Chapter 2- Privatization Methods and Regulations:
A. Methods of Privatization
Methods of privatization comprise a number of tools that can be used to privatize public enterprises, projects, and services, taking into consideration a broad definition of the privatization process. These methods include transferring of ownership, contracting for management and operation, leasing, and financing, either range from sale through public subscription, or sale to a principal investor. Each method has its own consequences, regulations, and factors that contribute to its success or failure. Generally, more than one method is utilized to achieve the targeted objectives. It is therefore important to choose the method of privatization in accordance with the specified objectives being the best means to be achieved. Various methods of privatization are described below.
With this method, responsibility for managing, operating, and developing an entity is transferred to a contractor or investor from the private sector for period of time and an amount of money to be agreed upon. This method is usually used in cases that require high levels of specialized experience in management, operation, and marketing, or when the government has a large investment in the project s assets and prefers to keep the investment rather than sell it; that is, ownership of the assets is not transferred to the private sector. Although the contractor takes over the tasks of monitoring and daily supervision of operations, he does not assume any commercial risks (operating losses), if they occur, which are borne by the owner (the government). Among the negative aspects of this method is the possibility of the contractor s misusing the project s assets, because management contracts, in the majority of cases, stipulate payment of a fixed sum to the contractor in exchange for specific services, regardless of profitability, and this is not a sufficient incentive for the contractor to maintain the assets in a good condition and improve performance.
Leasing contracts are agreements between the government and the private sector whereby the latter provides the government enterprise with administrative and technical expertise for a specific period of time, in exchange for an agreed-upon financial remuneration. The private sector investor leases and utilizes the assets or facilities owned by the government, and the contract determines the amount of the condition to be paid to the government as well as the responsibilities of each party towards the other. The distinctive feature of leasing contracts is that the investor assumes all the commercial risks associated with operating the assets, which is an incentive for the investor to reduce expenses and maintain the assets in good condition. The investor is also obliged to maintain and repair the used assets, or to contribute to the cost of doing so, in accordance with an agreed timetable. The amount to be paid by the private sector is generally linked to the condition of the assets and the expected income from their utilization. Under such contracts, the investor appoints the people who work with him, including current employees of the government enterprise, in accordance with the agreed terms of the leasing contract.
Financing contracts represent a more advanced method of privatization compared to previous methods. Under such contracts the investor assumes responsibility for providing the capital, operating, and investment expenditures unlike lessee. This method is generally considered better than leasing contracts, but implementation is more complicated owing to the large amount of financing needed for expansionary obligations. There are several kinds of financing contracts, including lease-build-operate (LBO), build-transfer- (operate) (BT, BTO), build- (own)-operate-transfer (BOT, BOOT), buy-build-operate (BBO), and build-own-operate (BOO) (Appendix). If one of these types of financing contracts is adopted as option, it must be carried out in accordance with the following:
- An appropriate regulatory and legal framework must be put in place to guarantee the rights of all parties (financer, government, and consumer).
- The project must be made open to general competition to which qualified parties from specialized enterprises are invited to bid, whether they are from inside or outside Saudi Arabia.
- The government shall not offer sovereign guarantees unless absolutely necessary.
- Sale contracts
i. Direct sale to the private sector through public subscription:
This method is suitable to enterprises that are characterized by stability, continuity of activities, a sound financial position, and commercial feasibility, or enterprises that can become commercially feasible in the short-run. Either the entire entity or some of its shares are sold to the private sector by offering them for public subscription. This method is also adopted by large public enterprises and projects, which would be converted into an enterprise in harmony with the customary conversion procedures, such as designing the general legal framework for purposes of the project, separating the non-commercial activities, amending the tariff systems, transferring the assets and liabilities to the enterprise after verifying that they are in order, establishing the article of association and accounting system, and the basis for assimilating the employees.
The success of this method depends on a number of factors, including:
- The entity must be continuing in carrying out its activities, most have a sound financial position, and be profitable or capable of becoming profitable in the short-term.
- A large amount of financial and administrative information on the activities of the entity must be available.
- It must have a reasonable amount of liquidity.
- Existence of an active capital market.
This makes it possible to expand the ownership base and attract additional investments, which in turn stimulate the shares market by opening the door to investors with limited financial capacity. The requirements for this method are focused on the procedures for offering shares for subscription, including choosing the appropriate time for the public offer, along with the need for a good regulatory and marketing framework and a well-developed capital market.
ii. Sale to a principal investor
Using this method, the government sells the enterprise to a principal investor who is capable of providing the required financing, management efficiency and technology for production and marketing development. The method has the advantages of ensuring the direct availability of the required financing as well as the financial and administrative expertise needed for technical and administrative development, in addition to providing new expertise and modern production and management techniques. In most cases the principal investor is an international enterprise or operator with extensive experience in the field. The negative aspects of this method are that it deprives small investors of opportunities for investment, does not expand the ownership base, and increases the possibilities of creating problems related to the work force.
