JBICI DISCUSSION PAPER
No.15

Exploring the Use of Revenue Bondfor Infrastructure Financing in Asia
Suk HyunToshiro Nishizawa
Naoyuki Yoshino

July 2008
JBIC InstituteJAPAN BANK FOR INTERNATIONAL COOPERATIONJBICI Discussion Paper Series

Exploring the Use of Revenue Bondfor Infrastructure Financing in Asia

Suk HyunToshiro Nishizawa
Naoyuki Yoshino

JBICI Discussion Paper No. 15
July 2008

JBIC InstituteJapan Bank for International Cooperation (JBIC)
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‘JBICI Discussion Paper’ is based on the research done by staff and/or fellow
researchers of Japan Bank for International Cooperation (JBIC) and published by JBIC
Institute. Views expressed therein are those of the author(s) and do not reflect those of
JBIC Institute.
©2008 by Suk Hyun, Toshiro Nishizawa and Naoyuki Yoshino. All rights reserved.

Exploring the Use of Revenue Bond for Infrastructure Financing in Asia∗
Suk Hyun, Toshiro Nishizawa and Naoyuki Yoshino
JBICI Discussion Paper No. 15
July 2008
Abstract
Considerable attention has been paid to private participation in infrastructure (PPI)
as an alternative approach for infrastructure development in order to minimize
government fiscal burdens and to maximize efficiency gains through the use of private
sector know-how. Growing financing gaps in infrastructure development, particularly in
Asia, have called for an urgent resolution. However, PPI can make the best use ofprivate funds to relieve fiscal burdens only with appropriate risk sharing between the
public and private sectors.
Local bond markets should play an important role in supplementing infrastructure
financing and for avoiding double-mismatch problems. Several cases of infrastructure
financing with private participation in Japan, the United States, and some of theemerging economies suggest that the use of revenue bond with appropriate risk sharing
and properly designed government support could help fill the gap without causing moral
hazard problems. In this paper, we tentatively propose a few conceivable variations ofrevenue bond for infrastructure financing with private participation based on appropriate
risk sharing concepts.

Keywords: infrastructure financing, moral hazard, private participation in infrastructure,public-private partnerships, revenue bond, risk sharing
JEL classification: G1, G18, H54, H63
Suk Hyun
ABMI Task Force, Japan Bank for International Cooperation (JBIC)
E-mail: s-hyun@jbic.go.jp
Toshiro Nishizawa (Corresponding Author)
JBIC Institute, Japan Bank for International Cooperation (JBIC)
E-mail: t-nishizawa@ jbic.go.jp
Naoyuki Yoshino
Faculty of Economics, Keio University
E-mail: yoshino@econ.keio.ac.jp∗

The authors are grateful to Akiko Sugiyama for her research assistance and to other JBIC staff
for their comments, in particular, Masaaki Amma and Satoshi Nakagawa. The views expressedin this paper do not reflect those of JBIC. The authors are responsible for any remaining errors.

1

Introduction
Owing to budget constraints and fiscal burden of the government, considerable

attention has been paid to the private sector as an alternative source of financing forinfrastructure projects. Consequently, the concept of private participation in
infrastructure (PPI) has been developed through methods such as privatization, private
finance initiative (PFI), and public-private partnership (PPP)1. In order to promote PPI,
the government introduced policy supports, such as tax exemptions, minimum revenue
guarantee, and other various measures to mitigate the risks inherent in infrastructure
projects that typically entail a lengthy gestation period and large-scale financing.
Contrary to the original intention, however, some PPI cases in the emerging Asian
economies did not relieve fiscal burdens because when the infrastructure projects failed,they were eventually rescued by government budgets based on the premise of social
necessity. In some cases, such government support without appropriate risk sharing may
cause moral hazard problems with the private parties involved in the project. For
example, they may fail to provide private sector sponsors or operators sufficientincentives to design and monitor their projects carefully if the government shows its
readiness, either explicitly or implicitly, to cover the loss of failed projects in any event.
Commercial risks are best controlled and absorbed by the private parties involved in the
project, while political and regulatory risks should be in the hands of the government.
With the Asian economy recovering after the financial crisis in 1997, the need forinfrastructure development and financing in the region started to rise again.
Nevertheless, vast financing gaps remain due to the immature long-term debt markets
and limited private participation in the region.

1

For the terminology, see Yescombe (2007).

