The new era of PPPs kicked off to a healthy start in Hong Kong, with construction of the AsiaWorld-Expo at the IEC site well nder way. The project is headed for completion by the end of the year. No doubt the landmark event will be met with much fanfare if the glitzy opening ceremony is anything to go by.

The second supposed PPP, the HK$40bn West Kowloon project, has not been as smooth a ride. In fact, it has come to a complete halt, for now. Allegations of favouritism on the part of the government over the selection of the developer have put a question mark over the fairness of the bidding process.

Australians have more experience on the PPP front compared to Hong Kong. Over there too, cynicism about the bidding process thrives, as fewer and fewer players have the muscle to participate in these massive projects.

Singapore, where PPPs remain at the debate stage, could learn valuable lessons from the experiences of its neighbours. During August and September 2004, the ministry of finance conducted a consultation exercise from various sectors, including the legal industry. A summary of the issues raised includes a list of the potential pitfalls of PPPs: long procurement  timescales, high bid costs, inflexible long-term contracts, inadequate explanations or project requirements and lack of proper risk allocation.

Here we canvass the latest developments in these different jurisdictions, focusing on the challenges firms face in dealing with these typically politically-charged, high-value infrastructure projects.

Hong Kong/China
The local legal market will take some time to catch up with the level of expertise on PPPs in overseas markets such as the UK and Australia. It's an advantage that firms with links to those jurisdictions will exploit.

"There are a lot of lawyers who go around and talk the talk, but nobody has the expertise," says Masons senior partner, Jon Howes. Masons is looking to address that shortcoming by importing UK expertise. "We can't service this work from the UK. We need lawyers here."

Australians are another breed to have 'carpetbagged' Hong Kong. Mallesons partner, Paul Starr, puts forward a convincing sales pitch for the Australians. Mallesons' Australian experience in construction brings cutting edge skills, he says. "Australia wants to single itself out. It has to because of its geographical location. The by-product is that there are new ideas generated out of Australia; for example, with property REITs, these were first developed in the UK and in Australia. Australian lawyers are coming into Hong Kong and bringing cutting edge skills, not only with construction, also with building and finance."

Significantly, it is an Australian firm, Minter Ellison, which is advising Dragages, the contractor charged with building Hong Kong's first PPP. Minter Ellison has a wealth of experience advising on the massive infrastructure projects in Australia, particularly on the government side. Mallesons, who leads in Australia when it comes to acting on behalf of the private sector for PPPs, advised a developer on its proposed tender for the West Kowloon Cultural District project.

An uncontroversial observation to be made out of the controversy surrounding the West Kowloon project is that in Hong Kong, where industry players and the government are only now getting used to working as partners, true cooperation is problematic. Says Paul Starr: "In general, the people administering this type of constructing come from a different background - I wouldn't say it's traditional, but it's difficult for them to break out of their roles as employer, contractor or consultant. They focus on disputes rather than acting on cooperating."

The gaffes that resulted in stinging allegations about favouritism on the government's part regarding West Kowloon might have been prevented, in hindsight, by more extensive consultation between the private and public sectors. Starr reckons that more could have been done to get the industry involved in the formulation of PPP policy, to enable the government to understand the mechanics of PPPs.

Looking ahead, taking from experience elsewhere in the world, risk allocation is bound to be another issue that will be up for debate in Hong Kong. Currently, says Howes, the trend for construction projects is that increasingly more risk is passed down to the contractor, citing specifically the ground conditions unique to Hong Kong construction contracts. Time will tell how the players in the industry will grapple with this burden in the context of what is supposed to be a partnership.

Howes predicts that contractors will continue to shoulder the greater proportion of risk, but there will be trade-offs on other negotiable points. "The way politicians do business, they want the private sector to take the risk. If the government  says that it wants the contractors to take on the risk, they have to make the terms of the contract sufficiently attractive for the contractor. For example, the concession term."

The nature of how PPPs are financed makes it difficult to balance the risk otherwise. Contractors can complain all they want, but at the end of the day, banks are getting on board the PPP train by offering low interest rates. PPPs offer value for money mainly because the winning bidder obtains finance at lower rates than what the government can negotiate on its own.

"People will always say that risk is not spread properly. I'm not sure if I would agree with that," says Howes. "If you talk to the banks - they're not looking to make very big dollars out of these projects."

