Russia

Russia
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Anton Konnov
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Elena Popova

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of philosophic brains, about veronika.kondruseva@allenovery.com
five hundred years) for sure our byways elena.popova@allenovery.com

will blossom into splendid highways: London

paved roads will traverse Russia’s length Andrei Baev
bringing her unity and strength;
and iron bridges will go arching Allen & Overy LLP
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over the waters in a sweep; Canary Wharf
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audacious tunnels will be marching.1 United Kingdom
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1 Translation by Charles H. Johnston.
Allen & Overy 2010 March 2010 | Global Guide to Public-Private Partnerships | 192
 1. Introduction
For the past 20 years Russia has had to rely on the deteriorating infrastructure it inherited from the Soviet
Union. As the country had one of the most distressed budgets in Europe in the 1990s, Russian Government
officials at the federal, regional and municipal levels deferred investment in public infrastructure (in line
with the position adopted by most Western governments). New infrastructure was not provided and essential
maintenance, repair and expansion of existing infrastructure did not take place. As a result, the average level
of degradation of fixed assets in transport, power and other infrastructure sectors reached 60%, with the
electricity grid and transport network in Russia’s regions needing significant redevelopment.

It is estimated by the Russian Government that approximately USD1 trillion is needed by 2020 to
upgrade Russian infrastructure to modern international standards. The investments required in Russian
infrastructure are vast:

(a) USD195 billion is needed for roads;

(b) USD204 billion for railways;

(c) USD380 billion for the health system; and

(d) USD462 billion for power generation.

Russia
Although Russia’s economic growth over the past few years has been stable and reached 7.8% in 2007,
Russian authorities have come to recognise that they cannot finance the necessary investments in public
infrastructure from current budgets and that a major part of future financing must flow from the private
sector. The Russian Government has estimated that approximately 80% of the required investment should
be leveraged from private investors. The need for the inflow of capital is becoming even more pressing in
the current downturn in the global financial markets. As a result, the authorities in Russia are trying to
offer some fiscal incentives and optimise the legal framework to encourage private investment in public
assets, including by way of PPPs.

2. Legal and regulatory framework

Background

The Russian legal system is based on civil, not common, law. The current legal framework governing PPPs
consists of the Constitution of the Russian Federation (the Russian Constitution), the Russian Civil Code
(the Civil Code), various federal laws, decrees of the President of the Russian Federation (the Russian
President), decisions and ordinances of the Government of the Russian Federation (the Russian Government)
and implementing regulations, instructions and procedures adopted by federal and regional regulatory
agencies, as well as municipalities.

Since Russia is a federation with a complex, multi-level system of government, all the powers in the sphere
of PPP activities have been allocated to federal authorities, regions and municipalities. The federation
is composed of 83 political subdivisions, each of which is an autonomous district (avtonomnyi okrug),
autonomous region (avtonomnaya oblast), federal-level city (Moscow and St Petersburg), region (oblast),
territory (krai) or republic (regions). Each region has a regional legislative body that has the power to pass
laws providing that they do not conflict with federal legislation. Within each region there are municipalities
which have their own local bodies empowered to pass ordinances which do not conflict with applicable
regional and federal laws. It is generally accepted that, together with the federal government, regions
and municipalities can use PPP-type structures to develop projects in the areas over which they have
responsibility: they are free to decide which PPP initiatives they wish to undertake, although the choice of

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 regulatory framework for such initiatives, in principle, very much depends on the nature of the project and
may not contradict any mandatory requirements of the federal legislation. Under the Russian Constitution,
federal authorities are responsible for a number of areas, including federal transport (federal roads, railway
and other federal infrastructure), the federal electricity system, nuclear energy and defence. The regions’
and municipalities’ responsibilities include water policy, social housing and transport infrastructure (other
than federal transport).

Legislative challenges

Particular problems regularly encountered in Russia are internal inconsistencies in the legislation and
the patchy enforcement and implementation of laws, including inconsistent court practices on a number
of matters sensitive for the development of PPPs in Russia, eg enforceability of certain types of security
(pledges over a bank account, direct debit (or withdrawal) agreements, conditional assignments, loss
payee appointments), parallel debt structures, step-in rights and direct agreements between a grantor and
lenders. This characteristic of the Russian legal system partially explains why Russian PPP legislation could
be regarded as a set of specific, separate regulations, rather than a detailed, coherent and comprehensive
system of rules and solutions. This is something that PPP participants may have to address in all PPP sectors
until an accepted solution is reached.