1

Against this background, this paper aims to propose new schemes for infrastructure
financing, which basically securitize cash flows generated by infrastructure projects,
with an appropriate risk-sharing mechanism between the public and private players.
Following this introduction, Section 2 provides a brief overview of the current stateof infrastructure financing in Asia and the need for local bond markets. Section 3
presents several cases of infrastructure financing with private participation with focus
on some of the key features of infrastructure financing. Thereafter, in Sections 4 and 5,
we tentatively propose a few conceivable variations of revenue bond for infrastructure
financing with appropriate risk sharing between the public and private sectors, followed
by a brief conclusion in Section 6.

2

Infrastructure Financing and Rationale for Local Bond Markets in Asia

2.1 Growing Financing Gaps in Infrastructure Development in Asia
In the 1990s, until the emergence of the Asian financial crisis, the prevailing
optimistic views on Asia’s high growth attracted local and international private investors
to infrastructure development in the region. However, a sudden economic downturn
after the crisis in 1997 resulted in the restructuring of some large-scale infrastructure
projects, followed by a sharp decline in private investments in infrastructure (Table 1).
Most private investments in the infrastructure sector were financed through mediumand long-term loans from domestic and foreign banks.

2

Table 1. Total Private Investment in Infrastructure Sector in Asia by Country2
Cambodia

China

Indonesia

Malaysia

MyanmarPhilippines

Thailand

1990

0

173

116

Laos
0

870

0

98

692

Vietnam
0

1991

0

2,379

11

0

0

0

433

268

0

1992

13

2,414

252

0

1,794

0

814

1,902

0

1993

18

3,369

602

0

4,702

0

1,934

2,631

0

1994

0

3,165

1,954

0

6,730

0

2,218

664

10

1995

122

1,447

4,977

0

4,111

394

3,222

3,615

256

1996

8

8,093

7,488

628

4,191

50

3,260

3,749

220

1997

205

13,220

4,857

0

3,070

0

12,111

2,846

180

1998

14

4,969

1,541

1

766

0

1,807

933

39

1999

17

7,247

2,413

7

805

0

888

698

121

2000

28

8,131

642

5

5,519

0

2,153

1,377

150

2001

97

1,861

1,458

12

2,868

0

2,738

3,257

241

2002

40

5,464

1,509

20

506

0

863

1,198

1,800

2003

17

7,831

1,749

6

4,056

0

1,388

2,079

642

2004

86

3,707

1,607

34

5,261

0

1,551

1,052

70

2005

94

8,761

1,445

1,260

2,666

0

768

2,560

0

2006

250

8,287

4,622

810

1,230

0

1,815

1,149

260

Source: World Bank, Private Participation in Infrastructure Database

The recovery from the financial crisis and high economic growth has resulted in agreat need for infrastructure development and financing in Asia. However, vastfinancing gaps remain due to the limited banking capabilities and immature institutionalframeworks for securing private participation. A joint study by ADB, JBIC, and theWorld Bank reports that the financing needs in infrastructure development in East Asiaamount to USD 228 billion per year for the period 2006–2010, but only USD 48 billion
can be secured (Table 2). UNESCAP (2006) also shows that the Asia-Pacific region
requires USD 608 billion per year, but there still remains a financing gap of USD 220
billion.
Table 2. Estimated Infrastructure Financing Needs
Infrastructure Needs (US$ billion)

Financing Gap (US$ billion)

ADB, JBIC, and World Bank

228

180

UNESCAP

608

220

Source: UNESCAP (2006)
2

The data covers contractual arrangements with and without investments in which private parties
assume operating risks. The sectors covered are energy, telecommunications, transport, and water.
For further details, see World Bank’s Private Participation in Infrastructure Database.

3

Table 3 presents the composition of the financing sources for infrastructure
projects: bank loans (foreign 58.8%, domestic 21.6%), equity (foreign 10.1%, domestic1.7%), and bonds (foreign 4.0%, domestic 3.9%). There are two mismatches ininfrastructure financing that are clearly observed from Table 3. One is a term mismatch
because 80% of the infrastructure projects are financed with bank loans, which aremostly converted from short-term deposits and only provide a maximum term of five toseven years. The other is a currency mismatch because project revenues are generated inlocal currencies while the major sources of financing are of foreign origin, most likely
being provided in foreign currencies (72.9%).