Beyond PPPs, the big news out of Hong Kong is the potential for construction work in Macau. The 'carpetbaggers' are also covering that jurisdiction.

Masons is already receiving instructions from those participating in the government-led initiatives in Macau. Market  conditions are ideal - big demand, small supply. "Macau doesn't have the legal expertise to deal with the growth in work," says Howes. "They have 98 lawyers, all generalists. Yet these are high value projects."

Howes divides Macau work into two categories. Firstly, tenders. Secondly, ongoing projects for which Hong Kong firms work with Macau lawyers, as the construction contracts are governed by Macau law. Macau has a civil law jurisdiction, a remnant from its colonial days.

Mallesons is currently assisting two separate contractors for fitting out, and superstructure tenders in relation to the new Macau casinos.

Mainland China, naturally, is also a draw card for firms. Starr says that Mallesons is taking a more regional focus with its construction work, with projects in the Pearl River Delta, for example.

Masons' Shanghai office has been busy acting for a number of the top 50 Chinese contractors. These clients are increasingly doing work outside of China, and Masons happily follows suit. For Masons, other regional work includes the Philippines, where the firm is advising Manila North Tollways Corporation on a major road infrastructure project. Meanwhile, Mallesons has  advised three consortia in relation to the Taiwan High-Speed Railway project.

The amount of regional work being done in Hong Kong could be suggestive of how limited the work is within Hong Kong itself. "Hong Kong is a tough market and continues to be so," says Howes. "A lot of our work has been on the back of government spending on infrastructure. That has been down. It's been a competitive market for firms - Denton Wilde Sapte closed down. It has been generally a period of contraction." Nevertheless, the firm has increased its revenue from the previous year.

Singapore
The Ministry of Finance in Singapore has, in typical orderly Singapore fashion, consulted industry participants in the formulation of a PPP framework. A report from the ministry boasts that a total of 79 companies in the construction, banking, legal and consultancy industries attended industry consultation sessions. Twenty seven individuals and organisations have also given written feedback.

Parallel to this general consultation, another consultation process for a specific project - the S$500-600m redevelopment of the National Stadium, which is likely to be Singapore's first PPP - has been under way. Harry Elias is one of the firms involved in this. Kelvin Tan explains: "It's a tender for consultancy as opposed to construction or investment - they are  getting the expertise on board to advise on how to set up. There were a number of consortia between lawyers and accountants. They're trying to get the framework in place."

Along with issues such as alternative PPP models and the types of projects to which PPPs might be applied, the Ministry of Finance also put up risk allocation for discussion.

In this regard, Harry Elias could draw on its recent experience on the public sector project, the Nicoll Highway. The firm is advising the insurer Aviva on the Nicoll Highway collapse, assigning substantial manpower to the government's special inquiry. Harry Elias received instructions in May 2004 and the inquiry began on 2 August. "If this were an arbitration, we could easily have spent two years in discovery," Tan says. The firm has gained valuable expertise dealing with knotty causation and risk issues.

For the benefit of readers not 'au fait' with the Nicoll Highway development, here is some background: The Land Transport Authority was building an extension to Singapore's road network when the collapse occurred. Part of the highway was shut down.

It had a sizeable impact on the progress of the underground system. In addition, there was concern that nearby buildings were affected. The government quickly organised a special inquiry to investigate the causes of the collapse. Singaporeans are waiting for the final report based on the inquiry's findings to be released.

Raising eyebrows in Singapore is the assurance from the government that the costs of rerouting the Nicoll Highway, additional to the original project costs, will not be coming out of the public purse.

"The numbers are very large," says Tan.

"The original contract was for S$270m. The minister has said publicly that it will only pay S$270m [including for the new project]."

The bills for the rerouting project must be building up quickly, with substantial delays pushing back the completion date to 2006 or 2007.

A government that seeks to impose excessive risk transfer on private participants toys with the potential for tenderers to shy away from accepting the risk or charging a high premium to address the risk value. It seems that the approach to risk in Singapore in the aftermath of the Nicoll Highway collapse does not bode well for PPPs.
 
