Financial and Banking Practice in the BOT/BOO Projects

Yung-san Lee (李庸三)

I. Introduction

In Taiwan, our governmant continues its encouragement for more private sector
to participate in public infrastructure and utilities projects which have been going on
since 1993. A number of specific policies and measures have been adopted for
implementation of the projects including privatization of state enterprises and new
infrastructure projects. The latter includes independent power plants, the Taipei
Financial Center, the mass transit system from international airport to downtown
Taipei, and the Taiwan high-speed railway. The "Build-Operate-Transfer" (BOT) or
"Build-Operate-Own" (BOO) methods have been tested for use by new private
infrastructure pojects which had traditionally been under development by the public
sector.

Since nothing can be ignored or spared in establishing efficient and reliable

infrastructure and utilities for economic development, substantial amount of funds
for investment is indispensable. It is impossible for the government to appropriate
huge amount of funds from a normal budget for financing the construction and
operation of these projects. A number of infrastructure projects therefore must be
financed by the private sector by means of BOT or BOO method. It is expected that
the cooperation between the government and the private sector is going to reduce
government financial burden, promote private investment and increase the
operational efficiency.

Unfortunately, due to lack of experience in the BOT/BOO projects, the ROC

government, private enterprise and financial institutions are still finding themselves
in the learning process. In my opinion, the major issues worthy of our consideration
relating to BOT/BOO projects are as follows:

II.Preliminary Planning and Bids Invited by the Government

As the first step, the government authorities will do some preliminary planning,
undertake feasibility study, calculate financial internal rate of return and self-
liquidation ratio, and clarify obligations and risk-sharing among those concerned.
Moreover, in order to provide reliable and timely information, the outcome of the
preliminary planning needs to be evaluated and revised following the political and
economic developments. Particularly, thorough market research is to be undertaken
to estimate project benefits. During the planning period, the BOT method needs to be
reconsidered if the estimated self-liquidation ratio falls below 100％. In the case of
an insufficient self-liquidation ratio, the government may either put in partial capital
or provide guarantee or other forms of assistance in order to raise the self-liquidation
ratio and provide incentives to arouse interest for active participation from the private
enterprise.

As a matter of fact, participation of private enterprise in the construction of

public infrastructure projects is not only in keeping with the principle of profit-
seeking incentive of the enterprise, but may also improve social welfare as well.
Therefore, most of the international BOT projects nowadays feature strong support
by the local government, such as the Malaysian North-South Interurban Toll
Expressway, the Sydney Harbor Tunnel and the Hong Kong Western Harbor
Crossing projects. The government provides the needed financing, allows project
company to operate existing facilities, and guarantees a minimum internal rate of
return, as well as interest and exchange rates in oder to strength the project self-
liquidation ratio.

Secondly, the concerned government agency must be thoroughly acquainted with

all specific items that need be completed by the government, such as schedule of
completion and provision of guarantee and other undertakings that require
government assistance. It should also include the above-mentioned into the bidding
notice in order to eliminate any ambiguity about the projects and set up clear-cut
terms for contest environment. Take the South-North High-Speed Rail (SNHSR)
along the island for example: the self-liquidation ratio of the project is said to be less
than 100％ according to some reports. But the government not only specified no-
guarantee provision in the bidding notice but also specified the lowest funding
provided by the government as one of the bid-awarding considerations. The above
two conditions did not seem to be in line with the lacking self-liquidation ratio of the
project.

Moreover, since the terms of the tender do not clearly specify the obligations
between the government and the tender, the following development became
somewhat intriguing. At first, the Taiwan High Speed Rail Company (THSRC)
refused to sign the construction and operation agreement due to differences of
opinion in financing of the project, and became involved in buck-passing with the
government authorities, the Ministry of Transportation and Communications
(MOTC), creating a crisis almost to the point of having to rescind the agreement.
After a prolonged discussion and negotiations, this crisis has been resolved for now,
but the authority of the government had been challenged, criticized, and even dented
by the constant revision and adjustment of this first BOT project in Taiwan.
III.Evaluation of Bidding by the Government

Regarding the evaluation of any BOT/BOO applications, the responsible

government agency will set up a screening committee to examine and evaluate the
construction and operation abilities of applicants in accordance with Article 37 of the
Statute for Encouragement of Private Participation in Transportation Infrastructure
Projects. From the perspective of financial institutions, the financial feasibility of a
project is the most crucial factor in terms of the success or failure of project.
However, the feasibility of financing relies on the willingness of financial institutions
to make loans, as the term of BOT can also be inferred as "Bankable or Terminate."

