Acknowledgment

As is typical for diploma thesis students, I would – at this point – like to include my acknowledgments.

My special thanks go to Paul Shih, Arthur Truman, Thomas Leu and, last but not least, Ms. Menni Ho.

Spending a period studying and living overseas is a great challenge. I would like to thank my friends back home, and especially my boyfriend Florian Meilinger for being by my side even though there were 10.000 miles between us.

II

Table of Contents

  Acknowledgment  II

Table of  Contents  III

Table of  Acronyms and Abbreviations  V

Table of  Figures  VIII

1.  Introduction  1

1.1  Motivation of the Thesis  1

1.2  Methodology and Containment of the Study  2

2.  Private Participation in Infrastructure  3

2.1  Private Participation in Asia  5

2.2  Public Infrastructure  6

2.2.1  Transport Sector in Asia  9

2.2.2  Railways Segment in Asia  10

2.3  Forms of Private Participation  12

3.  BOT Projects  15

3.1  General Definitions of BOT  16

3.2  Parties Involved in a BOT Project  17

3.2.1  Government Agency  17

3.2.2  Sponsors  19

3.2.3  Lenders  19

3.2.4  Multilateral Bilateral and Export Credit Agencies  20

3.2.5  Project Company  22

3.2.6  Construction Contractor  23

3.2.7  Operation and Maintenance Contractor  24

3.2.8  Offtake Purchaser  24

3.2.9  Input Supplier  25

3.3  The Contractual Framework  25

3.3.1  Concession Agreement  26

3.3.2  Shareholders Agreement  27

3.3.3  Lending agreements  27

3.3.4  Construction Contract  28

3.3.5  Operation and Maintenance Agreement  29

3.3.6  Offtake Purchase Agreement  29

3.3.7  Input Supply Agreement  30

3.4  Phases of a BOT Project  31

  III  

4.  Tendering Procedures  32

4.1  One-Stage Bidding Processes  33

4.2  Two-Stage Bidding Processes  33

4.3  Bid approaches  34

4.4  Issues Specific to Tender Procedures  35

4.4.1  Bid Bonds  35

4.4.2  Confidentiality of Intellectual Property  35

4.4.3  Competition during the Bid  35

4.4.4  Lack of Information  36

5.  Project Finance  37

5.1  Typical Characteristics and Features  38

5.1.1  Cash Flow Related Lending  38

5.1.2  Risk Sharing  39

5.1.3  Limitation of Liability  39

5.1.4  Off Balance Sheet Financing  40

5.2  Financing Instruments  40

5.2.1  Project Finance-Based Debt  41

5.2.1.1  Commercial Bank Loan  42

5.2.1.2  Bond Finance  43

5.2.1.3  Mezzanine Finance  46

5.2.2  Equity  46

5.2.3  Other Sources  46

5.2.3.1  Value Capture  47

5.2.3.2  Project Leasing  47

5.3  Finance Structure  47

6.  Risk Management  48

6.1  Risk Identification  49

6.1.1  Technology Risk  51

6.1.2  Completion Risk  52

6.1.3  Sales Risk  52

6.1.4  Financing Risks  54

6.1.5  Input Supply Risk  55

6.1.6  Operational and Management Risks  55

6.1.7  Political Risk  56

6.1.8  Legal Risks  57

6.1.9  Environmental Risk  58

6.1.10  Force-Majeure Risks  59

6.2  Risk Quantification  60

6.2.1  Static Risk Quantification Techniques  60

6.2.2  Dynamic Risk Quantification Techniques  62

6.3  Risk Reduction  64

6.4  Risk Spreading  65

6.5  Further Risk Allocation  66

6.5.1  Guarantees  66

6.5.2  Liquidated Damages and Indemnity Obligations  68

6.5.3  Insurances  68

6.5.4  Derivative Instruments  70

  IV  

6.6 Risk Management Process .............................................................................. 72

6.7 Risk Efficiency .................................................................................................. 73

6.8 Summary .......................................................................................................... 74

7. Conclusion ........................................................................................................... 75 Table of Enclosures ................................................................................................... 76 Enclosures ................................................................................................................. 77 List of References ...................................................................................................... 78

