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Interview of Oleg Pankratov, Global Head of Infrastructure Capital and Project Finance, for Inspiratia

27 January 2014

The Russian PPP bear is awakening with a pipeline of federal projects as well as regional deals that are progressing through the system. International construction companies are already heavily involved in bidding for a range of credible transport deals and national lenders are dominating the field...

The Russian federal government has a lively pipeline of PPP projects in the road and rail sectors with realistic ambitions as to what can – and what cannot – be delivered. While a number of these will be procured using the existing concessions law, a federal PPP law is expected to pass this year that will help to streamline the process. And with one major deal having closed last year in the regions, the market is opening up to the procurement model the length and breadth of this vast nation.

The state Russian highways company – Avtodor – is the main driving force behind projects and has already launched the tender process for a few roads that were first presented in December 2012. They were first aired at the From Russia to France: A Presentation of Russian Transport Projects for European Investors conference in Paris hosted by the PPP committee of the French-Russian Chamber of Commerce (CCIFR) and law firm Gide Loyrette Nouel (GLN).

At the time, Avtodor anticipated that €34 billion (£28bn US$44bn) would need to be invested by 2019, followed by a further €18 billion (£15bn US$23bn) from 2020-30. In addition to this, €9 billion (£7bn US$12bn) was to be raised from foreign investors through PPPs [Market Insight].
And it is not just road PPPs that are being looked at. The Russian government has plans for HSR and is currently evaluating 3 large-scale routes though the problem – as always with this type of infrastructure – that it will be hugely expensive.
Two major sporting events have also added impetus to the need to invest in infrastructure – the 2014 Winter Olympics (though this first event is mere months away) and the 2018 FIFA World Cup.

The projects
The Russian government has a realistic plan as to the potential for infrastructure investment and while the main source of projects are at a federal level, key regions – like St Petersburg and Moscow – retain the mantle of being the main hubs of PPP activity.

A few of these deals are using different types of models under the current concessions law including:
- O&M – mainly financed by the state
- O&M and construction – with a minor private finance element
- fully-fledged concession

Last year saw one major PPP deal reach financial close – Kama Bridge. VTB signed the deal with the Udmurtian Republic to provide a 15-year RUB 5 billion (£896m €1bn US$1.4bn) loan to the regional government for the construction of a 15km bridge across the River Kama near the town of Kambarka – followed by a 49-year concession. Investors include the Regional Investment Company consortium and 2 major construction companies – Mostostroy-12 and Tyumenstalmost.
Currently the only crossing is by ferry, severely restricting throughput capacity. The bridge will provide a permanent link across the Kama River, optimising transport flow between Ufa, Izhevsk, Naberezhnye Chelny, Perm and Yekaterinburg.

Oleg Pankratov, head of Infrastructure capital and project finance at VTB Capital, says: "There is currently a very healthy pipeline in Russia with a number of deals to be done federally as well regionally. Overall the Russian PPP market is in good shape. In 2013, we reached financial close on Kama Bridge – the first regional deal done under the federal concessions law."
Pankratov added: "VTB was senior lender, shareholder in the concession company and financial adviser. It was the only large PPP deal to close that year, and it was pretty important for the Russian market as it has now paved the way for more regional concessions. Previously only the central regions or federal government was able to launch large-scale deals but now we have an example of a more remote region being able to do this."

This market is indeed picking up and last year [2013], a project was launched for the construction of a bridge in Novosibirsk. In addition Avtodor – which is responsible for the procurement of all Russian toll roads, the non-toll roads being managed by the transport department – last year launched 3 road tenders.

Pankratov says these projects represent a great achievement for the Russian market: "We shouldn't forget that we had elections last year and a new government came into power – these things always take time to settle. What we do see is a very healthy pipeline being formed and strong initiatives coming into play like pension fund investments and federal money for infrastructure."
The 3 deals are:
Sections 7 and 8 of the of M11 – 4 bidders prequalified in October;
- Stolichniy Tract OJSC - RDIF, Gazprombank and the Macquarie Group Foundation
- Roads Construction Corporation - Sacyr, Autobahn OJSC and Khanty-Mansiysk DorStroi OJSC
- Two Capitals Highway – Holding VTB Capital IB, Vinci Concessions Services Russia and from Astaldi and ICICTASH INSAAT
- Corsan-Corviam Construccion (part of Groupo Isolux Corsan)