Optimistically, Tan regards Nicoll Highway, where a number of factors might have contributed to the collapse (soil, monitoring, structural and construction issues), as an exception to the rule. "This kind of case doesn't happen very often. Because of the inquiry, the LTA has put in place reforms to ensure safety. The outlook for future projects is very strong.  Contractors are not going to be loathe to get involved."

Tan says that procedures are in place to address risk management. Industry guidelines are in place; the issue is whether the commitment goes beyond words. "Ultimately, it boils down to the safety culture - whether there is one - not just paying lip service to it."

Those looking to participate in PPPs will take a long hard look at the final report for the Nicoll Highway, for which the main contractor was a joint venture. The findings will influence how project insurance is arranged in future infrastructure deals.

Australia
Australia's love affair with PPPs began in the 1980s. Among the first PPPs in Australia was the M4, a major artery in Sydney's road network, and the Sydney Harbour Tunnel that runs below the iconic harbour bridge. Mallesons' construction work dates back as far as these projects.

Partner Geoff Wood traces the balancing of risk between the private and public sector since those pioneering projects. With the Sydney harbour tunnel, the firm acted for the private sector. "As it was the first deal, and private sector financiers were wary of the risks; the NSW government retained more risks and passed legislation to facilitate things for the project to go through," Wood says.

The catalyst for the first change in the balancing act was the handover of the reins from the Labor party to the Liberals in the NSW government. "When the Greiner government came in, the conditions changed for the M4 - the toll road that was being built at the time. The risk was borne by the private sector, but because it was a road connecting Parramatta to Sydney, there was no resistance from the private sector. The private sector was happy with it," Wood explains. The area that the M4 covers has experienced one of the fastest rates of population growth in Australia.

Fast-forward to the new millennium and the shift looks to be in favour of the private sector. The most recently completed Sydney tollway is the M5. Wood comments: "With the original M5, it was called the 'road to nowhere' due to lack of interconnecting 'feeder' roads. It was harder to negotiate. The private sector was less prepared to take risks as traffic flow was less predictable than for the M4."

The parties came away with a renegotiation clause, which gives the agreement flexibility. A trendsetter, it has become a key feature of recent toll road and other PPP deals in Australia. "The parties can sit down and decide how to best deal with a problem when it emerges (that maybe won't happen until 15 years down the track). It's an escape valve without allowing a party to make a windfall gain or lose out," Wood explains. Within strict parameters, the parties can agree to solutions as  the problems crop up, such as to allow toll increases or extend the term.

Baker & McKenzie's Kate Munnings queries the extent of the partnership between public and private in light of the unequal spread of risk with infrastructure projects. "The lump sum risk is passed down to the contractor. From the contractor's perspective, it's not a real partnership in that sense," Munnings says. "Partnership is a word in the title. It's not a real element of the relationship. The risk is largely allocated wholly and solely to the contractor."

Munnings contrasts the situation in Australia with that in the UK. "The UK is a lot more experienced - it's one of the most advanced markets in the world. They have the end user as the lead proponent. There's an emphasis on the service provider. In Australia, it's a finance model. It focused on the immediate, not the long-term."

To illustrate, say that for a project there is an ABN special purpose vehicle, the builder is Leighton and the facilities manager is Honeywell. The leader in Australia would be the SPV, whereas in the UK, it would be Honeywell, who would earn the income, provide the service and has to meet the KPIs.

"I have spoken to some UK service providers who have said that in time things will change in Australia - they're hopeful that it will change," Munnings says.

Outside of road projects, participants building cultural centres and hospitals are also questioning how much risk they should bear. Some are more successful than others with transferring some of the burden on to the government.

"There are different modus operandi," Wood says. "Some players adopt the line of least resistance, they don't resist the government's risk allocation. Others engage in hard negotiations, and other financial organisations don't play as hard. "However, recently there has been a paradigm shift - the construction companies are saying that there's too much risk shoved onto them... With some high profile projects, some companies have found it difficult to make a profit. The construction companies are taking a tougher and more sophisticated approach to risk allocation and management. They are pushing back and looking for a bigger voice." With two hospital projects, bidders dropped out of the game after a review of margins.

Once they crunched numbers, they realised that their resources were better allocated elsewhere.

Speaking of balance sheets, firms in Asia would be very interested to know just how much money is spent on bidding for PPPs.  It is a topical issue in Australia, one that governments are currently addressing, under pressure from the private sector.