Table 3. Private Sector Infrastructure Financing by Instrument(US$ million; percentage of the total)
Bond
Foreign

Bond
Domestic

0

0

1,812
(5.0)
92
(0.3)
1,280
(4.5)
529
(2.5)

604
(1.7)
39
(0.1)

4,784
(22.6)

Myanmar00Philippines

2,028(14.1)

0Singapore00Thailand

180
(1.2)

295
(2.0)

Cambodia
China
Hong Kong
Indonesia
Malaysia0

Vietnam

0

0

Total

5,920
(4.0)

5,721
(3.9)

Loan
Foreign1(100.0)24,494(67.3)
14,885(55.1)
20,985(74.5)
3,229(15.3)
30(100.0)
10,662(73.9)
2,027(66.7)
7,913(54.7)
2,348(89.9)
86,573(58.8)

Source: Based on Kotecha and Sharon (2004); recalculated by the author
Figures in parenthesis denote for the percentage of total financing.

4

Loan
Domestic

EquityForeign

EquityDomestic

0

0

0

1

5,337
(14.7)
8,758(32.4)
2,524(9.0)
10,396(49.1)

4,172(11.5)
2,790(10.3)
3,314(11.8)
1,147
(5.4)

0

36,419

458
(1.7)
70
(0.2)
1,077
(5.1)

0

0

0

30

35
(0.2)
924
(30.4)
3,865(26.7)
18(0.7)
31,856(21.6)

1,698(11.8)

014,4210
1,454(10.0)
246(9.4)
14,822(10.1)

87
(2.9)
767
(5.3)

Total

27,022
28,173
21,162

3,039
14,474

0

2,612

2,459
(1.7)

147,3512.2 Bank Loans versus Bonds3
A bank loan is transacted via a direct relationship between a lender and a borrowerand can be characterized as a negotiable form of financing with flexible disbursement
and a possible rescheduling of repayment. Clause amendments and waivers of the loan
agreement enable the related parties to negotiate the terms and conditions of the loan.
Banks assess the creditworthiness of prospective borrowers (or projects) and sort out
safe borrowers from the less safe ones. After loans are made, banks monitor the
borrower’s business and projects to prevent moral hazards and negligence. Information
gathering and monitoring take place on a bilateral basis between the borrower andlender.
On the other hand, bond financing is characterized as a direct tool via financial
markets comprising a broad range of investors. In order to issue bonds, a firm’s financial
conditions are rated and the information gathered in the process of rating is shared withpotential investors. Bonds constitute a standardized financial vehicle and, mostimportantly, a transferable financing instrument through the markets. Because of thesecharacteristics, however, bonds are normally not as flexible as bank loans in terms ofsuitability of size, timeliness4, and negotiability and consequently involve additionaltransaction costs.
Despite the disadvantages of bonds as compared to bank loans, given the nature of
infrastructure projects, local bond markets could play an important role in mobilizing
3

The standard literature on project finance provides detailed explanations of the advantages anddisadvantages of the use of bond markets as compared to bank loans. For example, see Hoffman(1998) and Yescombe (2002, 2007).
4
Medium term note (MTN) program may potentially be utilized for financing long-term
infrastructure projects by issuing bonds based on issuer’s financing needs within the fixed amountprogrammed. Incidentally, a study exploring the promotion of the Asian MTN Program was
proposed at the 10th ASEAN+3 Finance Ministers’ Meeting held in Kyoto in May 2007, as stated in
ASEAN+3 (2007).

5

supplementary funds for large-scale projects and in minimizing double mismatch
problems. Large financing gaps and advantages of bond financing for long-term
infrastructure projects constitute an impetus for the development of long-term, local
currency-denominated bond markets, and therefore the rationale for the Asian Bond
Markets Initiative (ABMI)5.

3

Cases of Infrastructure Financing with Private Participation

3.1 Revenue Bonds Used by Municipalities in the United States
A model of bond structure suitable for infrastructure financing is the revenue bondused extensively by municipalities in the United States. Municipal bonds or securities in
the United States are defined as “… securities issued by local governmental
subdivisions such as cities, towns, villages, counties or special districts, as well as
securities issued by states and political subdivisions or agencies of states. A prime
feature of these securities is that interest or other investment earnings on them usuallyare excluded from gross income of the holder for federal income tax purposes. Issuersof municipal securities are exempt from most federal securities laws.”6 In the UnitedStates, municipal bonds are used to finance a wide range of public projects such as ports,
airports, highways, sewages, hospitals, and colleges.
There are two types of municipal bonds depending on the source of debt service.
Revenue bonds (RBs) are a type of municipal bonds, whose debt service is normally
payable from identified sources of revenue generated from the financed project. On the5

For further development of Asian bond markets, a study exploring new debt instruments forinfrastructure financing was proposed at the 10th ASEAN+3 Finance Ministers’ Meeting held in
Kyoto in May 2007, as stated in ASEAN+3 (2007). For details on the progress in ABMI, see Hyun
(2007).
6
See MSRB (2004).