PPP legislative developments

Russia

Although Russia developed some experience of PPP-based projects during the 1990s, it became obvious
that the successful implementation of such projects would not be effective without a more comprehensive
statutory legislative package on concessions and PPP procurement. In the period from 2005 to 2008,
Russian legislators introduced far-reaching changes to the legal framework applicable to PPPs, but Russia
still does not have a specific law or set of rules governing all types of PPP project. However, a number
of initiatives in this period have facilitated the development of PPPs, including the adoption of modern
concession and investment legislation, including Federal Law No. 115-FZ “On Concession Agreements”
of 21 July 2005, as amended (the Concessions Law), the implementation of the Investment Fund
of the Russian Federation (the Investment Fund) (see below) and the liberalisation of sector-specific
regulation, especially in the areas of energy, construction, transport and infrastructure. At federal level,
the main PPP instruments are the Investment Fund and a number of state corporations, being in essence
separate “special investment funds” through which the Russian Government may provide state financing
to particular national projects and programmes. Examples include the preparation for the 2014 Winter
Olympic Games in Sochi and the reform of housing and utilities infrastructure. Such state financing may
be used for the implementation of both federal and regional PPP projects.

Advisory initiatives

There is no single central PPP policy unit to guide the implementation and promotion of PPPs in
Russia. Some sector-specific ministries at the federal level and a number of regional governments have
championed the formation of advisory councils, PPP forums and other entities with the aim of addressing
the lack of co-ordination and consistency of approach in the PPP market, increasing competition between
private sector participants and reducing transaction costs. As a result quite a few legislative initiatives
have been developed recently, and a number of public forums and consultations have been held. For
instance, the PPP Expert Council of the Committee for Economic Policy and Business of the State Duma
of the Russian Federation has come up with a list of PPP initiatives which are intended for discussion
at governmental level. The Vnesheconombank (VEB) PPP unit has arranged numerous round-tables
and conferences for Russian market participants to discuss key PPP issues and share experience in
overcoming associated difficulties. Although it is probably too early to speculate about the overall success
of such bodies, they do raise public awareness in relation to PPP problems in Russia and provide valuable
assistance to state authorities and private investors in improving the existing framework for PPP.

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 Various government representatives have announced on many occasions that concessions, and PPPs in
general, are acknowledged and welcome in Russia. However, there is still a long way to go to create a
transparent and investor-friendly legislative environment for PPP deals. Despite the existing shortcomings
of the Russian legal and regulatory regimes in the area of PPPs, there have been a number of PPP projects
implemented in Russia to date, as further discussed below.

3. PPP market overview

Early PPPs

PPPs emerged in Russia in the mid-1990s as an alternative to privatisation and the traditional methods
of state and municipal development, financing, construction, operation and maintenance of public
infrastructure. Russia has a relatively young but growing PPP market. Taking a historical perspective,
about 40% of all the projects in the water supply, sewage water treatment and power sectors developed
in the 1990s were completed in the form of various project financings. The first PPP projects were
medium-sized regional or local projects and were structured as Build, Own, Operate, Transfer (BOOT)
projects where a special purpose vehicle (SPV), wholly-owned by a private sponsor, built and acquired
ownership of the completed facilities and transferred them to a state enterprise at the end of the

Russia
operational phase. Those first Russian project finance deals included, for example, the project for the
reconstruction of wastewater treatment plants in the South Butovo district in Moscow, the project for
the reconstruction and refurbishment of the Southwest Wastewater Treatment Plant in St Petersburg
and the project for the construction of a waste incineration plant in Moscow.

Recent activity

This successful initial testing of project finance techniques in relation to medium-sized regional projects
and individual private projects (without any state involvement) has contributed to widespread confidence in
promoting large-scale national projects using project finance, and PPPs in particular. Although there was limited
PPP activity moving into the new millennium, recently, a further tier of PPPs and independent private investment
projects have been coming to the market with continued investment in water and sewage treatment and an
increased move into the transport, oil and gas (including both greenfield and complex brownfield projects),
electricity, housing and other social infrastructure sectors. There is a strong pipeline of projects in Russia,
although none of the major rating agencies has yet assigned a public rating to any Russian project finance deal.

