Masanori Sato and Shigeki Okatani of Mori Hamada & Matsumoto in Tokyo review the latest changes in Japan’s PPP environment
I. Dawn of a new era of PPP in Japan
This year 2014 will mark the beginning of a new era for public-private partnerships (PPP) in Japan. Last year, there were significant movements to improve the legal and regulatory framework of the Japanese PPP and the national government and the local governments started studying the possibility of adopting the concession type of PPP to privatise their infrastructure.
This article features the efforts of the national government to promote PPPs in recent years and the latest developments in some asset classes.
II. Government’s moves to promote PPP
Introduction of PFI Act Concession
The recent trends for the promotion of PPPs started with the revision of the Act on the Promotion of Private Finance Initiative (the PFI Act) in 2011. Since the original PFI Act was enacted in 1999, more than 400 PFI projects have been implemented. However, most PFI projects in Japan have been BTO (build-transfer-operate) types, which rely on availability payments from the government for the purpose of constructing limited kinds of social infrastructure such as governmental buildings and local public facilities.
On the other hand, demands for new infrastructure are decreasing in Japan due to an aging and declining population. Furthermore, the Japanese government has ranked the maintenance and renovation of existing infrastructure under severe fiscal conditions as a national priority. In addition, the government’s operation of infrastructure has often been perceived as poor or inefficient, and support from private sector, it is claimed, achieves a more efficient operation.
Against the foregoing backdrop, the 2011 Revised PFI Act introduced concessions (the PFI Act Concession) as a new type of PFI project in order to promote a “user-pay” type of projects in which private entities operate and maintain existing infrastructure by financially relying on users’ fees rather than service fees or availability payments from the government.
More specifically, under a PFI Act Concession, a public entity that administers public facilities (the Public Authority) confers the right to operate those facilities (the Concession Right) on a private entity (the Concessionaire).
The Concessionaire is allowed to charge the users fees for using the public facilities. This means that, in principle, the Concessionaire itself determines the fees and earns the collected fees as its own income, although fee determination may be subject to a concession agreement with a Public Authority or to laws and regulations on the pertinent infrastructure business (e.g., the Airport Act, the Water Supply Act and the Sewage Service Act.). From an accounting perspective, a Concession Right is recognized as a depreciable asset.
Under the PFI Act, a PFI Act Concession project cannot rely only on payments from a Public Authority. A PFI Act Concession should take the form of either a “user-pay” type of project, or a combination of user’s fees and payment from the Public Authority.
Revisions to guidelines for PFI Projects
On June 6 2013, the Cabinet Office revised the following PFI guidelines.
• Guidelines for Concession Right and Operation of Public Facilities (new)
(the Concession Guidelines)
• Guidelines for the PFI Project Implementation Process (revised)
(the PFI Procurement Process Guidelines)
• Guidelines for Contracts – Matters to be Considered in PFI Project Contracts (revised)
(the PFI Contract Guidelines)
1. Concession Guidelines
The issuance of the Concession Guidelines, the first detailed guidance on PFI Act Concessions, is a very significant development in the practice of Japanese PFI. (Actually, the fact that these guidelines were not in place up to recently could partly explain why no PFI Act Concessions under the 2011 Revised PFI Act closed.) Described below are some of the notable provisions of the Concession Guidelines.
(a) Expansions, renovation and construction of the facilities
The Concession Guidelines provide the scope of the measures that a Concessionaire is permitted to take in respect of the subject public facilities during the concession period.
According to the Concession Guidelines, generally speaking, a Concessionaire may make expansions or renovations that are necessary for the operation of the facilities, but the specific range of permissible expansions or renovations in a specific project must be determined by the relevant Public Authority.
In contrast, the construction of new facilities and the complete removal and redevelopment of existing facilities, which are outside the scope of a Concession Right, will be conducted through traditional public works or conventional PFI projects (for example, build-transfer-operate (BTO) with availability payments).