In addition to the above-mentioned methods, there are a number of other mechanisms and instruments such as offering the enterprise for sale to its employees or allocating a portion of its shares for sale to its employees at market prices. These methods are usually used to privatize enterprises with low profitability or productivity, in order to encourage employees to improve their performance of the enterprise. Another mechanism is a debt swap, whereby the debts are valued and converted into shares in the name of the creditors.
B. Rules for the privatization of public enterprises and projects
The basic principles that must be taken into consideration when implementing the privatization process are:
1. Disclosure and transparency.
2. Expeditious implementation.
3. Changing the management pattern.
1. Disclosure and Transparency
To ensure proper disclosure and efficiency in the privatization process, the privatization program should be guided by:
All activities should be carried out in a clear and transparent manner, and announced in accordance with recognized commercial standards. When there are no legal rights involved in the case of joint venture, direct sales or preliminary negotiations based on a special agreement shall take place only after bids have been obtained through public tenders. Prior to and during completion of the sale, the public must be aware of all aspects of the process to the extent possible, by means of the following:
- Preparing a memorandum of information and advertising it in connection with the offer for sale of any project.
- Publishing complete information on the financial, administrative, and other aspects of the enterprises to make them readily available to investors.
- Preparing and publishing standards for the classification of bids.
- Public opening the bids.
- Publishing the valuation of assets and details of the bids.
- Publishing the names of investors, the amounts paid, and conditions of the sale after it is completed.
2. Expeditious Implementation
Expeditious implementation is extremely important for the success of the privatization process, and a realistic timetable should be established for each stage of the privatization process, as activities that proceed slowly are more susceptible to failure.
3. Changing the Management Style
Bringing about effective change in the style and methods of management is considered a basic objective of every privatization process. Without such change, it is not possible to achieve the desired benefits of privatization. This does not necessarily mean replacing the current managers, but rather involves improving performance and implementing private sector management practices.
C. Basic steps for a model privatization of a public project or enterprise
- Studying the feasibility of privatizing the enterprise or project proposed for privatization: The competent government agency, in coordination with the Privatization Committee of the Supreme Economic Council, conducts a study of the financial and operational position of the enterprise, its subsidiary sectors, the justifications for privatization and the expected returns, alternatives to privatization and obstacles to its implementation, and hence an assessment of the possibility for privatizing this project or enterprise. The competent agency submits the results of this study and its recommendations to the Privatization Committee.
- The Privatization Committee issues a recommendation to privatize the enterprise or activity.
- If a decision to privatize the activity is issued, the government agency responsible for supervising this activity prepares an implementation program for privatization, based on the required studies. After the Supreme Economic Council approves it, the procedures and measures required to complete the privatization procedure are implemented.
- The implementation program includes:
- The defining elements of the government s policy for the sector, the appropriate regulatory frameworks, and the steps and timetable required for implementation.
- Defining and addressing the obstacles to implementation, and the extent of the need to restructuring the enterprise (conversion to an enterprise, financial structure, and settlements of employees), the steps and timetable required for implementation.
- Developing a preliminary plan for privatizing the enterprise, including the percentage to be sold and method of sale, and a timetable for completing the process. The preliminary plan serves as a basic for choosing a general advisor to assist with implementation of the plan.
- The concerned government agency, under the supervision of the Privatization Committee of the Supreme Economic Council, manages the program for privatization, in cooperation with other government agencies, as deemed necessary by the Privatization Committee. Managing the implementation program involves the following elements, by way of example:
- Defining the terms of reference of the general advisor and the selection method.
- Selecting the general advisor and other technical advisors.
- Developing an implementation plan for the privatization process.
- Implementing steps for restructuring the enterprise.
- Auditing and evaluating the position of the enterprise.
- Preparing the documents required for selling the enterprise.
- Managing the sale process (e.g. marketing the process, qualifying the investors, inviting bids by investors, evaluating the bids, negotiating terms of the sale, and preparing the sale contract).
- Method for addressing manpower questions: Employees must clearly understand the method for dealing with the manpower aspect in the privatization process and its impact on them.
There are a number of methods for dealing with the workforce in the privatization process, some of which are:
- Employee participation in ownership of the enterprise, which could induce them to support restructuring and privatization.
- Fair compensation for employees who retire voluntarily or are terminated.
- Obtaining a commitment from the investor to retain current employment.
- Training and upgrading the qualifications of employees.