Construction and O&M of M4 – 2 bids submitted for the 23-year concession in December 2013: OJSC DSKAvtoban and Transstroymekhanizatsiya (affiliate company of OJSC Mostotrest)
Central Ring Road in Moscow –O&M of the first section

Other deals expected to be announced in the future by Avtodor are:
- new sections of the M1 and M3
- section of M4 though not unknown whether this will be a full concession or O&M
- more sections of the Moscow Central Ring Road, connecting up with federal roads – tenders could be announced this year
- another section of the Moscow-St Petersburg highway

As well as these deals, the Ministry of Transport is currently procuring 2 large-scale deals. The first is a US$2 billion bridge over the river Lena in north east Siberia. It will comprise a 3km bridge between the Siberian city of Yakutsk and the mainland, which is currently only accessible via minor roads and the river. A tender was announced in July 2013 and 2 bidders prequalified that November:
- OOO Yakutskaya mostostroitel'naya kompaniya: Chinese Railway Construction Company, Stroygazconsulting andNPO Mostovik
- OOO Transportnye kontsessii (Sakha): Northern Capital Highway, VTB, VTB Capital and Istner, Freshfields is advising VTB Capital
Bids are due to be submitted early this year. There may be a short delay, but this should not go beyond early spring.
The second project is 12 Tonnes – which is for the installation of a system to collect tolls from heavy vehicles across Russian federal roads. The curious project name is because it levies a tax on trucks of 12 tonnes and more. Three teams have prequalified:
- Infrastructure satellite systems: VTB Capital, Rostelecom, Russian Direct Investment Fund, LANIT and Vinci
- Optima Plus: Gazprombank, Sberbank and VEB
- JSC Navigation Information Systems: JSC Navigation Information Systems, MTS Bank and Kapsch TrafficCom
Final decisions are to be submitted on 13 February 2014 and bidders have been asked to include their proposals on how the project will be financed. The estimated capital investment is expected to cost over RUB 26bn (£459.9m €560.8m US$789.3m) and will have a 13-year concession.
Meanwhile HSR is still under discussion, but this is taking a long time due to the sheer scale and vast expenditure this project would involve. The government is still working on plans, though it is clearly on the agenda.

The 3 routes being considered are:
- Moscow-Kazan-Yekaterinburg
- Moscow-St Petersburg
- Moscow-Adler

Olga Revzina and Roman Churakov, respectively a partner and senior associate at Herbert Smith Freehills in Moscow, say the Moscow-Kazan section of the HSR has been split into 4 parts due to its capex of RUB 1 trillion (£17bn €21bn US$29bn): "The first one – the most expensive one – will be constructed and maintained by Russian Railways, the state-owned railway monopoly, and the remaining 3 will be constructed and operated by private consortia.
"It is expected that the privately-operated concessions will be structured as real toll [patronage risk] projects supported by a minimum revenue guarantee from the state. In addition to the guarantee, the projects will be leveraged by capital grants – which will in turn be financed from the state-owned pension fund and the federal reserves."
Revzina and Churakov say that the government expects the remaining 3 projects to attract:
- debt amounting to around 30% capex
- 6% equity from sponsors
- rest to be financed from a capital grants

Both lawyers are optimistic that a tender will be announced mid-May, with a view to signing the concession agreements in January 2016.
Aside from the pipeline from Avtodor and the HSR projects, St Petersburg and Moscow are continuing on with their PPP deals, perhaps less so St Petersburg as it has a number of projects under construction – the Odintsovo Bypass and Western High Speed Diameter [Deal Focus] – and needs to be wary of taking on more commitments.
Moscow has an ambitious transport development programme with the Moscow Metro Rolling Stock PPP at an advanced stage. Freshfields and Ernst & Young are advising and it is still being decided which sections will be part of the tender.
Some PPP activity is expected in the ports sector. However, Russian ports have fairly complex ownership structures that may make it difficult for the government to implement a pure PPP scheme. However, for new developments – like the Taman seaport, which is to be located on the Black Sea coast of Russia – it is an option.

VTB's Pankratov says: "There is no reason why current deals being procured will not be successful. There is already a good precedent for similar transactions in Russia, but whether we reach financial close towards the end of this year or the next is another question.
"It has been clear for a long time that infrastructure needs are great. Oil prices are currently stable so there is no super revenue coming out of it – whatever is, is counted towards the federal budget. With no unexpected earnings coming into the Russian budget to realise the ambitious infrastructure development programme, a lot of private money is needed."