6other hand, general obligation bonds (GOBs) are a type of municipal bonds, whose debt
service is payable from general revenues of the issuer of such municipal bonds. In otherwords, the full faith and credit of an issuer with taxing power is pledged to GOBs, but
not to RBs. Long-term municipal bonds7 issued in 2007 amounted to USD 424.3 billion,out of which USD 293.2, equivalent to 69.1% of the total, were RBs (Figure 1).

Figure 1. Municipal Bond Issuance
450

400

350

US$ billion

300

250

200

150

100

50

0

1996

1997

1998

1999

GOB

2000

2001

2002

2003

2004

2005

2006

2007

RB

Source: SIFMA

Procedures and regulations applied to RBs and GOBs are inherently different due totheir respective characteristics. RBs are neither subject to the issuance cap of amunicipality nor require approval of the voters prior to issuance. On the other hand,
GOBs often require approval by election prior to issuance.
RBs generally offer a higher coupon rate than GOBs. Investors take some risks inexchange for the higher return. On a dollar volume basis, 83.8% of GOBs and 70.6% of
7They are defined as municipal securities with a maturity period of 13 months or longer at the timeof issuance.

7RBs issued during the first half of 2007 were rated Aa or above by Moody’s.
Third-party credit enhancement, for example, by monoline insurers, is used in somecases to provide additional security to a bond.
3.2 Social Overhead Capital Bond Financing in Korea
In order to facilitate PPI in Korea, the Promotion of Private Capital into Social
Overhead Investment Act (PPI Act) was passed and enforced for the first time in 1994.
The PPI Act and the Enforcement Decree, as the principal components of the legal
framework for PPPs, define the “eligible facility types, implementation schemes andprocess, conflict resolution/termination mechanism, and the roles of the public andprivate parties.”8 The Act was amended in 1999 to introduce risk sharing and minimum
revenue guarantee (MRG) mechanism and again in 2005 to introduce the
Build-Transfer-Lease (BTL) scheme, diversification of facility types, and expansion of
investor profile.
The government supported PPI projects through various policy measures 9 .
Construction subsidies can be granted to the concessionaire if the subsidies areunavoidable for maintaining the user fees of the services provided at an appropriate
level. A certain fraction of projected revenue can be guaranteed through the MRG
agreement if the actual operating revenue falls short of the projected level. Moreover,various preferential tax treatments are applied to PPI projects. Furthermore, Korea
Infrastructure Credit Guarantee Fund (KICGF) 10 , which was established in 1994,
provides credit guarantee services, including guarantee for infrastructure bond.
Among these government supports, the MRG mechanism resulted in an increasing

8

For details, see MPB (2006).
For the details, see MPB (2006).
10
For the details, see KODIT (2006).
98

fiscal burden because the actual revenue fell far short of the projected revenue (SeeTable 4). Against this background, since the revision of the PPI system in 2006, thegovernment has become more selective about providing MRG11. While MRG continues
to be reduced, the government expects an increasing demand for infrastructure credit
guarantee.

Table 4. MRG Subsidies(Unit: %, KRW billion)
Traffic Volume
Year

MRG Subsidy

Actual Volume

Year

AmountIncheon International Airport Expressway

2005

52.8%

2001-2005

481.7

Cheonan-Nonsan Expressway

2004

52.2%

2003-2005

118.0

Gwangju 2nd Beltway, Section 1

2004

62.2%

2001-2004

24.7

Woomyunsan Tunnel

2004

26.8%

2004

10.6

Source: Korea Fixed Income Research Institute

Korean Social Overhead Capital (SOC) bonds are broadly classified into twogroups depending on whether the bond is issued based on the PPI Act or not; for thesake of simplicity, we refer to the former as the “PPI bond” and the latter as the“non-PPI bond.” The PPI bond is defined and regulated by the PPI Act and is granted
special tax treatment. The non-PPI bonds were issued to finance the construction and/or
operation and maintenance (O&M) costs and to refinance the project expense after theconstruction completion.
There have been six cases of SOC bond issuance in Korea since the first one forfinancing the combined heat and power plants at the Incheon International Airport in
1999. Because of the special tax treatment and the difficulty in obtaining syndicated

11

MRG to unsolicited projects proposed by the private sector has been eliminated and the period
and amount of MRG for solicited projects have been substantially reduced.