Investment Fund

In 2006 the Russian Government established the Investment Fund to facilitate and promote PPP projects.
Its size amounted to RUB69.7 billion (USD2.56 billion) for 2006, RUB95.8 billion (USD3.74 billion) for
2007 and RUB91.4 billion (USD3.7 billion) for 2008.1

Most of the current large-scale PPPs co-financed by the Investment Fund are structured as concessions
or provide for direct financing of the assets under the project on the basis of an investment agreement
between the relevant governmental body granting the contract (the Authority) and a private investor. Under
an investment agreement, the project is partially financed by the relevant budget and/or the Investment
Fund and partially by a private investor or consortium of investors. The major PPP deals being co-financed
by the Investment Fund are as follows:

(a) Nizhnekamsk refinery and petrochemical complex in the Republic of Tatarstan (direct co-financing);

(b) M-1 “Belarus”, a section of the Moscow-Minsk Motorway (concession);

1 Exchange based on OANDA average exchange rates for 2006, 2007 and 2008.

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 (c) Moscow to St Petersburg Motorway (15-58 km) (concession);

(d) Boguchansk Hydropower and Metallurgical Complex (Lower Angara Project) (direct co-financing); and

(e) the Chita Region transport infrastructure (direct co-financing).

Developments at local level

The Russian Government’s intention is for regional and municipal medium-sized and small-scale infrastructure
projects to be procured at a local level. Some regions and municipalities such as the City of Moscow, the City
of St Petersburg, the Altay Republic, the Republic of Dagestan and the Tomsk Region have been quicker than
others to embrace the PPP initiative. At the same time, across all regions and municipalities, the attitude
towards PPPs is changing as more infrastructure needs are identified and regional and municipal authorities
warm to private sector investment as an alternative to more traditional state procurement methods. Quite a few
regional and municipal authorities have already used PPP as a tool for delivering public transport, airports,
sea or river ports and motorway construction projects.

City of St Petersburg

The extensive experience of the City of St Petersburg in the PPP field merits a separate mention. Due to its
unique location as a port city on the Baltic Sea and its relatively high level of economic development, the
City of St Petersburg has recently become a leader in PPPs, pushing forward with a number of large projects:
Russia

(a) Western High-Speed Diameter Road (WHSD);

(b) Orlovsky Toll Tunnel;

(c) Pulkovo Airport Expansion;

(d) “NADEX” high-speed light rail;

(e) “Nevskaya Tower” Business Centre;

(f) “Morskoy Fasad” St Petersburg Seaport Redevelopment; and

(g) Waste processing plant in Yanino.

Three of these projects (WHSD, Orlovsky Toll Tunnel and the Pulkovo Airport Expansion projects) were initially
launched as PPPs under the Concessions Law. The rest were structured as BOOT and other non-concession type
PPP projects on the basis of Law No. 627-100 of the City of St Petersburg “On the participation of the City of
St Petersburg in Public Private Partnerships” of 25 December 2006, as amended (the St Petersburg PPP Law).
However, as a result of the financial crisis, most of the projects mentioned above have either been postponed
(eg Orlovsky Toll Tunnel and “NADEX” high-speed light rail project), or have undergone restructuring (eg WHSD).
Some of the above projects have been more successful eg a PPP agreement has recently been signed with regard
to the Pulkovo Airport Expansion project.

Typical size of projects

The size of projects being implemented in Russia varies. At federal and regional levels, the typical
size is approximately USD2 billion (though most of the large-scale projects, particularly in the oil
and gas sector, substantially exceed this figure), while at the municipal level it is approximately
USD50-70 million per project. It is estimated that the total value of the projects currently in
procurement in Russia amounts to USD142 billion, which may be as much as a quarter of all such
projects in the pipeline in Europe. However, many of these projects been put on hold. The Investment
Fund has also been forced to freeze new investment projects and reconsider the financing schedule
for existing projects. None of the infrastructure projects so far launched has yet been completed.