Table of Acronyms and Abbreviations

ADB Asian Development Bank ADRs American Depositary Receipts ADSCR Annual Debt Service Cover Ratio b.d.s.c. before debt service costs BI Business Interruption BLA Bilateral Agency BLO Build Lease Own BLOT Build Lease Operate Transfer BOD Build Operate Deliver BOL Build Operate Lease BOO Build Own Operate BOOST Build Own Operate Subsidise Transfer BOOT Build Own Operate Transfer BOT Build Operate Transfer BROT Build Rehabilitate Operate Transfer BRT Build Rent Transfer BTO Build Transfer Operate BTS Bangkok Transit System BTSC Bangkok Mass Transit System Public Company Ltd. CEAR Construction and Erection all Risks CEO Chief Executive Officer COFACE Compagnie Francaise d’Assurance pour le Commerce Exterieur COMFAR Computer Model for Feasibility Analysis and Reporting COPE Computer Oriented Project Evaluation

V

Cp. Compare

CPI Consumer Price Index

CSC China Steel Corporation

DBOM Design Build Operate Maintain

DBOT Design Build Operate Transfer

DRB Dispute Review Board

d.s.c. debt service costs

DSCR Debt Service Cover Ratio

DSU Delay in Start-Up

EBRD European Bank for Reconstruction and Development

ECA Export Credit Agency

ECGD Export Credits Guarantee Department

e.g. for example

EIB European Investment Bank

E-MAS ERL Maintenance Support Sdn. Bhd.

ERL Express Rail Link

ERLSB Express Rail Link Sdn. Bhd.

etc. etcetera

EYDF Executive Yuan Development Fond

f. and following page

ff. and following pages

FBOOT Finance Build Own Operate Transfer

FIDIC International Federation of Consulting Engineers

GDP Gross Domestic Product

Gov. Government

GPA Agreement on Government Procurement

Ibid. Ibidem

ICC International Chamber of Commerce

ICP Industrial Cooperation Program

i.e. that is

IFC International Finance Corporation

IRR Internal Rate of Return

JBIC Japan Bank for International Cooperation

KfW Kreditanstalt für Wiederaufbau

VI

KLIAX Kuala Lumpur International Airport Express

KMRT Kaohsiung Mass Rapid Transit

KRTC Kaohsiung Rapid Transit Corporation

LLCR Loan Life Cover Ratio

LRT Light Rail Transit

MIGA Multilateral Investment Guarantee Agency

MLA Multilateral Agency

MRT Mass Rapid Transit

NATO North Atlantic Treaty Organisation

NT$ Taiwan Dollar

p. page

PLCR Project Life Cover Ratio

pp. pages

PPI Private Participation in Infrastructure

PPP Public Private Partnerships

RLT Rehabilitate Lease or Rent Transfer

ROT Rehabilitate Operate Transfer

RSEA Retired-Service Engineering Agency

SA Shareholder Agreement

SACE Servici Assicurativi per il Commercio Estero

Sdn. Bhd. Sendirian Berhad

SPV Special Purpose Vehicle

SRT State Railway of Thailand

THSRC Taiwan High-Speed Rail Corporation

TS Transportation Systems

UNCITRAL United Nations Commission on International Trade Law

UNIDO United Nations Industrial Development Organization

USA United States of America

WTO World Trade Organisation

VII

Table of Figures

  Figure 1 Annual Investment in Infrastructure Projects with Private Participation in  

  Developing Countries  4

  Figure 2 Annual Investment in Infrastructure Projects with Private Participation in  

  East Asia and Pacific and South Asia  5

  Figure 3 Sectors and Segments of Infrastructure  7

  Figure 4 Investment in Infrastructure Projects with Private Participation in  

  Developing Countries by Sector 1990 2004  8

  Figure 5 Cumulative Investment in Transport Projects by Sector in East Asia and  

  Pacific and in South Asia 1990 2004  9

  Figure 6 Cumulative Investment in Transport Projects in East Asia and Pacific and  

  in South Asia by Type 1990 2004  15

  Figure 7 Contractual Structure for a BOT Project  26

  Figure 8 Phases of a BOT Project  32

  Figure 9 Simplified Cashflow Calculation Formula  39

  Figure 10 Schema of Project Risks  51

  Figure 11 Cashflow Ratios  60

  Figure 12 Cashflow Scenarios  63

  Figure 13 Risk Management Process  72

  VIII  

1. Introduction

1.1 Motivation of the Thesis

The rapidly developing economies in Asia are undergoing unprecedented growth. This explosive development has placed incomparable demands on the existing infrastructure in many countries. Governments struggle with the challenge of providing modern, efficient, and affordable infrastructure services for their people; finding it difficult to finance what are often multimillion dollar projects on their own. Involving the private sector in the financing and operation of infrastructure promises several benefits for both parties. 1