9

bank loans in the aftermath of the 1997 financial crisis, SOC bonds were a popular typeof instrument for infrastructure financing. However, in recent years, a relatively low
expected rate of return and high transaction costs involved in SOC bonds made them aless attractive option for infrastructure financing; whereas investors are competing forhigher returns provided by alternative financial products as reflected in the recent
performance of private sector infrastructure funds in Korea12.
3.3 Hong Kong Link 2004 Limited
In order to reduce fiscal burdens, in April 1999, the government of Hong Kong
Special Administrative Region (HKSAR) raised HKD 6.0 billion by securitizing
revenues from the existing tolled infrastructure facilities consisting of the five tunnels
and one bridge/road link. The transaction structure is set out in Figure 2.

Figure 2. Transaction Structure of Hong Kong Link 2004 Limited

Source: Hong Kong Link 2004 Limited

12

For example, Macquarie Korea Infrastructure Fund (MKIF) established in December 2002 has
eventually become “one of the private sector infrastructure funds in Korea with the largest portfolio
of infrastructure assets in Korea that have been, or are being, constructed under the Private
Participation in Infrastructure Act” (MKIF Company Profile).

10For the purposes of this transaction, a single-purpose limited liability company
named Hong Kong Link 2004 Limited (HK Link) was established with its share capitalwholly owned by HKSAR. HK Link issued retail notes and bonds (Retail Notes &Bonds) to institutional and individual investors, respectively. The gross proceeds of
Retail Bonds & Notes issued were used by HK Link to subscribe for the toll revenue
bond (TRB) issued by HKSAR. Debt service payments on Retail Notes & Bonds areultimately backed by the net toll revenues from the tolled facilities through HK Link’s
subscription of TRB, supplemented by direct payments from HKSAR to mitigate risks
under certain pre-specified circumstances.

Figure 3. Stable Traffic Volume through Tolled Facilities

Source: Hong Kong Link 2004 Limited

The successful factors of this securitization scheme include the robustness of cash flows11generated by the operationally matured tolled facilities (Figure 3) and strong
government support in the form of direct payments to mitigate certain pre-specified
risks, as reflected in the favorable rating assigned by rating agencies13. With thisfinancial scheme, the government did not sell infrastructure assets to HK Link, which
was a special purpose vehicle.
3.4 Bydgoszcz Water Revenue Bond in Poland
The Polish legislature made amendments to the Polish Law on Bonds in 2001 toallow certain entities to issue revenue bonds to facilitate financing of public services. It
was expected that the introduction of an innovative financing instrument would enable a
new class of investors, such as pension funds, to finance infrastructure for the first timein Poland.
Polish revenue bonds are characterized by the following two features. First, only alimited number of issuers, such as towns, cities, local self-governed entities, and firmsthat are partly owned by these entities, may issue revenue bonds only to satisfy theneeds of the local society or to perform activities in the field of public utilities. Second,the obligee holds the preferential right as regards the satisfaction of their claims fromthe issuer’s revenues and assets.
In 2005, Miejskie Wodociagi i Kanalizacja w Bydgoszczy Sp. Z.o.o. (MWiK), a
water company owned by and servicing Poland’s eighth-largest city Bydgoszcz, issued
the first revenue bond in Poland to finance its investment program for the improvementof the water and sewage system in Bydgoszcz. The issue was a total of EUR 100 million
with various tranches and priced based on the 6-month WIBOR, rated BBB- by Fitch.
Of the total revenue bonds, 40% of the issue was purchased by European Bank for13

For example, Fitch assigned AA+. For the details, see Fitch Ratings (2004).

12

Reconstruction and Development (EBRD) and 60% by the local pension funds andother institutional investors.
The total project cost was EUR 222 million, of which EUR 100 million wasprovided by a grant from the EU, another EUR 100 million by the revenue bonds, andthe rest by BWC (Bydgoszcz Water Company) from internally generated cash flow. The
bonds have a strong security package as envisaged by Polish Law on Bonds. MWiK, thecity of Bydgoszcz, and the administrator (Bank Polska Kasa Opieki S.A.) have enteredinto a support agreement. They do not guarantee any repayment of obligations resulting
from issued bonds, but support the issuer (MWiK) in obtaining sufficient revenues toensure the correctness and timeliness of debt service and funds for the issuer’s
operations. It is also agreed that no new individual permits for the construction of
deep-water wells and sewage disposal should be issued and that such permits should not
be extended by the city of Bydgoszcz.
In this program, the EBRD tried to play a role as an anchor investor, who can help
build confidence in revenue bonds in a new market. Until then, even though there werepotential institutional investors such as pension funds, there had been no
investment-grade local instruments to invest in infrastructure.
3.5 Tokumei Kumiai Scheme: The case of Japanese wind power
Although this scheme does not involve any bond financing, it has implications forfinancing community-based infrastructure projects with appropriate risk sharing
between the public and private parties. In this particular case, Tokumei Kumiai, a type ofpartnership structure in Japan14, is used to mobilize private funds to finance a wind
14