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 4. Concessions
Concession Agreement

In Russia, the Authority may grant a concession to a project company only by awarding a concession
agreement. Granting the concession by way of a licence or special enabling legislation is not permitted
under Russian law. A concession involves mutual obligations of the parties to the concession agreement,
rather than an exclusive right or authorisation issued by the Authority to the project company to develop
a project (as may be the case in some countries). Russian law classifies the concession agreement as a
private law contract which combines several types of civil law agreements envisaged by the Civil Code.

The concession agreement entered into between an Authority and a private sector partner, often a
consortium, (concessionaire) will require the concessionaire to design and construct (or reconstruct) the
relevant asset(s) or piece(s) of infrastructure (concession facilities) by a certain date, operate them for a
certain period of time (concession period) and transfer them to the Authority at the end of that period.
The concessionaire will be responsible for the financing of the construction and operation of the concession
facilities; however, the Authority may compensate the concessionaire for part of the construction and
operation costs. The concessionaire may assign its rights or transfer its obligations under the concession
agreement only with the Authority’s consent and only after putting the concession facilities into operation.

Russia
Concessions Law

The Concessions Law contemplates government concessions only, which means that a project will qualify
as a concession only if it relates to immoveable property owned (or, if to be constructed, to be owned) by
a public entity. All concessions in Russia are one-off concessions, while routine concessions from federal,
regional or municipal authorities are not permitted.

Upon completion of the construction phase, ownership of the relevant concession facilities must be
transferred to the Authority. Under the Concessions Law the concessionaire cannot own the concession
facilities. Nor does the Concessions Law provide for structures where there is no transfer of the concession
facilities to the Authority at the end of the concession period, such a structure being, in effect, a full
privatisation. Hence Russian concessions may only be structured as either Build, Transfer, Operate (BTO)
or Design, Build, Transfer, Operate (DBTO) projects. The Concessions Law appears not to apply to BOOT or
Build, Own, Operate (BOO) or similar structures where the project asset is owned by the project company
for the period of the project.

The Concessions Law fails to provide for some key concepts broadly recognised in other jurisdictions
and necessary for an effective PPP such as lenders’ cure rights, step-in rights, direct agreements and
transparent availability fee and termination payment mechanisms, which are currently subject to complex
budgetary rules.

The Russian concession model does not contemplate any specific land, tax or environmental regime
applicable to a concession project.

5. Other forms of PPP

Due to the absence of a federal law dealing with all types of PPP structures or of any other national level
guidance on PPPs, regional authorities keen on using PPP structures as an alternative to the traditional
methods of procuring public services and infrastructure may introduce regional PPP laws. Often such laws
differ from the Concessions Law and provide for various non-concession forms of PPPs.

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 Some legal commentators take a liberal view that the Concessions Law is not intended to restrict PPP
structures to concessions alone and that other forms of PPPs (such as BOOT) are permitted if they are
authorised by the relevant regional PPP laws. However, there is still an ongoing discussion in respect of
potential inconsistencies between the relatively prescriptive Concessions Law and Federal Law No. 94-FZ
“On the Procurement of Goods, Works and Services for State and Municipal Needs” of 21 July 2005, as
amended, on the one hand, and often more flexible regional PPP laws, including the St Petersburg PPP
Law, on the other hand. So far the private sector has been left to rely on its own judgement in deciding how
any such inconsistencies may be resolved. Although in the event of an obvious contradiction the federal
laws prevail, there are many grey areas where inconsistencies may exist or where the regional PPP laws
have a broader scope, which leaves room for debate.

By way of example, there is a risk that the inflexible tender rules for state procurement stipulated by Federal
Law No. 94-FZ may apply to a non-concession PPP. At the regional level, the most developed St Petersburg
PPP Law sets out the powers of the City of St Petersburg to provide budgetary funds under non-concession
PPP projects which go beyond the scope of the Russian Budgetary Code (Art. 80).

6. Additional issues
Russia

A number of other important legal issues need to be taken into account when contemplating a Russian
PPP, whether it is structured as a concession agreement or otherwise. We have highlighted some of
them below.

Tariff regulation

The existing procedure for setting tariffs is based on the broad discretion of the tariff regulators in
determining the components of a particular tariff. The calculation models used by the tariff regulators
often do not take into account the economic interests of a project company and the debt service pattern
of a particular project. As a result, when the applicable tariffs are decreased by the tariff regulators,
the project company may face the risk of not being able to comply with its debt service obligations
because of the lack of revenues generated by the project.

