Improving the Bankability of PPP with Proper Risk Sharing - Korean Experience - PIMAC Soojin Park June, 2014

Part 1. Foundation for PPP Vitalization

 Aug. 1994, PPP Act legislated. ‘Act on Promotion of Private Investment into Social Overhead Capital’  2 Major Revisions Jan.1999 Amendment ‘Act on Public-Private Partnerships in Infrastructure’ Unsolicited PPP Projects Revised Risk-sharing mechanism (Minimum Revenue Guarantee) Jan Amendment. Introduction of BTL scheme Diversification of PPP Project facility types (Education facilities, Military residence, Environmental facilities, etc.)  Direction: Facilitating the procurement process, Promoting Bankability, Improving transparency and VFM. Evolution of the PPP legal framework 3

Private Sector (SPC) End-user Government Provides Services Pays User Fee Grants Operational Rights Transfers Ownership Build-Transfer-Operation Private Sector (SPC) End-user Government Pays User Fee (If necessary) Transfers Ownership Provides Services Build-Transfer-Lease Grants Operational Rights/ Pays Government Payment Major Procurement Schemes 4

5 Enactment (‘94): ‘The Act on Promotion of Private Capital into Social Overhead Capital Investment’ Revision (‘99): ‘The Act on Public-Private Partnerships in Infrastructure’ KDB’s PF commencement (‘95) Korea Credit Guarantee Fund for PPP was established (‘94) MRG support Most of the PPP foundations are equipped by late 90s, since then Korea saw a rapid increase in PPP PICKO was established (‘99) PIMAC was found in merge of PICKO & PIMA (‘05) Risk Sharing PPP unit Legal Foundations Financial market PPP Vitalization through Enhanced Bankability 3

PPP Track Record (As of Dec. 2012) 6 Total number of projects and project cost (billion USD) Under operation Under construction Under preparation Procurement Method BTO No. of Projects 207 (32.8%) Project cost 65.5 (72.1%) BTL No. of Projects 423 (67.2%) Project cost 25.3 (27.9%) Total No. of Projects 630 (100%) Project cost 90.8 (100%) Korea achieved 630 projects that amount accumulates about $90 billion within 18 years since PPP law was introduced in 1995

The Role of PPP Unit (PIMAC)  PIMAC is an affiliated body of KDI. KDI, founded in 1971, has been the leading economic think-tank of Korea.  Statutory Organization ; PPP Act entitles PIMAC To support PPP work.  Responsible Tasks of PPP Division in PIMAC PPP Policy Unit : Consultation of PPP Act Revision, PPP Basic Plan (PPP Annual Plan), Feasibility Test (VFM Test), Standard Concession Agreement PPP Project Unit : Evaluation of Project, Agent of Government in Negotiation with private sector Finance & International Cooperation Unit : Review of Refinancing plan, International Relation, capacity building and training 7

Part 2. Risk Sharing Scheme

9 “Proper risk sharing” and “Government supports” are the integral parts for PPP facilitation through enhanced bankability Risk sharing items Construction periodOperation period Financial viability Construction subsidy- Investment risk - New investment risk sharing scheme (*) Tax - Tax exemption Termination Termination payment Land Land acquisition work by government agent Free use of state owned land Funding Infrastructure credit guarantee fund (*) Introduced in substitution for MRG(Minimum Revenue Guarantee), and eligible for only solicited BTO project Risk Sharing Scheme – The Overview

Risk Sharing Scheme - by Sources 10  Statutory Basis PPP Act & Decree declares Financial support for PPP Project Establishment of Infrastructure Credit Guarantee Fund (3) Free use of State-owned land Basic Plan for PPP Project explains in detail Early Termination Payment New Risk-sharing scheme (BTO, Solicited Project) (4) Infrastructure Credit Guarantee Fund (3)  Individual Concession Agreement Construction Subsidy (how much, when to pay) (1) Early Termination Payment (How calculated) MRG or Risk-sharing scheme (2)

Risk Sharing Scheme (1) : Construction Subsidy  Subsidy shall be determined by individual concession agreement 11 TypeNegotiation Guideline 1. Roads 25 – Ports 1) Container terminal 30 2) General Cargo Railways 50 [PIMAC Internal Guideline on Negotiating Construction Subsidy] (% of total construction cost) SOURCE : Internal data of PIMAC Notes: 1. Many port projects have attracted private participation even without fiscal commitment to construction cost. Recent support ratios have averaged 20%. 2. Container terminal refers to facilities that specialize in containers. 3. General cargo is used to refer to freight such as wheat, iron ore, coal and crude oil that is not packaged and transported in bulk. Terminals that mainly process such freight are referred to as general cargo.