(b) Assignment and transfer of Concession Rights
The transfer of a Concession Right, including one following a foreclosure sale, requires the permission of the relevant Public Authority under the PFI Act. The Concession Guidelines suggest that if (i) the transferee is not subject to any ground for disqualification and (ii) the transfer of the Concession Right is appropriate under the bid tender documents prepared by the Public Authority, then the Public Authority does not have any discretion and must permit the transfer. Any condition that a Public Authority may impose on the transfer of a Concession Right must be provided in the tender documents. It can be said that the Concession Guidelines have improved the predictability of granting permissions for the transfer of Concession Rights although requirement (ii) above still suggests ambiguity.
(c) Rescission of Concession Rights
A Public Authority may rescind a Concession Right if certain events occur with respect to the Concessionaire or if rescission is necessary to protect public interest.
The Concession Guidelines suggest that Concessionaires who suffer losses as a result of the rescission of its Concession Right due to public interest will be compensated in accordance with the standards of compensation for business as stipulated in the Standards for Compensation for Land Acquired for Public Use. They further suggest that the Public Authority must refund the portion of the concession fee that corresponds to the remaining project term.
2. Revised PFI Contract Guidelines: transfer of shares of Project Company
In past PFI projects in Japan, consortium members were required to be shareholders of the project company throughout the project term, and in many cases the transfer of shares of the project company without the approval of the Public Authority was prohibited in the basic agreement between the Public Authority and the consortium members as well as the PFI project agreements. However, the revised PFI Contract Guidelines clearly acknowledge that the need to restrict share transfers depends on various factors such as the content and phase of the project, and clarify that conditions to the transfer of shares held by a consortium member must be kept to the minimum extent necessary to appropriately implement the project, given the role of each such consortium member in the project.
Action plan for fundamental reforms of PPPs/PFIs
The Council for the Promotion of Private Finance Initiatives of the Cabinet Office established the ‘Action Plan for Fundamental Reforms of PPPs/PFIs’ on June 6 2013. This action plan aims to intensively promote PPP/PFI projects to achieve a more efficient operation or renovation of infrastructure, enhance the level of services and reduce government fiscal burdens. The action plan presents specific project types and ambitious size targets (totaling ¥10–12 trillion over the next ten years from 2013 to 2022) as follows:
1. Concessions: ¥2–3 trillion
Relevant authorities will actively promote PFI Act Concessions in airport, water and sewage projects
2. Public facilities with income-producing facilities: ¥3–4 trillion
PFI projects for the construction, renovation, maintenance or operation of public facilities, which, together with income-producing facilities attached to them, may generate sufficient revenues to cover the costs associated with those projects.
Relevant authorities will study the use of PPPs for the maintenance and renewal of public facilities such as expressways (especially the Shutoko Metropolitan Expressway, which requires major repairs)
3. PPP projects based on private proposals: ¥2 trillion
PPP projects that adopt proposals from the private sector, for example, for the effective utilisation of unused or underused public real estate.
4. Other project types: ¥3 trillion
Other conventional types of PPP projects in which measures to reduce government fiscal burdens are to be pursued, such as structuring facility management fees based on revenues generated from the project (i.e., as opposed to availability-based fee arrangement) or combining the renovation and maintenance of multiple facilities.
Creation of an infrastructure fund co-sponsored by the public and private sectors
The Private Finance Initiative Promotion Corporation of Japan (PFIPCJ) was incorporated on October 7 2013 under the 2013 Revised PFI Act. The PFIPCJ is co-sponsored by the national government and private entities such as banks and insurance companies. The PFIPCJ is supposed to financially support PFI projects mainly by mezzanine financing, which will primarily take the form of mezzanine debt or preferred shares in project companies. It should be noted that, under the revised law, the PFIPCJ should focus on the user-pay type of PFI projects.
The PFIPCJ is expected to promote equity investments in PFI projects and nurture the infrastructure investment market by using national funds as seed money. User-pay PFI projects are expected to reduce the national deficit and create business opportunities for the private sector.