“With a share of over eleven percent in German foreign trade, exports to Asia are – in terms of volume – now two percent higher than those to the USA. >…< “Many German companies have taken on public private partnerships as a form of cooperation and thus play a part in the sustainable development of the Asian economies.” ² To date the most common sub-type of private participation in infrastructure is the BOT (Build-Operate-Transfer) model, where a project company finances and constructs new infrastructure and operates that infrastructure over a long-term period, before it is transferred back to the government. But despite the long history of projects of this type, only a few are very successful and usually mean more costs than income to the companies. 3

Eurotrain, a joint venture between rail giants Alstom and Siemens, proved in May 1998 it was ready to build Taiwan’s US$ 14 billion high-speed rail (BOT) project, with a successful test-run of its integrated train system in Germany. The only problem was that after at least a two-year effort, the Taiwan High Speed Rail Corporation (THSRC) suddenly decided to give the core contracts to the Japanese Shinkansen Consortium. THSRC has yet to explain why Eurotrain was not given a chance to match Shinkansen’s offer. De facto ambassadors from Germany, France and even the

¹ Cp. World Bank, (1996), p. 1

² Pierer, (2004), p. 7f

³ Cp. Duff, (2002), pp. 2-5

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CEO’s of the companies met with THSRC’s chairwoman Nita Ing, who failed to provide any explanation whatsoever for this change of plan. 4

BOT projects are extensive in nature, with the companies therefore always finding themselves in international competition and/or having to forge global partnerships to get the project done. They have to be aware of every single potential local and global risk which could threaten the whole project; not only to ensure that the project is won, but also to successfully complete it.

For companies, there is often the difficulty that risks are misjudged, meaning that projects are either canceled completely or, in case of overestimated risks, the bidding price is much higher than the competitors, which ultimately both lead to a loss of image and references.

On the other hand, there are more than enough examples of risks being severely underestimated, with the project turning out to be absolutely unprofitable and companies often have to face long and cost-intensive legal disputes ⁵ . This turns especially fatal when construction companies are also under the sponsors/investors of the project.

Within companies, there are clearly differences in the perception of the risks. The goal of this thesis is to provide a better understanding of the most important risks during Build–Operate–Transfer Projects in Asia.

1.2 Methodology and Containment of the Study

Due to the specific employment of the authoress in Taiwan and the wide range of the umbrella term “infrastructure”, this study will concentrate on specific examples and statistics in Asia with specific reference to the subsector “transport” and the segment

⁴ Cp. Feliciano, (2000), p. 1ff ⁵ On Friday November 26 ^th 2004, THSRC agreed to pay US$ 65 million to the Eurotrain consortium to settle the four-year dispute. The settlement sum was US$ 24 million less than what the International Chamber of Commerce (ICC) had demanded in a ruling made in March. (Cp. China Post, (2004), p. 5). For satisfaction of the Europeans the Japanese Consortium is currently one year behind schedule with its planned revenue service date.

2

“railways” therein, while at the same time providing enough information to also offer a general overview of the other sectors.

This dissertation looks first at private participation in infrastructure. Chapter 2 introduces the idea of private participation and the development in Asia as well as the different forms of participation and the sectors of infrastructure. The researched form of private participation in this dissertation is the Build-Operate-Transfer model. This and the relationship between the parties to a BOT project and the relevant documents are discussed in Chapter 3. Tendering procedures are reviewed in Chapter 4 and Chapter 5 discusses issues specific to financing a project and its instruments. The emphasis of this dissertation on risk management is discussed in Chapter 6, with a focus on identification, quantification, reduction and allocation of risks.

2. Private Participation in Infrastructure

The coverage and quality of a country’s infrastructure plays a vital part in economic growth. From the 1950s until the 1990s, most developing countries relied on public sector monopolies to deliver electricity, telecommunications, transport infrastructure, and water and sewerage services. Progress in expanding service coverage has been slow. An estimated 1.2 billion people in the developing world have no access to electricity more than 1 billion lack access to clean water, and nearly 1.2 billion are without adequate sanitation. Moreover, inefficiency has been high. Technical inefficiencies in roads, railways, power and water alone caused losses estimated at US$ 55 billion a year in the early 1990s – equivalent to 1% of the GDP of all developing countries, a quarter of their annual investment in infrastructure, and twice the annual development finance for infrastructure in the developing world. 6

Disenchantment with past approaches to providing infrastructure services, coupled with tightening budget constraints, led governments to explore how to best harness the benefits of private participation. In doing so, governments also reexamined their own role and are seeking to transform it – moving away from being the exclusive financiers, managers, and operators of infrastructure to becoming facilitators and regulators of services provided by private firms.