A Tokumei Kumiai resembles a limited partnership formed under US law. The formation,
construction, and the rights and obligations of the parties of a Tokumei Kumiai are provided in
Articles 535 to 542 of the Commercial Code of Japan. A Tokumei Kumiai is formed by Tokumei
Kumiai agreements entered into between the General Partner (Eigyo-sha) and each Limited Partner

13

power project, which at the same time receives subsidies provided by a government
agency to develop renewable energy technologies.

Figure 4. Tokumei Kumiai Scheme: The case of the Japanese wind power
Investment Investor

Wind power developer
Profitdistribution
Loan

Repayment

Publicorganization

Loan

Subsidies

Banks

Project company
Repayment
Servicepayments

Community
wind
servicecompany

Investor

ProceedProceed

NEC*
sales

Other
power
retailersElectricity
sales

Construction fee

Local
government
Constructor
ProceedElectricity
sales

Power
generatingcompany* NEC stands for “New Energy Certificates”, which can be obtained by generating renewable energy and traded between electricity retailers andrenewable energy generators. Under Japanese RPS (Renewable Portfolio Standard) System, electricity retailers are imposed an obligation to use acertain amount of electricity from new energy, and such obligation can be met by generating the new energy electricity, purchasing the new energy
electricity from another party, and/or purchasing NEC from another party.

Sources: Prepared by the author based on the information from Natural Energy Civil Fund (Shizen Enerugi Simin Fando); and Agency for Natural
Resources and Energy

As of June 2007, there have been ten cases of such community-based wind power
projects operating in Japan with private sector funding partly coming from Tokumei
Kumiai. With this arrangement, a wind power developer serves as a General Partner(Eigyo-sha) and recruits investors (Limited Partners, or Tokumei Kumiai-in) that makeequity investments based on Tokumei Kumiai agreement. In the recent cases, equity
contributions are multiples of a minimum transaction value ranging from JPY 100,000(Tokumei Kumiai-in). Each Limited Partner invests a certain amount with the General Partner for thebusiness operated by a Tokumei Kumiai. A Tokumei Kumiai is managed by the General Partner, andeach Limited Partner has a right to inspect the management and the financial/asset condition of theTokumei Kumiai. Under the Tokumei Kumiai investment structure, income and/or losses from thebusiness operated by the Tokumei Kumiai are allocated to each Limited Partner unless otherwise
agreed upon in the relevant agreement. In general, the liability of each Limited Partner to third
parties is limited to the amount of investment made by them in the Tokumei Kumiai, whereas theGeneral Partner’s liability to third parties is unlimited.

14

(about USD 1,000) to JPY 500,000 (USD 5,000). Subsequently, a Tokumei Kumiai
makes loans to a project company for the construction of a wind power plant. A projectcompany sells electricity to a power generating company through the local government
and uses the revenue to repay its debt to the Tokumei Kumiai. In the most recent caseunder preparation, 45% of the total project cost was expected to be financed by thesubsidies, and the rest was to be financed mostly by private individual investors without
any direct credit enhancement provided by the public sector.
The key to the success of this scheme is a one-off public fund injection into theproject at the initial stage, which makes the project commercially viable and attractive
to the investors. Further, the existence of local individual investors who can afford suchan investment is crucial to the success of the scheme. Another benefit is that individual
investors in a rather small community are most likely motivated to monitor the
performance of the community-based project.

4

Conceivable Variations of Revenue Bond for Infrastructure Financing

4.1 Prerequisites for Effective Private Participation in Infrastructure
Private participation and the role of the government should be reviewed from two
perspectives: the commercial viability and the social essentiality of a project.
Government finance was traditionally regarded as a major source of infrastructure
financing from the perspective of social essentiality. However, private finance has been
popularized as a vital alternative source for financing infrastructure projects withcommercial viability.
Given the risks of long-term and large-scale financing as well as other risks
inherent in infrastructure projects, the private sector alone cannot finance infrastructure
projects. For this reason, appropriate risk sharing between the public and private parties
is required to effectively utilize both the knowledge and funds available in the private