During the stage of screening and investigation, it is advisable that financial and
banking consultation should be provided by experienced professionals. The authority
should fully respect and consider their professional opinions. In addition, the
committee should also include representatives from the financial institutions in order
to scrutinize the financial plan of bidding firms. One should know that when
evaluating the financial feasibility of the project from the perspective of the financial
market, bidding prices should not be the only factor considered.

IV.Resolution of Concession Agreement

The essence of BOT/BOO projects is to increase social benefit through the

cooperation of the government and the private sector. Therefore, based on the
foundation of mutual trust, the government and the private sector both should bear a
reasonable part of the risk as the role of a partner. Furthermore, they both need to
specify clearly all the related rights and obligations on the concession agreement for
observation accordingly. For instance, in the acquisition of land, specification of
standards for environmental protection, certificate issuance and settlement of
disputes, the government must exercise its full authority in order to maintain the
administrative efficiency and eliminate any suspicion and anxiety of the private
enterprise. On the other hand, the private enterprise should not unreasonably ask for
favors from the government, but plan cautiously to undertake operational and price
risks.

Moreover, the authorities should recognize that the funding source of BOT/BOO
projects mainly come from the financial institutions. Therefore, the concession
agreement should take into account the laws and tradition of the financial market in
order to prevent any misunderstandings from growing among the government, the
financial institutions, and the project company. It is advisable that financial
institutions be invited to participate in the preparation of BOT projects not only to
disseminate financial information but also to obtain consensus of opinion from the
trio (MOTC, THSRC, and the Syndicated Banks).

Take the High-Speed Rail Project for example. Although the construction and
operation agreement of the government and THSRC had specified on the right of
intervention by the financial institutions, the time, scope and method of execution
were somewhat ambiguous. As a result, different views were entertained by the
government and the financial institutions while the THSRC was searching for a
source of financing, and it had taken extensive negotiations before an agreement was
reached.

Take the privatization of power plants for another example. The draft of the
Taipower's purchasing power agreement initially did not cover such contingencies as
the exchange rate risk allocation and the right of banks' intervention. As a result, it
increased the financing difficulty for the awarded firms. Fortunately, after
discussions among the awarded firms, the government authorities and the Taipower,
the project risk was lowered and the willingness of the participation of financial
institutions increased due to the loosing of restrictions. This example shows that the
practical requirements from the financial perspective and the domestic laws and
regulations, had been duly considered for the concession agreements; or if the
feasibility of financing were granted at the early stage of project preparation,
unnecessary delays in project processing could have been avoided.

V. Level of the Government Coordinating Agency and Effective Regulatory

Framework

Take the High-Speed Rail Project as an example. Problems cannot be solved

promptly due to the limited authorization and obligations of the responsible agency.
Inter-ministerial meetings are often called but a common ground can not be reached
owing to the rigidity of the concerned parties. Besides, if the contracts are revised
and appear different from the previous assessment, the responsible officials are under
suspicion of cronyism and will very likely be accused as such. Therefore, civil
servants are normally reluctant to accept any proposal for revision of contracts.
Moreover, they do not have the power to make any change, even though flexibility is
desirable and the motive is based on the consideration of public interest. Promotion
of the High-Speed Rail Project was delayed mainly due to the above hindrances.

In this regard, it is suggested that the level of the responsible government agency
should be upgraded and be given a free hand to exercise its full power. Consequently,
any autonomous decision can be made during the decision-making process.
Alternatively, special laws may also be provided so that the executive agency can act
accordingly, thus reducing the conflicts among agencies during the negotiation and
implementation period. Additionally, regarding the scope of government authority,
the government should play the role of a coordinator. For example, the Executive
Yuan may set up a taskforce unit and coordinate with other government agencies in
order to maximize the administrative efficiency.

