilities are fundamentally different from somebody's home.
Bahrain will shortly complete its first affordable housing PPP, and we are aware of a number of other MENA governments that are now considering some pilot PPPs in this sector.
An example of the sort of project to which this structure could apply is one for the delivery of housing for Government employees. In any such arrangement the Government is looking for quality housing built on time and then well managed and maintained. The private sector contractor (Contractor) looks for certainty as to what it is being required to deliver both in terms of works and services; a predictable income stream; and a strong covenant in relation to payment of that income stream.
What are the Key Requirements for a MENA Housing PPP?
Specification; output rather than input
To ensure that quality accommodation is delivered on time there are a number of key features to be incorporated into the PPP documentation. It is fundamental that a clear specification is produced. Such a specification must clearly set out the Government's requirements in a way that can be measured objectively. We would expect the specification to be drawn up on an output rather than an input basis. Ultimately, sign-off of the dwellings on practical completion will be dependent upon meeting these output requirements.
Monitoring, review and approval of the works
Whilst the Government is not directly employing the building contractor, it is necessary to have the ability to monitor the works as they progress. This will enable problems during construction to be picked up at an early stage. Equally however, given the nature of the project structure, one would not expect the Government advisors to be on site on a regular basis.
As practical completion is reached independent sign-off against the specification requirements is key. An independent certifier should be appointed i.e. not a professional employed by the Contractor. Such an independent professional needs to owe a duty of care to the Government.
Payment triggers, liquidated damages and compensation
To ensure that the project is delivered to the appropriate standard, payment for the delivery of the service only commences once that service is available i.e. when the dwellings are practically complete and signed-off as meeting the specification requirements. If there is a delay in construction the Government should consider whether it is appropriate to levy damages (both for delays and underperformance). The Contractor is already incentivized to deliver the project because payment only commences when the project is complete. It may be, however, that there is a need for the accommodation to be delivered by a certain date, perhaps linked to vacation of another property. That might make levying damages appropriate. In the MENA utility sector, there tends to be a very heavy liquidated damages regime on PPPs because of the critical and time sensitive need for power and water.
If problems emerge during the construction period and these relate to the standard of construction, the periodic inspections and potential opening up of works ought to identify them. That should give the Government the opportunity to require remedial action to be taken during the construction process. If that remediation is not tackled adequately, or if the Contractor runs into solvency difficulties, then a right to terminate the arrangement needs to be built into the documentation.
If the project is terminated part way through construction, consideration needs to be given as to whether any compensation will be paid to the Contractor. The Contractor will be looking to ensure that the Government does not seek to benefit from a windfall through the termination of the project. It may be appropriate to incorporate compensation perhaps along the lines adopted in the UK for PFI projects. This works on the basis that the Contractor is paid the value of the remaining term of the contract. Bidders are sought and whatever a bidder is prepared to pay to take on the project, is passed across to the Contractor.
This type of compensation arrangement may result in no payment at all. As a consequence, the Contractor's funders will typically require a right to "step in" prior to the final termination of the concession. This is likely to be of assistance to the Government as it avoids having to take on a partially completed project and pass it onto a third party. The funder is incentivised to act because that is a way of preserving the project cashflows and ultimately, therefore, repayment of debt.
Once practical completion is achieved the housing will be let and operational responsibility will sit with the Contractor. The concern here will be to ensure that the property is managed and maintained to appropriate standards. As with the construction phase, it is essential that a service specification is drawn up which defines what is required. That service specification should be one against which performance can be monitored.
Under a PPP contract one would expect payment to be made only where services are provided to the requisite standard and for deductions from payment to be made where standards slip. A payment mechanism sits alongside the services specification. That translates failure into financial deductions.
If services are completely unavailable because, for example, the premises have been destroyed by fire, then no payments are made until reinstatement is achieved. This of course means that the Contractor is taking the insurance and reinstatement risk.