⁶ Cp. World Bank PPI Database

3

All of this launched a trend of liberalizing and privatizing infrastructure, beginning in a few countries in the 1980s. According to the World Bank’s Private Participation in Infrastructure (PPI) Project Database ⁷ , 26 developing countries awarded 72 infrastructure projects with private participation in 1984 – 89, attracting almost US$ 19 billion in investment commitments. In 1990 – 2001 developing countries transferred the operation risk for almost 2,500 infrastructure projects to the private sector, attracting investment commitments of more than US$ 750 billion. Annual allocation is shown below in Figure 1. Investment commitments for infrastructure declined in the wake of the East Asian financial crisis ⁸ and subsequent crises in the developing world, starting in September 1997.

Figure 1 Annual Investment in Infrastructure Projects with Private Participation in Developing Countries 9

Those projects were implemented under schemes ranging from management contracts to divestitures to greenfield ¹⁰ facilities under build-operate-own (BOO) contracts, BOT contracts, or merchant facilities. 11

⁷ For further information on this database please refer to the explanations in the bibliography ⁸ The Asian crisis started on July 2 ^nd 1997 when the Thai Central bank floated the exchange rate of the local currency. The Thai currency promptly plummeted 20% against the US Dollar. Starting in Thailand the Asian crisis reached Indonesia, Malaysia and the Philippines in July and August, and South Korea in November. The year 1998 saw the crisis heighten, with it encroaching upon Russia and other emerging markets like Brazil and Mexico in August.

⁹ compiled by the authoress in dependence on the World Bank PPI Project Database ¹⁰ Means, by which users are provided with a new facility where none previously existed ¹¹ Cp. World Bank, (2003), p. 1ff

4

In 2004 developing countries saw investment flows to infrastructure projects with private participation grow for the first time since 2000. Growth was driven by just one sector: telecommunications. Investment flows to other infrastructure sectors fell by 20 percent. 12

2.1 Private Participation in Asia

East Asia and Pacific, and South Asia together attracted more than US$ 250 billion in investment commitments for infrastructure projects with private participation. The annual allocation is shown below in Figure 2.

Figure 2 Annual Investment in Infrastructure Projects with Private Participation in East Asia and Pacific, and South Asia 13

Private activity in the region began early with major programs in Malaysia and the Philippines in the second half of the 1980s, and grew rapidly in the 1990s. In 1997, investment declined sharply as a result of the before-mentioned financial crisis in the region. The largest economies in the area – China, Malaysia, Thailand, Korea, the Philippines, Indonesia and India – drew the most investment in PPI projects. The region focused on creating new assets through greenfield projects that served or complemented investments by public sector providers.

¹² Cp. Izaguirre, (2005), p.1

¹³ compiled by the authoress in dependence on the World Bank PPI Project Database

5

In both regions, 978 infrastructure projects with private participation reached final closure between 1990 and 2004. Energy and Telecom were the most active sectors and greenfield projects were the most frequent form of private participation in these countries. In East Asia, some of those deals turned sour. 40 projects representing 12% of investment were either cancelled or running into problems by 2004. 14

Much of Asia continues to grow rapidly, driven to a considerable extent by China. Urbanization is proceeding at a rapid pace. Demand for infrastructure services is increasing massively, particularly in cities. Much of the demand comes from the newly-urbanized poor. Infrastructure has to meet the needs of this population.

2.2 Public Infrastructure

“The availability of infrastructure facilities is imperative for the overall development of any country. Infrastructure is but one part of the development challenge, but its impacts are among the most important.” 15

Yet a general definition for the term “infrastructure” is still missing. This interpretation should transcribe the fact, that the benefits of infrastructure are the key to the economic incentives of a national economy ¹⁶ : to promote economic growth, to share the benefits of growth with poorer groups and communities, and to connect countries within the region and with the rest of the world ¹⁷ .

The term “infrastructure” first appeared in the 1960s and had economic-political reference. It is actually a military term of the NATO, which described fixed military and transport facilities.