At present, the legitimacy of promoting BOT projects is based on the Statute for
Encouragement of Private Participation in Transportation Infrastructure Projects and
its by-laws. However, the issues not specified in the Statute need to be regulated by
other regulations. For example, according to the Company Law and other related
regulations, the project company, during the period of construction, is unable to raise
fund by initial public offering or the issuance of corporate bonds, which increases the
difficulty of funding for private enterprise. Therefore, to promote the BOT/BOO
projects, it is necessary to enact or revise related laws and regulations. It is suggested
that the government authorities should scrutinize and study their necessity and
legitimacy, then coordinate with related law-making parties to specify and enact the
laws accordingly. Thus the government and project company can be regulated with
appropriate laws and regulations, and the rights of the project company can be
protected

VI.Appraisal and Implementation of BOT Projects

As mentioned earlier, the financing feasibility of BOT/BOO projects is the

crucial factor to the success or failure of any project. Therefore, bidding firms must
prepare and submit a comprehensive and reasonable financial plan. The government
authority not only needs to scrutinize and assess the viability and financing source of
the project, but also needs to check the funding ability of the bidding firms as well as
the allocation of benefits from land development. Moreover, in order to reduce
project uncertainty during the period of implementation, the budget for the
investment should include the provision and calculation of the self-liquidation ratio
should take the provision into account to avoid an over-blown financial plan and lack
of risk-taking flexibility.

In the meantime, since the project plan is part of the concession agreement, its
power to restrain the awarded firm should be fully implemented. Besides, there is
also a need to show that it has passed through the scrutinization and evaluation by the
awarded firm. Or, the plan could be modified and revised for the pre-condition and
procedure of the project to prevent the bidding firms from providing an unfeasible
plan, for otherwise they would keep on changing plans or breach the concession
agreement. For example, after the awarding of the bid, the firm needs to pay a
royalty, carry out re-capitalization, and sign other related contracts (such as
construction turnkey and insurance contracts), to ensure risk-sharing. Moreover, the
bidding firms are requested to have a financial institution as an appraiser to present
an independent report on project feasibility study. Additionally, the financial
institutions should also submit a legal "letter of intent" and provide concrete
financing commitment or guarantee to ensure the required funding.

VII.Participation by the Financial Institutions in BOT Projects

In general, financial institutions themselves are expected to undertake the credit

risk since they are the major funding providers of BOT projects. But, in order to
clarify the project risks and set up a proper and reasonable risk-averting mechanism,
it seems like a more preferable arrangement to have financial institutions fully
participate in the bidding, screening, evaluation and negotiation of the BOT/BOO
projects. Take the High-Speed Rail Project for example again. The concession of the
BOT project can not be considered as a collateral, and other collateral provided are
difficult to dispose of due to the restrictions of existing laws and regulations and the
consideration for the interest of the public. The project itself has also involved
several uncertainties, such as the accuracy of ridership forecast, the difficulty of
acquiring land from the private individuals and the coverage of related laws, etc.
Therefore, the financing risk of this project is higher than ordinary general cases.

However, some considered that the issue of financing is the main hurdle in
causing the High-Speed Rail Project to postpone its construction; while others
accused the financial institutions as culprits of conservatism. In fact, one needs to be
aware that the loanable funds in the financial institutions are coming from the
deposits of the general public. Security should be the first priority of responsibility of
the financial institutions to the public deposits. Besides, financial institutions are also
restrained by the requirement of BIS ratio. Moreover, although the plan of SNHSR
project has changed tremendously since the concession was awarded, the risk-sharing
mechanism seemed to be incomplete and financial institutions have no chance to
evaluate the project. All of the above matters weaken the willingness of financing by
the financial institutions.