15sector.
4.2 Revenue Bond with Viability Gap Funding
As described in Section 3, there exist various cases of infrastructure financing withprivate participation. However, it appears difficult for most emerging Asian economies
to follow a model of bond financing similar to those shown in Section 3, because of thelack of a well-established institutional setting. Against this background, referring to theJapanese wind power case as described in Section 2, Yoshino (2007) proposes aninternal mechanism to increase the commercial viability of a project through a one-off
injection of the fixed amount of public funds. This concept is basically a one-off subsidy
and is similar to that of viability gap funding15 being discussed in the context of PPPs.
For this reason, we may refer to a type of bond issued for the purpose of infrastructuredevelopment in parallel with viability gap funding as “Public-Private Participation
Bond” or “PPP Bond.”
With infrastructure projects that are socially essential but commercially less viable,
the injection of public funds may be employed so as to raise the expected rate of returnfrom the financed project to a level comparable with that of market interest rates. The
important feature of the proposed internal mechanism to increase commercial viability
is “done only once, not repeated” in order to not create moral hazards on the part ofprivate sector players such as a sponsor of the project. Without this one-off feature, theexistence of time-inconsistent preferences or tendencies can prevent the effective andcareful designing, monitoring, and implementation of the project.

15

The World Bank (2006) states that “GoI (Government of India) acknowledges that the needed
infrastructure investments for India may not be possible out of the budgetary resources ofGovernment of India alone. In order to remove these shortcomings and to bring in private sector
resources as well as techno-managerial efficiencies, the Government has committed to promoting
Public Private Partnerships (PPPs) in infrastructure development. That said, it is also recognized that
infrastructure projects have a long gestation period and may not all be fully financially viable on
their own. On the other hand, financial viability can often be ensured through a mechanism thatprovides government support to reduce project costs. The GoI has therefore proposed to set up a
special facility to provide such support to PPP projects. This support is generically termed as‘viability gap funding’ and this facility will be housed in the DEA (Department of Economic
Affairs). Suitable budgetary provisions will be made on a year-to-year basis. In the last couple ofyears, the central government has made available budgetary resources towards viability-gap funding.
However, to date no amount has been drawn down.”

16Figure 5. “Leverage” Provided by Injecting Public Funds
One-time

Rate of Return of Project

Public Injection= Market Interest Rate

For particular types of infrastructure projects in developing countries, additional
revenues generated by the sale of the so-called carbon credits, or “certified emission
reductions,” under the Clean Development Mechanism (CDM)16 may help increase theexpected rate of return from the financed project although there are risks inherent in
CDM projects.
4.3 Performance-linked Coupon Bond
In order to utilize private funds and to make government finance in infrastructure
more efficient, in parallel with a one-off injection of the fixed amount of public funds toraisecommercial

viability,

Yoshino(2007)

proposestheconceptofaperformance-linked coupon bond17. While principal and interest payments are securedby the securitized future cash flows from the financed project, the level of coupon
payments varies according to the performance of the financed project 18 . This
performance-linked variable coupon mechanism, with its unique characteristics similar
to that of equity in part, provides investors with incentives to closely monitor the project
performance, which in turn determines the level of interest earnings for the investors19.
To introduce such mechanism, the additional interest payments should be tied to aset of variables that represent the performance of the project. However, such acontingent interest arrangement of linking the performance of a project with the variable
16

See Appendix.
Yoshino (2007) does not use this particular term.
18
Yoshino (2004) points out that the major reason for the inefficiency of government finance inJapan is that government finance is often not implemented effectively and is offered at a fixedinterest rate that does not reflect the productivity of the use of funds.
19
Incidentally, Daiwa Securities SMBC designed a euro dollar denominated CO2L Bond, whose
coupon payments are linked to the price of certified emission reductions. This product has a featuresimilar to the concept of Yoshino’s performance-linked coupon bond. For the details, see Daiwa
Securities SMBC (2007).
17

17

coupon rate should be carefully designed so as to not undermine the motivating factors,
such as the maximum potential returns, for investors to provide equity capital. Perhaps,
a maximum rate needs to be specified to establish a ceiling on the performance-linked
variable coupon rate. Moreover, the feasibility of the performance-linked coupon bond,which can be seen as a type of sub-debt or mezzanine finance instrument, needs to be
examined in light of the limited usage of sub-debt or mezzanine finance instruments ininfrastructure financing.