New federal PPP law
A new PPP law passed its first reading in the Duma in April 2013. The second reading is expected during the spring session. Despite the law becoming more elaborate and – in some instances – overcomplicated compared to how it looked like when it was first introduced to parliament by the economics ministry, it is still not far from market expectation.
"Once the law is there and effective it will knock the bottom out of critics who recommended against non-concession PPP schemes based on a questionable logic that since non-concession PPPs are not regulated by federal laws they are invalid. The law will operate as a gateway to many regional PPP projects that were constrained by the absence of federal PPP framework," say Revzina and Churakov.
The PPP law is essential as the existing concession law is too prescriptive. As it has very defined steps that have to be followed – St Petersburg has adopted its own PPP law.

Fedor Teselkin, associate at Freshfields, says: "In terms of contractual models, concession-based PPPs are actively used in toll roads and other greenfield projects, however for brownfields with complex ownership structure, such as in airports or sea ports, concessions may not be the optimum tool because of various restrictions set out under the Russian concession law.
He adds: "It is expected that the PPP Law will address this and provide a more flexible framework for such projects."

Domestic domination

The Russian PPP market is domestically orientated for a number of reasons – one of which is foreign currency risk which is perceived by many commercial lenders to be a good reason to stay away.

The market is dominated by domestic banks, namely the big 4:
- Gazprombank
- VTB
- Verbank
- Vnesheconombank

While major domestic players continue to play a key role in the Russian PPP market, there is certainly room for international companies – in particular technology investors – to bid for deals. As always in such situations, bidding with a Russian partner is the wisest course of action.
Multilaterals – like EBRD and to some extent the IFC – are active in the Russian market but they have a specific role. They are looking to use Rouble Treasury bonds as a means to finance Russian infrastructure projects, giving them a vehicle to access local currency.

Pankratov says that commercial banks can lend and says that Pulkovo Airport [Deal Focus] was a good example of this: "We had a 14-bank syndicate – with a combination of national and foreign banks – for Pulkovo Airport so it can be done.
"But there is a good reason why Russian infrastructure is financed by domestic banks – currency. It is fundamental that toll roads inside Russia are rouble-denominated. The government certainly has no desire to link tolls to foreign currency because at the end of the day the majority of people using the roads are Russians earning Russian salaries and it may not be affordable for them to pay euro or dollar-denominated tolls."
Pulkovo Airport was an exception to this rule as it is an international airport deriving half its revenues in foreign currency. This will like be the case for other international airport deals being brought to market.
The other sector where foreign banks may participate is the HSR projects because of the sheer scale of them and they will be delivered by consortia of international companies.

As a great deal of investment is needed into Russian infrastructure, local governments are seeking other funding instruments and sources to promote economic development. However, most Russian lenders cannot provide long-term financing which is where the door opens for:
commercial banks that have government stakes
- non-government pension funds
- infrastructure funds
- international financial institutions
Russian pension funds have been expressing interest in PPPs as well as the Russian Direct Investment Fund, which can only co-invest with a foreign player. The latter is a US$10 billion (£6bn €7.3bn) fund established in 2011 by the government to make equity investments primarily in the Russian economy.

Conclusion
The Russian PPP market is progressing from infancy, but at the same time it is still an immature market. For it to mature, more deals need to be delivered by a range of market participants, some with foreign currency, most with Russian roubles and with heavy involvement from the pension funds.
The biggest challenge for the Russian market is to create a sustainable pipeline of projects.
"We [VTB] have proven that we can successfully do PPP transactions – having closed 3 large-scale deals. But we would ideally like to see 10-15 projects announced a year," says Pankratov.
Although a number of transport deals are expected – toll roads, airports and railways – the market would also like to see social infrastructure projects being brought forward. As to currency, airports, ports, oil & gas and refineries will continue to see foreign banks involved because revenues are derived in foreign currency.
This vast nation is beginning to get to grips with the amount of infrastructure investment needed and has a coherent pipeline of projects, which may not necessarily excite the banks. However, it will certainly attract construction companies seeking to gain a foothold in this rapidly evolving market.

VTB Capital

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