In the UK, measurement of performance against the standards is normally undertaken by the Contractor on a self-monitoring basis, audited periodically by the Government or its advisors. It is unlikely that this would be the preferred approach in the MENA region and assuming that this is the case, the Government could undertake monitoring itself but this will have obvious cost implications.
Consideration needs to be given to the appropriate party to take the risk of demand continuing for the accommodation. It is unlikely that the private sector will wish to take this demand risk or, if they do, they will charge a significant risk premium for doing so. Accordingly, it is likely to be appropriate for the Government to undertake to pay for the dwellings whether they are occupied or not but only, as indicated above, where the dwellings are to the appropriate standard.
In relation to the power, water and waste PPPs that have already been implemented in the region, there is always a single government offtaker that takes full demand risk by entering into a "take or pay" contract for the full output of the facility. On the other hand, transportation projects in the MENA region have sought to pass on some of the demand risk to the concessionaire. For the first MENA housing PPPs, the regional utility model (rather than transportation model) is the preferred starting point from a bankability perspective.
If there is failure during the operational phase this may be a failure of service delivery or a solvency failure. As with the construction period, the Government needs the right to terminate the contract. Funders will wish to have the right to step in to preserve the concession cashflows. If the contract is ultimately terminated we would suggest that compensation payments are appropriate but that as with the construction period, these should be geared to the value of the remaining project term.
We have referred to termination of the concession in circumstances where the Contractor has defaulted. Other bases for termination also need to be considered. The Government may wish to bring the concession to an end early. If the Government fails to pay or is otherwise materially in breach the Contractor may wish to be able to terminate. Force majeure may result in the concession ceasing to operate. In all of these scenarios termination compensation will be expected by the Contractor. Where the Government is at fault or wishes to terminate early that compensation is likely to be of an amount sufficient to pay off lenders, subcontractors and equity returns.
In the UK, dealing with land issues is reasonably straightforward. In the MENA region, it is important to make sure the basic platform for all rights necessary to (i) undertake the concession, and (ii) provide appropriate security to the lenders are in place. If the land is owned by the government, a long lease/usufruct agreement will need to be given for the duration of the concession. If the land is privately owned, arrangements will need to be made to ensure that the interests of all members of any housing consortium and lenders are properly protected (given the restrictions on foreign ownership and the constraints on being able to grant long leases in many jurisdictions).
Ownership of the asset
Consideration needs to be given to ownership of the asset being developed. The asset may be owned by the Government and the Contractor may build and manage under licence. Much here depends upon whether the Government's intention is to retain the asset in the long term or whether it is willing for the Contractor to take the property once the project term ends. If the Government is prepared to leave the asset with the Contractor then it ought to be possible to factor in the residual value benefit to the Contractor thus lowering the periodic payments to be made under the concession agreement. The Government can retain the option to repurchase the asset. The Government may also wish to consider retaining an interest in an uplift in value at some point in the future. For certain strategic assets, the Government may be reluctant to allow the asset to be owned by the private sector. This was the case on the Hajj airport BTO project, where the Government of KSA felt that the Hajj airport was a national and religious asset of the country that should not be owned by the private sector. This meant that the transaction had to be structured on a BTO basis (i.e. build, transfer, operate-so that as each stage of the construction was completed it was handed over to the Government). Whilst this did create serious challenges in making the project bankable because the traditional project finance security package, including a mortgage or charge over the assets could not be given, the deal did eventually reach Financial Close.
Other likely provisions in a PPP structure of this type will include the following; a right for the Government to vary the contract but with the Contractor being left in a 'no better no worse' position; risk sharing in relation to changes in law during the concession period; refinancing provisions allowing the Government to share in refinancing gains; change of control clauses ensuring the ownership of the Contractor does not change too early or become vested in a body the Government regards as unacceptable; and clauses allowing for the Contractor to be afforded relief from termination or payment deductions in certain limited circumstances arising from events beyond the Contractor's control.