Today, infrastructure facilities can be divided into the following main sectors and segments as shown in Figure 3 below:

¹⁴ Cp. World Bank, (2004) p. 1

¹⁵ Asian Development Bank, (2005), p. xxi

¹⁶ Cp. Tytko (1999), p. 183

¹⁷ Cp. Asian Development Bank, (2005), p. xiii

6

Sectors and Segments of Infrastructure 18 Figure 3

But private participation has also been seen in developing single buildings, for

example, the 101 Tower in Taipei. Currently the tallest building in the world, it was

financed with a BOT model and is a very successful project. 19

¹⁸ compiled by the authoress in dependence on the World Bank PPI Project Database

¹⁹ Cp. Mei-Chun, (2005), p. 22

7

Figure 4 below shows investment amounts by sector in the past years.

Figure 4 Investment in Infrastructure Projects with Private Participation in Developing Countries by Sector 1990 - 2004 20

Telecommunications led the growth of private infrastructure in developing countries, which is confirmed also in 2004. The sector accounted for 70% of annual investment flows. This outcome is not surprising; around the world, mobile phone firms outperform other utilities in financial returns, service provision, and cost-recovering tariffs ²¹ .

Energy attracted the second largest share of investment. Most of the investment occurred between 1994 and 1997, during the boom in greenfield projects for independent power producers implemented through BOO or BOT contracts.

Private activity has lagged in transport and in water and sewerage, where technological change has been less pronounced, political barriers to reform can be strong. Transport accounted for 18% of the cumulative investment from 1990 to 2004. Much of this share went to toll roads. Countries introducing private participation in transport have focused on transferring existing assets through concessions and constructing toll roads through greenfield projects. 22

²⁰ compiled by the authoress in dependence on the World Bank PPI Project Database

²¹ Cp. Izaguirre, (2005), p. 2

²² Cp. World Bank, (2003), p. 3-4

8

2.2.1 Transport Sector in Asia

Transportation projects, including airports, seaports, roads, railways, tunnels and bridges, have traditionally been financed by a combination of private and public funding. Below in Figure 5, the cumulative investment in the four main segments is shown.

Figure 5 Cumulative Investment in Transport Projects by Sector in East Asia and Pacific and in South Asia, 1990 - 2004 23

Private activity in transport started in the 1980s with mainly tollroad projects in Malaysia, Indonesia and Thailand ²⁴ .

The trend, of governments to privatizes new and already existing transportation schemes, has developed largely as a result of the tremendous expense the public sector has incurred in subsidizing transportation operations. Cost concern in the public sector is aggravated by the need to increase capacity in the near future. Developing economies have a particular need for increased capacity in their transportation services, yet the costs of such increases are prohibitive. 25

²³ compiled by the authoress in dependence on the World Bank PPI Project Database

²⁴ Cp. Gomez-Ibanez, (1993), p. 146

²⁵ Cp. Delmon, (2005), p. 369

9

2.2.2 Railways Segment in Asia

Private investment in and financing of railways has had a long and illustrious history and a number of different structures and models are available for private sector involvement in rail projects. Historically the most common type has been concessions, but this is giving way to greenfield models. 26

One of the primary differences between a BOT railway project and, for example, a BOT power project is the absence of a universal offtake agreement (discussed in Chapter 3.3.6). Although commercial carriers may make contracts with the railway operator for long-term rail access, such contracts will generally not cover the entire period of the concession.

Further, just as with roadway and bridge projects, there is no guarantee that once the project has been completed private passengers will use the service. Even with market testing and traffic forecasts, the project company can be left bearing the majority of the project’s market risk. The traffic forecast in particular is one of the major weaknesses of transport projects. Such forecasts have proven to be unreliable in the past, often failing to take account of demographic changes, shift in demand, competition, cost increase and willingness to pay. 27

This also happened to be the main failure on the Bangkok Transit System (BTS) in Thailand (discussed in detail in chapter 7.2). The Skytrain is among the best technical local traffic solutions practiced today in the world, but the revenue from ticket fares is to date still not enough to repay the debts. To attract the BTS the government even granted cheaper fares, making the situation worse.

Looking at a number of countries in this region to assess where the most likely new rail projects will occur in the next few years suggests that a return to the heady days of rail investment in the 1980s and 1990s is unlikely. But there is no doubt that rail, particularly urban rail, will continue to play an important role again, especially in China.

²⁶ Cp. Tynan, (1999), p. 7

²⁷ Cp. Delmon, (2005), p.372-375

10