Presented to ACET Seminar Accra, Ghana January 25, 2012 Okyu Kwon

1. Public-Private Partnerships in Infrastructure of Korea Presented to ACET Seminar Accra, Ghana January 25, 2012 Okyu Kwon KAIST Graduate School of Finance

2. Overview on PPPs I III Success Factors of Korea’s PPP Government Support Concluding Remarks II IV Table of Contents 1

3. I. Overview on PPPs 2

4. 1. Major Functions of PPP In 1994, the Act on Promotion of Private Capital into Infrastructure Investment enacted. Expected Functions of Public-Private Partnership (PPP) • Effective alternative to financially constrained government • To utilize private sector’s know-how and creativity • Long-term investment opportunity for private investors • Partnership between government and private sector • Government role was to plan, evaluate, approve execution, and support implementation. • Private partner’s role was to design, finance, build, and operate facilities. 3

5. 2. Evolvement of PPP Act • PPP Act introduced with components of market contract. • Started from Total Project Cost Management System. • Basic Plan for PPP drawn. Revision of PPP Act in 1998 • Execution agreement between Ministries and concessionaires • Supporting measures: minimum revenue guarantee, request for government buyout, credit guarantee, supporting agency • Further reforms undertaken since 2003: • Introduced infrastructure fund and compensation scheme for dropouts. • For effective competition, price factor taking more than 50% weight 4

6. Build - Transfer - Operate ① Construction by the private sector ② Ownership transferred to government ③ Operation by the private sector • IRR is determined through negotiation(9~15%) - BTO • Build - Transfer - Lease ① Construction by the private sector ② Ownership transferred to government ③ Lease and payment by the government • IRR = Reference rate (government bond) + α(80~100bp) - BTL 3. Implementation Method Others : BOT, BOO, etc. Private Participant (SPC) Private Participant (SPC) delivers Service Grants operating rights delivers Service Lease payments Transfers Ownership Transfers Ownership User User Government Government Tax or Fees 5 BTO BTL Pays usage fee

7. Welfare (4) Public Housing (1) Road (3) Forestry (2) Rail (3) Port (3) 15 Categories Airport (1) Education (1) Communication (5) Military Housing (1) Water Resources (3) Energy (3) Culture & Tourism (9) Environment (5) Logistics (2) * Positive listing Available Facility Types There are 46 types of infrastructure facilities in 15 sectors specified by the PPP Act BTL BTO 6

8. Operation Period • Decided at concession agreement between the authorities in charge (gov’t) and the concessionaire (private participant) • Within 50 years under the PPP guideline < Average Operation Period > Road : 30 years (20~40 years)  Railway : 30 years  Seaport : 50 years (30~50 years)  BTL : 20 years 7

9. 4. Achievements of PPP in Korea Private Investment Fast Growing • Private played a key role, complementing public investment. • The proportion of private investment over public investment • From 3.9% in 1998 to 15.4% in 2009 • At the end of 2009, 461 projects PPP contracts approved. • 106 BTO and 145 BTL projects were completed to provide services to the public. • <Table 1> Share of PPP in Government Infrastructure Investment • (KRW trillion, %) 8

10. II.Government Support 9

11. Government Support Land Acquisition Support Construction Subsidy Infrastructure Credit Guarantee Fund Risk Sharing Measures, etc. Financial Support Tax Benefits Termination Payment Risk-Sharing Structure 10

12. Construction Subsidy 1.Costruction Subsidy Land Compensation : 100% Government Subsides Roads : Up to 30% of Total Investment Railways : Up to 50% of Total Investment   Ports : Up to 30% of Total Investment *Foreign exchange loss compensation scheme was abolished. 11

13. Construction Subsidy Risk-Sharing Structure 2. Risk-Sharing Structure *Available for solicited projects only* - Under the new risk-sharing structure, government guarantees redemption of the minimum costs* of the project(costs for PSC at maximum) *Minimum Costs= (Private investment cost + interest on government bonds) 12

14. - Government pays the amount of shortfall when the actual operation • revenue is less than the level of risk-sharing revenue* • * 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, • Government subsidies are redeemed on the basis of realized payments. Risk-sharing By the Government Risk sharing of Private Participants • Subsidy is only provided when the actual operation revenue is greater than 50% of the risk-sharing revenue. • Uncertain guarantee of IRR (Internal Rate of Return) Risk-Sharing Structure (Introduced in PPP Revitalization Plan to ease credit crunch - Aug. 2009) Prospective revenue Redemption Revenue Risk-Sharing revenue Subsidies No Subsidies Revenue 50% of Risk-Sharing revenue Revenue Revenue n n+1 n+2 n+3 13

15. Various Tax Benefits Construction Subsidy Risk-Sharing Structure 3. Tax Benefits • Exempt from Acquisition and Registration Tax • Application of 0% VAT • Separate Tax on Interest Income from Infra Bond (14%) • Separate Tax on Dividend Income from Infra-Fund (14%) • Dividends from SPC are tax-exempt (if more than 90% of the profit was distributed) 13

16. Various Tax Benefits Construction Subsidy Termination Payment Risk-Sharing Structure 4. Termination Payment • Increased Coverage for Payment Upon Termination • i.e. If the project has to terminate for unavoidable reasons, the amount of compensation is increased (50~55% of investment cost → 80~85%) • (PPP Revitalization Plan to ease credit crunch ) 14