III. Development of PPP in each asset classes
Airports
1. Privatisation of national airports
The Act for the Operation of Government Controlled Airports by Private Sector Entities (the Airport Concession Act) enacted in 2013 enabled the government and local governments to privatise airports through a PFI Act Concession. Later, in November 2013, the Ministry of Land, Infrastructure, Transport and Tourism (MLIT) promulgated the Basic Policy on the Operation of Government Controlled Airports by Private Sector Entities (the Basic Policy on Airport Concessions), which provides the basic framework for concessions of national airports.
The central government intends to sell 30-50-year Concession Rights for national airports, which it owns and manages, subject to the consent of the local government of the region where the airport is located. With the strong support of the governor of Miyagi Prefecture, the government is now preparing the privatisation of Sendai Airport as the first case of a national airport concession.
The move towards privatisation is driven by increased demand for the efficient management of airports: the government needs to maintain airport facilities under severe fiscal conditions, and airlines face a severe competitive environment and are demanding more flexible airport services at lower costs from airports.
In addition, in many airports in Japan, the government owns basic aeronautical facilities, such as runways, aprons and aeronautical ground lights, and manages aeronautical operations such as negotiating new routes, number of flights and arrival and departure times with airlines, while private or third sector entities own and manage non-aeronautical facilities such as airport terminals and car parking facilities. That division is believed to hinder Japanese airports from taking strategic approaches, such as offering lower airport charges to airlines by generating income from non-aeronautical operations, to improve airport services and economics. According to the Basic Policy on Airport Concessions, a Concessionaire will manage both aeronautical and non-aeronautical operations by acquiring the ownership of airport terminals and car parking facilities from the existing owners as well as acquiring the Concession Right on basic aeronautical facilities from the government.
As there has been no precedent for airport concessions in Japan, many issues need to be discussed, such as the scope of work to be provided by the Concessionaire, the structure of concession fees (e.g., upfront or annual fee, fixed amount or revenue share), and whether the government will compensate the Concessionaire for the renovation or upgrade of facilities. In addition, the risk allocation between the government and a Concessionaire in case of force majeure events is one of several major legal issues. In this regard, the Basic Policy on Airport Concessions suggests the basic idea that the Concessionaire takes the risk covered by insurance, and the government takes the risk beyond insurance.
2. Privatisation of Kansai International Airport and Itami Airport
Separately from the privatisation of national airports under the Airport Concession Act, the government is considering using a PFI Act Concession to privatise Kansai International Airport (Kanku) and Osaka (Itami) International Airport (Itami), the two main airports in the Kansai region, which is the second largest regional economy in Japan.
Kanku opened in 1994 off the coast of southern Osaka as an alternative to Itami, the main airport in the region and was overcrowded and suffered from noise issues. Kanku is still heavily indebted due to its construction costs.
In 2010, MLIT adopted a policy to merge Kanku and Itami and privatise both airports using a concession under the PFI Act in order to repay Kanku’s debt and revitalize Kanku. In 2011, the government enacted a special legislation (the Kanku-Itami Act) to implement the policy. In June 2012, MLIT published a set of basic principles for the operation of both airports, their merger and the concession under the Kanku-Itami Act.
In July 2012, Kanku and Itami were merged into the New Kansai International Airport Co., Ltd. which is wholly owned by the national government. The merged airport is now preparing for a bid process, which is expected to start in the middle of this year, to select a Concessionaire.
Water
In principle, water supply services are provided by municipalities. The water supply section of a municipality is deemed as a Local Public Corporation, which has a separate account from the general account of the municipality. In general, Local Public Corporations for water supply services cover their expenses through water charges. Although many parts of the operation, such as the operation of filtration plants, the checkup of pipes, meter reading and water charge collection, have been separately outsourced to different private companies and some PFI projects have been implemented for the construction of filtration plants, there has been no project involving the privatisation of the whole local water supply system.