The Concessions Law provides that the concessionaire is entitled to request amendments to the
concession agreement in the event of a negative change in its financial position due to the reduction of
applicable tariffs during the concession period. However, the Concessions Law does not clarify how the
concessionaire may in practice claim amendments to the concession agreement.

In addition, as the tariffs levied in Russia are denominated in Roubles, this will result in a currency
mismatch for the project company whose debt obligations are in whole or in part denominated in another
currency. Hedging arrangements, if available, can be prohibitively expensive in the current market
conditions and, as a result, may not be available in all cases for the tenor needed.

Security

Existing security enforcement procedures under Russian law, even after recent improvements, still
impede effective and quick realisation of secured assets for the purpose of satisfying creditors’ claims.
The restrictions on the creation of security over certain types of assets, such as bank accounts, limit the
security package available to creditors under PPP projects in Russia. In addition, the concessionaire
may not grant a security interest over either its rights under the concession agreement, or the concession
facilities2. It is possible to create a security governed by foreign law (except in respect of Russian real
estate) but the enforcement of such security and related finance documents may still be problematic due
to mandatory provisions of Russian law, especially if the project company goes into insolvency.

2 Although this position is not fundamentally different from that in some other jurisdictions.

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The uncertainty over the application of the security agent concept in Russia
results in the need to apply complicated legal structures in order to provide
security for a debtor’s obligations in favour of multiple lenders in project
finance transactions. The enforceability of such structures in Russian courts is
yet to be tested.

Infrastructure bonds

Infrastructure bonds (ie bonds issued specifically to finance infrastructure) have

been under discussion for some time in the Russian market. Only recently, the
Federal Service for Financial Markets amended its regulation on the organisation
of trading in the securities market. Although the concept of infrastructure bonds
has not been developed, the regulations allow for certain categories of Russian
corporate bond to be entered into quotation lists of Russian stock exchanges,
including “list A” (the highest standard), without complying with some of the
requirements which would otherwise be applicable. This simplified listing
procedure covers only bonds: (i) secured by state guarantee issued by the
Russian Federation (but not one
of its regions); (ii) secured by guarantee issued by the State Corporation Bank for
Development and Foreign Economic Affairs (aka Vnesheconombank); or (iii)
issued by a Russian legal entity which has entered into a concession agreement
under the Concessions Law with either the Russian Federation or one of its
regions.

In the last case, the issuer of bonds may benefit from the simplified listing
exception if the terms and conditions of the bonds have been approved after
the execution of the concession agreement and provide for the bond proceeds

Russia
to be used for the purposes of the concession agreement. For the exception to
apply, the bondholders must have a right of early redemption if the bonds are
delisted, or if a party to the concession agreement has filed an early
termination claim with the relevant court, or if the concession agreement has
been terminated upon consent of all the parties.

According to the Russian Transport Ministry, the first offerings of

infrastructure bonds to finance PPP projects are going to be launched in early
2010 in relation to the M1-”Belarus” (Moscow-Minsk) concession, the Moscow to
St Petersburg Motorway (15-58 km) concession and the “Ust-Luga” sea port
investment project. Russian Railways are also expected to enter the
infrastructure bonds market in 2010. According to media reports, the Russian
Government is ready to earmark in the relevant budget RUB75 billion and
USD2.5 billion for state guarantees under the bond-financed projects. The Russian
Government’s anti-crisis plan approved in November 2008 expressly mentions
infrastructure bonds among other measures aimed at tackling the consequences
of the financial crisis in Russia.

Anti-crisis measures

The Russian Government has not adopted a specific set of anti-crisis

measures to encourage PPP in response to the recent downturn. However,
certain measures have been taken in various infrastructure sectors, eg interest
rate subsidies under investment credits and control over increase of tariff rates
in the transport sector. The general Russian anti-crisis package provides for the
support of the financial and banking system, inter alia, to make long-term
money available to private investors and project companies. In order to inject
liquidity into the Russian banking system VEB has obtained access to a certain
part of the National Wealth Fund to be used for unsecured subordinated loans
to Russian banks. VEB may also participate in PPP projects, including those co-
financed by the Investment Fund. This makes VEB one of the key instruments
for arranging the financing for major projects in Russia.