17. Various Tax Benefits Construction Subsidy Termination Payment Infrastructure CreditGuarantee Fund Risk-Sharing Structure 5. Credit Guarantee Scheme ` Credit guarantee for concessionaires to obtain bank loan - Guarantee limit per project is increased from KRW 200 billion to KRW 300 billion - Guarantee for subordinate debts is increased from 4.5 to 20% of the total guaranteed amount (PPP Revitalization Plan to ease credit crunch ) 15

18. 6. Two Ways to Invest A. Direct investment • Acquisition of Equity • * minimum equity ratio of project company has decreased: • - BTO : 25% → 20% • (20% → 15% if financial investor’s participation exceeds 50%) • - BTL : 5~15% → 5% • Granting loans • Underwriting infrastructure bond 16

19. B. Indirect investment • By establishing or participating in infra-fund • * Macquarie Korea Infrastructure fund invested in 15 Projects • worth 1.8 billion USD (30%FDI), which ismanaged by Macquarie • Capital Fund Limited (Europe) 17

20. Infrastructure Funds • Equity acquisition of loan for PPP projects • Minimum required capital : 10 billion KRW (8.5 million USD) * To decrease from 10 billion → 1 billion KRW (850,000 USD) by the end of this year (PPP Revitalization Plan to ease credit crunch ) Advantages : No limit in investment portfolio Debt allowed up to 30% of equity Current status : 10 funds, as of 2010, (1 public equity fund, 9 private) 18

21. III. Success Factors of Korea’s PPP 19

22. 1. Sound Legal Framework: PPP Act • Prime regulator: Ministry of Strategy and Finance (MOSF) • Draw the Basic Plan for PPP • Prepare directions of government policy • Workable, clear and detailed legal framework • Procedures, rights, obligations, risk sharing mechanism • Reduce potential business risks for private sector Act Enforcement Decree Basic plans of Individual Project General Guidelines The PPP Act [MOSF] Enforcement Decree on PPP Act [MOSF] Basic Plans for PPP [MOSF] Request for Proposals [Competent Authority] 20

23. 2. Creation of Supporting Agency: PIMAC • Established PICKO to provide professional supports for PPP projects. • Expanded to PIMAC, which • - consists of experts from economics, finance, accounting, law, engineering, urban planning, etc., • - performs feasibility studies, VFM tests, request for proposal (RFP), evaluation, etc., and • - provides education programs for government officials, and cooperation with international organizations and foreign countries. • PIMAC contributed to designing efficient PPP implementation conditions and enhancing transparency on bidding process. 21

24. 3. Reasonable Level of Incentives • A reasonable level of incentives to attract investors is necessary. • Private sector risk: high up-front cost, delayed ROI, economic uncertainties, limited financial resources • Over-incentives hazardous and undesirable will cause fiscal burden. • * Korea’s the six government support schemes seem to be well designed. • support for land acquisition, credit guarantee, termination payment, risk-sharing structure, tax benefit, and construction subsidy • * However, overly protective incentives are not desirable due to potential moral hazard and future fiscal burden.  • minimum revenue guarantee, a general government's buyout scheme, foreign exchange rate risk sharing 22

25. 4. Foreign Investors’ Participation • Equally treated with domestic investors • Entitled to additional benefits • For more than US$10 million to build PPP facilities in a Foreign Investment Area, tax breaks were granted • For foreign exchange losses, government could offer subsidies or long-term loans • Positions of foreign investors, holding significant portion of a project, are better respected: language and provisions in conflicts resolution in the agreement 23

26. 5. Existence of Developed Construction Industry And Soft Infrastructure • Construction companies have participated in overseas construction works vigorously • - with skilled workers, work discipline, and low wages. • - In 1982, construction orders received exceeded US$13 billion. • Learned advanced technologies, construction management skills, and financial know-how’s. • Contributed to successful adoption of PPP in 1990s as well as efficient domestic infrastructure development. • Soft infrastructure, such as legal, accounting, taxation, finance, etc., also helped fair contract and negotiation. 24

27. IV. Concluding Remarks 25

28. 1. Infrastructure development plays a leading role. • Preemptive, sufficient and steady investment necessary • A top-down approach is essential considering weak capacity of private sector. • Foreign capital with local partnership should be encouraged. • A transparency in bidding procedure as well as strict construction supervision is essential. 26

29. 2. PPP needs to be widely adopted. • PPP provides solutions to inefficiency of government monopoly supplier and capital shortages. • Outright privatization may not be a good option. • Need not to wait until the country reaches middle income level. • Foreign suppliers with domestic partners will provide opportunities to learn. 26

30. 3. A strong coordination function is necessary. • Government: interested in infrastructure growth and effective public policy • Private sector: interested in maximizing the ROI. • Regulators: interested in ensuring transparency and interests balancing. • Consumers: seek to realize their value for money. •  Need to establish a good framework to coordinate stakeholders’ interests. 27

31. 4. A good framework for coordination includes; • Policy making role given to the most competent Government Ministry. • Regulatory framework should be clearly stipulated by laws. • A transparent and efficient process of PPP should be put in place. • A reasonable level of incentives to attract investors is necessary. 27

32. 5. Foreign capital inducement should be encouraged. • Including loans from international financial organizations • Complements domestic capital shortages. • Provides momentum to adopt international standard in infrastructure development. • Essential for domestic companies to have opportunities to learn. 28

33. 6. To avoid political pressure, a transparent and professional decision-making process is necessary. • PPP Act clearly stipulates a strict compliance to the law. • Use professional organizations like PIMAC. • Civic group’s surveillance activities could be a great help. 28

34. T h a n k Y o u !