VIII.The Feasibility Study of the Project Finance

Project finance differs from traditional non-project loans as the former

emphasizes the cash flow analysis and is referred to as "Cash Flow Finance." The
main concept is that the financing agency chooses a specific plan or business entity
to provide financing; and the payment of principal and interest will solely come from
the profit and cash flow generated by that plan or business entity. With regard to the
collateral, it is limited to the asset purchased under that specified project. The key
issue is that banks do not allow having recourse to the project sponsor, shareholders
of business entity, or the affiliated company when the borrowers fail to honor their
debts (principal and interest). Because of the features of "without recourse" and
"limited recourse" in project finance, banks strongly emphasize the mechanism of
financial risk-taking and project risk sharing.

As for the risk-sharing mechanism, it is made through the arrangement of project

contracts to transfer the potential risks to the most competent undertaker. Several
examples are that borrowers sign with EPC contractors for fixed prices, fixed date
turn-key contracts in order to lower the construction risk; operational company for
operation and maintenance contracts in order to reduce the operational risk;
suppliers for long-term contracts in order to make sure sufficient raw materials
and/or fuel can be supplied. In addition, borrowers need to purchase suitable
insurance in order to avoid losses caused by contingencies (like natural disasters). To
safeguard the financiers' rights, loan agreements not only specify the supervisory
mechanism of independent engineering consultant and allocate the stream of capital
flow, but also control and earmark money for special accounts. Additionally, all the
financial claims generated from related project contracts should be assigned to the
financiers.

The previous examples show that the structure of project finance is quite
complicated and comprehensive. The borrowers should undertake a comprehensive
feasibility study and carefully read over every project contract. Moreover, major
shareholders should come up with necessary commitments such as technical
assistance, providing subordinated loans, maintaining the minimum share holding
and pledge lien on shares, helping to get the mechanism of risk-sharing
acknowledged by the financiers. Due to the complexity of project finance, arranging
project finance is generally time- consuming and costly. More often, higher interest
rates are reasonably expected. But, at the present stage, only some domestic large-
scale investment projects, except in a few cases of private power plant construction,
can fulfill the above requirements mainly due to the cost factor and other
considerations. Hence, the willingness of local financial units to provide project
finance may be weakened since the matching means are not fully fledged to sustain
the project.

Furthermore, some features of project finance are not quite consistent with the
lending guidelines of domestic banks, such as low equity/asset ratio, extensive
financing period, insufficient security rate, etc. Additionally, the financing agency not
only needs to consider the maximum amount of financing to the individual borrower
as specified in the Banking Law, but also have to take into account the requirement
of the BIS ratio. These restrict domestic financial institutions in providing financing
to BOT projects.

IX.Key Factors for Implementing Successful Project Finance

Project finance features higher risks since it involves a sizeable amount of funds
and a long payback periods. A severe loss to the financial institutions, the borrowers
and the general public may occur if the project fails. According to the Asian
Development Bank (ADB), the failure rate of its cases in project finance had reached
as high as 10 percent. Its post-evaluation reports show that for those failed projects,
major factors are as follows:

1.Delays in hiring engineering consultants;

 2.Defects and errors in the engineering design, lack of innovation or adoption of
obsolete production technology, and alteration of planning scope;

3.Incapability of executive agency, i.e. insufficient technicians, incompetent

managers, poor supervision and faulty assessment;

4.Interruptions in construction work due to bad weather;

5.Delays in construction due to possible causes such as labor disputes, difficulty

in acquisition of land, financial difficulties of contractors and local disturbances;

6.Cost overrun with ever escalating wages and rising prices of construction
materials;

7.Difficulty for project to start off or finish on time owing to disputes over
environmental protection;

8.Insufficient funds available for borrowers resulting in suspension of project;

9.Inability to fully utilize production capacity though project may have been
completed on time for reasons such as price increase of raw materials; lower
market demand from as originally estimated; lack of competitive power in the
product market.