5

Project Time Horizon and Bond Financing

5.1 Securitization of Revenues from Matured Infrastructure Projects
From the perspective of the time horizon in infrastructure projects, during the initialperiod of three to five years from the start of construction, there normally exist highrisks such as delays in construction, completion failure, and cost over-run. Taking into
account such a time horizon of infrastructure projects, the government can bear the costat the initial high-risk stage for building infrastructure. Rather than providing guarantee
for the entire life of a project, the government can securitize cash flows generated by theoperationally matured infrastructure facilities to secure private financing at a later stage.
This enables the government to refinance the project cost after the construction
completion and to mobilize funds for O&M.
5.2 Conversion of Government Bond to Performance-Linked Coupon Bond
An apparatus for appropriate public-private risk sharing and market discipline canbe conceived by introducing a government bond (or a government-guaranteed bond; thetwo terms will be used interchangeably hereinafter) embedded with the fixed coupon
rate (or the pre-determined variable coupon rate) and a call option so as to convert it
into a performance-linked coupon bond. The conversion provision in the bond scheme
grants bondholders the right to convert a government bond into a performance-linked
coupon bond after the construction period. The bondholders decide whether to exercise
their call option by closely monitoring the cash flows and the performance of the
project.

18

Figure 7. Returns on Convertible PPP Bond
Convertible Revenue
Bond Rate
CRBr (t )GBrConstruction
PeriodRate of Return on Investment in the Project

CRBr (t ) = Max(GBr , PRR(t ))if GBr > PRR(t ) then CRBr (t ) = GBr
if GBr < PRR(t ) then CRBr (t ) = PRR(t )Note: GBr denotes the fixed interest rate of the government bond.
CRBr(t) denotes the variable interest rate of the convertible revenue bond.
PRR(t) denotes the rate of return form the project.

For example, as long as the perceived rate of return on a particular project remains
below the fixed coupon rate of the government bond, the bondholders do not exercise
their call option to convert the government bond into a performance-linked couponbond. In that case, the government needs to pay the bondholders GBr and bear theburden GBr − PRR(t ) . This mechanism provides the government with an incentive tocarefully select and finance a project in light of both social essentiality and commercial
viability. If the bondholders expect higher project returns, they convert the government
bond into a performance-linked coupon bond and possibly obtain higher returns fromthe project.
A conversion ratio, a term that is different from the one normally used for referringto the number of common shares into which a convertible security may be converted, isaptly defined as the number of revenue bonds into which a government bonds may be
converted. This ratio therefore indicates the performance of the project, implying thatthe ratio will increase if the bondholders expect the revenues from the project to be
sufficiently high. Conversely, the ratio will be low or zero if the revenues are expected19to be lower than the fixed coupon or pre-determined variable coupon rate of thegovernment bond. With this ratio, investors can monitor and evaluate the performanceof the project.

6

Conclusion

Considerable attention has been paid to private participation in infrastructure (PPI)
as an alternative approach for infrastructure development to minimize the government’s
fiscal burdens and to maximize efficiency gains through the use of private sectorknow-how. Growing financing gaps in infrastructure development, particularly in Asia,
have necessitated an urgent resolution of this problem. However, PPI can make the bestuse of private funds to relieve fiscal burdens only with appropriate risk sharing between
the public and private sectors.
Local bond markets should play an important role to supplement infrastructure
financing and to avoid double mismatch problems. Several cases of infrastructure
financing with private participation in Japan, the United States, and some of theemerging economies suggest that the use of revenue bond with appropriate risk sharing
and properly-designed government support could help fill the gap without causing
moral hazard problems. We tentatively propose a few conceivable variations of revenue
bond for infrastructure financing with private participation based on appropriate risk
sharing concepts.

20Appendix
The CDM is one of the Kyoto Mechanisms under the Kyoto Protocol, which allows
industrialized nations to undertake projects jointly with developing countries so thatindustrialized nations may use greenhouse gas (GHG) emission reductions (carbon
credits) generated from such projects in order to meet their own emission reduction
targets under the Kyoto Protocol.
Infrastructure projects such as photovoltaic power and rice husk power plants could
potentially employ additional cash flow streams obtained from the CDM under the
Kyoto Protocol. Such infrastructure projects with the CDM component can have tworevenue sources—one from the sale of services produced and the other from the sale ofcertified emission reductions (CERs).
In addition to the risks traditionally involved in infrastructure projects, there arerisks inherent in CDM projects, such as the additionality assessment risk, the volatility
risk of CER prices, and uncertainty with regard to the Post-Kyoto Protocol.

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Author(s)Eiji Ogawa

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http://www.jbic.go.jp/japanese/research/

ISSN 1347-9148