12 Capital Stack of PPP – BTO BTO projects are funded by 27.6% of construction subsidy, 54.7% of project loan and 17.74% of equity.  Financial investors constitute 42% of equity, among which 21% are investment trusts, 14% are bank and insurance companies, and 7% are pension services % (25%) (*) All the figures are contract basis and thus real investment balance may be different 27.6% 57.4% (75%) 12

13 Capital Stack of PPP – BTL 6.09% BTL projects are financed with 54.7% of project loan, 17.74% of equity, and without construction subsidy  Financial investors constitute 73% of equity, among which 49% are investment trusts, 18% are bank and insurance companies, and 6% are pension services. (*) All the figures are contract basis and thus real investment balance may be different 93.91% 13

Jan 1999 May 2003 January 2006 Oct.2009 Solicited*Unsolicited SolicitedUnsolicited PeriodWhole operation period15 Years10 Years Abolished Guarantee Level (Max) 90%80% First 5 Years 90% Next 5 Years 80% Last 5 Years 70% First 5 Years 75% Next 5 Years 65% ConditionNone No MRG applied if Actual Revenue < 50% of Forecasted Revenue Same as Left  Minimum Revenue Guarantee (MRG): Certain fraction of projected annual revenues may be guaranteed when the actual operating revenue falls considerably short of the projected revenue prescribed in the contract.  36 out of 145 signed contracts include MRG clauses at the end of  Drawback of MRG Government took most of the risks, but still provided high returns to concessionaire. MRG scheme provided concessionaire with incentives to overestimate future demand. Risk Sharing Scheme (2) - (BTO) Former Risk-Sharing Scheme MRG (Now Abolished) 14

15 Risk Sharing Scheme (3) Infrastructure Credit Guarantee Fund Source :

Scope of Guarantee  Loans and borrowings from financial institutions by concessionaire for private investment project expenses.  Infrastructure Bond issued pursuant to the Act on PPP.  For a single project up to KRW 300 billion Types Contents Facility fund guarantee Guarantees against concessionaire’s debt on construction fund Government subsidy guarantee A ceiling on the guarantee is established in preparation for concessionaire’s operation fund shortage resulting from delayed subsidy payment Refinancing guarantee Guarantee support on refinancing where the current high interest loan is changed to new interest loan or Infrastructure Bond Operating revenue guarantee A ceiling on the guarantee is established in preparation for concessionaire’s operation fund shortage resulting from reduced operational revenue guarantee Infrastructure bond guarantee Guarantee for Infrastructure Bond issued to procure funds necessary for concessionaire in project implementation Guarantee Fee  Maximum annual fee rate: 1.5% Risk Sharing Scheme (3) –Cont’d Infrastructure Credit Guarantee Fund Guarantee Limit

Risk Sharing Scheme (4) (BTO) New Risk-Sharing Structure (MRG substitute) 17 Risk-sharing By the Government Risk-sharing By the Private Sector  When the actual operation revenue is less than the designated risk-sharing revenue*, government will make up the difference and pay the private sector the amount of shortfall. * Risk-Sharing Revenue : The amount of operation revenue that guarantees the IRR comparable to the government bond’s rate of return  When the actual operation revenue exceeds the risk-sharing revenue, the amount of government subsidies that have been given so far will be withdrawn.  Subsidies are given only when the actual operation revenue is higher than 50% of the risk-sharing revenue.  Uncertain guarantee of IRR Risk-sharing revenue Revenue Redemption Prospective revenue n Revenue n+1n+2n+3 Subsidies 50% of the Risk-sharing revenue No Subsidies

Risk Sharing Scheme (4) – Cont’d New Risk-Sharing Structure (MRG substitute) 18 Risk sharing Revenue Total Investment Interest rate on treasury bonds = x 1-(1+interest rate on treasury bonds) ‾ * The average interest rate on treasury bonds maturing in five years during the construction period, which may be adjusted every five years. ** Total Investment : (Total private investment) – Interest during construction Total investment PMT 1PMT 2PMT 3 ··········· n ··········· PMTn

19 New Risk-Sharing SchemeMRG Government Supports the private sector’s Investment Recovery by setting the PSC as a ceiling Guarantees certain level of income Private Sector Low-Risk, Low-Return - Project IRR is comparable to government bond yield(interest payment not included) - Government subsidies withdrawn Low risk, High return, - 65~90% of the projected revenue guaranteed -Government subsidies not withdrawn Coverage Period The Overall period of operationA portion of the total operation period ImpactInvestment risk borne by the Private sector is mitigated with greater motivation for profit Pro: Incentive to participate Con: Result in private sector’s moral hazard New Risk-Sharing Vs MRG

20 Risk Sharing Scheme - BTL  Total Investment Cost will be recovered by Government Payment. ☞ Total Project Cost +Inflation Rate + Interest during Construction  Government Support : Support for Land acquisition, Construction Subsidy, Early Termination Payment

Part 3. Lessons Learned

 MRG may enhance the bankability … However, it has Pros & Cons Pros Incentive to participate from private sector by enhanced bankability Mitigation of operation risk for private investor Steady cash flow during operation period for private investor Cons Government’s severe risk-taking Severe budget burden Private’s incentive to overestimate future demand ☞ Serious “Moral hazard” may occur, if not properly monitored ! Pros. and Cons. of Minimum Revenue Guarantee (MRG) 22

 The PPP is justified When it expands fiscal space AND increases the value of tax payer’s money.  Private sector’s creativity and Efficiency can be promoted Thorough Competition among participants AND Transparency in selecting concessionaire  Balance Keep the balance between PPP market promotion and fiscal discipline in the practice of the PPP policy  Decisions toward PPP Should be based on VFM Test. Enhancing Bankability Vs Fiscal Discipline 23