However, the municipalities are facing a decline in water demands in parallel with the decline in population. In addition, the number of public personnel in charge of water supply operations is decreasing due to severe fiscal conditions that local governments are facing. At the same time, demand to renovate aging facilities is rapidly growing. Not a few experts point out the need for municipalities to make their water supply business more efficient by combining their water supply services with those of neighboring municipalities, and by privatising through PPPs. These developments have led to some recent notable advances to utilise PPPs in the water sector.
On November 11 2013, Osaka City, the third largest city in Japan with a population of 2.6 million, decided to draft a basic policy as early as March 2014 to privatise its water services by utilising a PFI Act Concession. According to its preliminary report, the City will give the concession right to a project company as early as 2015. The project company will provide water services for around 30 years under the concession agreement with the City. It will be wholly owned by the City at the beginning but will accept private investments in five years.
Starting April 2014, Kanagawa prefecture is outsourcing its entire water supply business in the Northern Hakone region to a private consortium led by JFE Engineering Corporation. This is the first case of a local government outsourcing all of its water supply business to a private entity.
Sewage
The municipalities also provide sewage services. Unlike water supply services, however, the sewage service divisions of many municipalities receive financial support from the relevant municipality’s general accounts. Although it is more common for segments of sewage services to be outsourced, the issues faced by municipalities regarding their water supply services also apply to sewage services.
In March 31 2014, MLIT published the guidelines for sewage concession, which reflected discussions of the Study Group on the Utilisation of PPP/PFI in the Operation of Sewage Facilities set up by MLIT in December 2012. The guidelines clarify the interpretation of laws and regulations related to the sewage business and local governments, and are expected to help local governments consider concessions as a possible answer to their problems in the management of sewage systems.
Roads
In principle, only certain limited types of entities such as local governments, local road public corporations founded by local governments, and certain highway companies are allowed to manage toll roads and collect tolls under the current laws. Highway companies were incorporated about 10 years ago under laws on highway privatisation but they are still owned by the national government and local governments. Unlike airports, water and sewage, new special legislation is necessary to allow private entities to manage toll roads and collect tolls. However, despite such legislative hurdle, severe fiscal conditions are forcing some local governments to consider PPPs for road management and maintenance.
For example, Aichi prefecture has been requesting the national government to set up a special reform zone under the Act on Special Zones for Structural Reform and allow the prefecture to use a PFI Act Concession to privatise its roads currently maintained by its local road public corporation. That act allows the government to set Special Reform Zones, which are excluded from the application of certain laws and regulations.
IV. Conclusion
Significant reforms in regulatory frameworks for PPPs in Japan, particularly in the use of concessions to operate infrastructure facilities, have been put in place in recent years. The government has shown a positive attitude towards PPPs with the hope of reducing its fiscal deficit and stimulating the economy. The introduction of the PFI Act Concession in various infrastructure projects such as airports, roads, and water and sewage systems is being widely discussed. Efforts to enhance investments in infrastructure such as the creation of the PFIPCJ are also being made. These recent trends demonstrate encouraging and exciting times for PPPs and PFIs in Japan.
Masanori Sato
Partner
Mori Hamado & Matsumoto
Tokyo
About the author
Masanori is the head of MHM’s banking and structured financing practice group. He advises across the board on structured finance transactions, both internationally and domestically, including PFI, project finance, REIT and syndicated loans. He has led teams advising on a number of high profile transactions, including the first Japanese publicly offered CMBS transaction, the securitisation of public loans originated by the Japanese government and whole business securitisations in a number of sectors. Masanori was educated at the University of Tokyo and the University of Chicago Law School.
Shigeki Okatani
Senior associate
Mori Hamado & Matsumoto
Tokyo
About the author
Shigeki has expertise in PPP (public-private partnerships), particularly airport and water concessions, real estate law, financial regulations and trust law. He has advised foreign investors on renewable energy projects in Japan and entities in the Japanese public sector on PPP projects. He is a core member of MHM’s infrastructure practice group. Shigeki was educated at the University of Tokyo and the University of Virginia School of Law and has also been seconded to the Ministry of Economy, Trade and Industry of Japan.