Wood explains: "The issue is that the government has developed a 'fully-documented' approach to bidding. If there are three bidders then there is a multiplication times three of costs. Ten years ago, it was not a short form, but it was not the same detailed documentation negotiation with multiple bidders. The government looked at the figures and picked a winner, and then only negotiated full documentation with them. Now it's fully documented for all shortlisted bidders."

For the A$2.5bn Mitcham-Frankston freeway in Melbourne, the transaction costs were A$30m for each short-listed bidder. The transaction costs include fees from lawyers, engineers and designers.

"$30m is actually an understatement," Wood says. "The typical fee structure is that the client pays a relatively low fee to each adviser up front, then more if they win. So it's well in excess of $30m, especially for the winning side.

"For large contracts, the transaction costs are whoppers. For smaller contracts, if the bidding costs are $2m-3m, this can be prohibitive." And to illustrate the kind of manpower committed to the gargantuan projects, according to David Storr, 40 people at Mallesons were on the job for a year-and-a-half for Connect East, the consortium that won the bid for the Mitcham-Frankston project.

On another project currently in the construction phase, the Western Sydney Orbital, for which a complex, innovative financial structure was implemented, there were 66 separate contract documents that had to be stitched up to achieve financial close. "We started calling the Western Sydney Orbital 'Route 66'," says Wood.

The size of these projects might well justify the transaction costs that bidders need to meet. It's the small to medium sized projects that are hurting the pockets of construction companies. "The complexity of bidding doesn't vary that much between the projects of different sizes," Wood explains, "but the transaction costs... they are scarily high for some small projects [in proportion to the project value]. With toll roads, it's not that great."

The substantial gamble at the bidding stage, along with the transaction costs of obtaining finance, have contributed to a shrinking within Australia of the pool of construction companies willing to participate in large PPPs. Following the insolvency of major player Walter Constructions, a client of Mallesons, Leighton Holdings, looks to dominate the playing field even more than it already has.

Leighton Holdings' subsidiaries - Thiess, John Holland and Leighton Contractors - often bid on the same project, partnered with different parties. "So probity arrangements - that's another thing that the government is concerned about," Wood says. "Clients like Leightons are scrupulous about ensuring their approach is above reproach from the probity perspective."

As mentioned, the government is looking to ease contractors' pain. A work in progress in Australia is model documentation, although those in the know approach the governments' efforts with cynicism. With so many projects under way of different size and model, uniformity might be an unachievable goal.

Is the construction industry complaining too much? As there are varying project sizes, there is substance behind the counter argument that there is sufficient competition in the market. James Forrest says: "For jobs that are A$200-500m, there are probably seven to eight contractors who could undertake those jobs."

Another argument is that perhaps the government is unfairly copping all of the criticism about what is wrong with PPPs.

"It could be that the lawyers acting for governments are partly to blame," says Wood. "They take a process heavy and risk transferring approach to the project. It's safer for the bureaucrats who are often averse to risk by nature, so they sleep easier at night by doing that."

Other issues cropping up in Australia that Hong Kong and Singapore might want to consider include the tension between public interest and private culture. David Storr illustrates the issue by referring to hospitals: "The private sector builds and operates the hospital, but the staff remain government staff. There are cultural differences between private and public sector workplaces and there are union issues. With the Mater Hospital, the union protested against the proposal to transfer the payroll to the private sector."

The human dimension complicates PPPs. The politics is potentially divisive, going to the root of the government's duties. As the government offloads the cost of building infrastructure, and the private sector benefits by sourcing work from these projects, who takes on the social responsibilities?

"It's more complex with a big human element, when it's political," Wood says. "With Bonnyrigg, the first property PPP and the redevelopment of a public housing estate, it throws up a new array of challenges. The government has said that the consortium has to deal with socio-political issues."

From the practitioner's perspective, grappling with these issues that tickle the brain and challenge the political animal within, can, on the upside, lead to job satisfaction.

Storr sums this up as follows: "When you think about it, the Sydney Harbour Bridge was built during the depression. For that time, it was an enormous infrastructure. In recent times, the government has not spent a lot of money on infrastructure, in comparison. It's good to be able to help rebuild the nation's infrastructure - the roads are too small, and hospitals are getting old." ALB