On the other hand, the ADB found out successful project finance hiding in the
following elements: specific and clear goals, reasonable rates of returns, sound
financial plan, responsible sponsors, a fair deal for all parties, experienced and
professional contractors, well-functioning equipment and highly-skilled workers, etc.
Besides, ardent support by the government, stable political environment and
favorable economic environment are also essential to the success of BOT projects.
X.The Feasibility of Multi-channeled Funding

From the perspective of the financing plan of the High-Speed Rail Project, the
project requires total financing of NT$280 billion, which is to be secured from postal
savings, several pension funds, and loans from the domestic banks. Analyzing this
project, it is evident that it is not looking for a variety of financing means but will
rely exclusively on local funding. Several reasons behind all this are such as
abundant local funds, favorable long-term rates provided by the government, and
higher exchange rate risks for foreign financing. For example, if the awarded firm
applies for foreign currency export finance and enjoys lower rates, it may flatter itself
for the wise choice in the beginning but an exchange rate risk may sometimes occur
since the New Taiwan dollar is not an internationally convertible currency and cannot
request a large-amount or a long period of hedging. Besides, foreign export credit
agencies have enforced specific ruling over the structure of export finance. It is still
under discussion whether the local banking practice, e.g. domestic financing frame,
related loan agreements and tight schedule to arrange financing, can cope with its
requirement.

With regard to the issuance of overseas corporate bonds, the U.S. is still the
dominant market in the international bond arena. However, the above overseas
corporate bond should first be evaluated by international ratings agencies (such as
Moody's, S&P, etc.). The outcome of their evaluation has become an important index
to reflect on the rate of corporate bonds. Take the infrastructure projects in the
Southeast Asian countries for example: the rates of corporate bonds issued in the
U.S. are equal to the rate of U.S. government bond plus 250 base points. At the same
time, issuing overseas securities has to follow the related regulations issued by the
Securities and Futures Commission (SFC), Ministry of Finance. In short, after
considering the required evaluation, capital cost and legal restrictions, private
enterprise would be better off being conservative in issuing overseas corporate
bonds, particularly when domestic capital funds are abundant and available for the
project.

By analyzing the channels of local funding, CEPD's medium- and long-term

funding, supported by the postal savings, is the main financing source for domestic
large-scale projects. However, under the continual promotion of local public
infrastructure and private investment projects, the sufficiency of medium- and long-
term funding should be taken into account seriously. Aside from the said funding, the
issuance of domestic corporate bonds, by private enterprise, is often an alternative
approach. However, restricted by the Statute, the Company Law and other
regulations issued by the SFC, the private enterprise, during the construction period,
are prohibited from issuing bonds. In the meantime, neither are they allowed to put
out convertible bonds before going for the public or the over-the-counter market.
Consequently, it will affect the feasibility of diversifying funding sources.

XI.Concluding Remarks

The government has been promoting large-scale public infrastructure projects by

adopting the BOT frame for several years. It mainly hopes to mobilize private capital
to participate in infrastructure projects, stimulate more investment, and improve the
operational efficiency. However, the other side of the bargain is having a large sum of
money involved, an extensively long payback period, and high project risks.

First, I believe that the responsibilities and obligations should be specified

clearly between the government and the private sector; and both parties need to
strictly stick to the rules of the game accordingly. Secondly, the government should
not hesitate to demonstrate its public authority to the fullest extent and be ever ready
to assist the private investors in their needs over the project and, when it comes to
dire necessity, be willing to also bear partial risks and responsibilities for the benefit
of the project. Thirdly, the private investor not only needs to study and analyze the
project feasibility, but also should obtain the financing support before the bidding.
After the tender is awarded, the awarded firm is expected to implement the project on
schedule, control every possible risk and complete the project successfully. At the
operational stage, professional and skilled workers are much needed. With regard to
the financial viability, the estimated self-liquidation ratio should not be too low. If the
project sponsor cannot acquire reasonable profits, then the project cannot last long.

Fourth, the financial institutions that provide financing should fully participate in
all the stages of bidding, examining, and negotiations in order to provide timely
information on financial practice and regulations. Regarding the application of
project finance, the pre-condition is to establish the mechanism of project risk-
sharing. They also need to be aware that arranging a BOT project consumes
significant time and higher costs. All in all, any BOT/BOO projects require close
cooperation among the government agency, financial providers, and the private
sponsor to make them successful.