1Key Elements of Private Infrastructure Financing in
the Asia-Pacific Region
Yutaka Masaoka
Nagasaki University
Abstract. In each country of the Asia-Pacific Region infrastructure investment has failed
to keep pace with requirements of expanding economies. The expansion of infrastructure is
now a pre-condition to further growth. The question of how best to finance infrastructure
requirements is being addressed by such governments in a broader policy framework ofliberalization, which contemplates a more limited public sector role and the encouragementof private sector led development. But international commercial banks still have a rather
cautious appetite for financing such infrastructure projects and are particularly concerned
about sovereign risks.

KEY WORDS: Asia-Pacific Region: Infrastructure: Sovereign Risk: AsianDevelopment Bank.

I.

OutlineDriven by fiscal constraints and growing disenchantment withthe performance of state-provided infrastructure services, an increasing numberof governments have turned to private solutions for financing and providing
energy, transport, telecommunications and water services.
While economic fundamentals of the region are moving
favorably after the unprecedented financial and economic crisis that took placein July 1997, close to 900 million of the world’s poor live in the Asia-PacificRegion. It is the region which has attracted dramatic levels of foreign
investment, and yet that investment is focused on a small number of countries
in the region while other countries remain critically short of foreign equity
capital.
On most subjects it is difficult to generalize with any confidence
across such diversity, and the subject of infrastructure finance is no exception.
This paper starts with the description of the Region's infrastructure
requirements and the scope of the response to date in terms of projects
completed and the projects in process and then will turn to how the frameworkfor project financing of infrastructure projects in the Asia-Pacific Region differs;
i.e. the "distinguishing characteristics" of infrastructure project finance in the
Asia-Pacific Region. In explaining them, one troubled infrastructure financing in
the Region, “ the Bangkok Expressway Project in Thailand”, in which the author
was involved in its early stage of development as an investment officer of the
Asian Development Bank (ADB), will be cited and the case will be used to
explore its relationship to such distinguishing characteristics and to lessons

2which might be learned from its problems. Finally, the paper will touch on thesubject of the role to be played by the ADB in infrastructure financing in the
Region and, in particular, about how ADB is working with host governments,
project sponsors and other financiers to deal with the "distinguishing
characteristic" risks of infrastructure finance in the Region.
II.

Investment Requirements

The infrastructure requirements of the developing countries of the
Asia-Pacific Region are enormous and growing in their magnitude. In the firsthalf of the 1990s, investment requirements for infrastructure in East Asia1/
were estimated by ADB to be the order of US$1,000 billion for the 1990s.
Subsequently, they were estimated by the World Bank to be the order of
US$1,500 billion for the decade 1995 to 2004 as against US$1,800 billion
pre-crisis projection. The following chart indicates baseline projections for
1996-2005 infrastructure investment whereas Case 1 is based on the current
GDP forecasts, while Case 2 adds the impact of a transition to a lower
infrastructure-to-output ratio and a gradual 25% increase in efficiency in eachsector in each economy. It highlights the magnitude of investment requirements,
in excess of US$120 billion per year, and the need for private sector
participation.
Figure 1:
1996-2005 Infrastructure Investment Projections
Scenario
Baseline
Case1
Case2

US$ trillion
1.78
1.53
1.37

%
100
86
77

Source: “Private Sector Participation and Infrastructure Investment

3

in Asia”, an Asian Development Bank paper prepared for the Finance
Ministers Meeting, Asia Pacific Economic Cooperation, May, 1999.

Looking at the power sector, it is estimated that electric power is yet toreach 2 billion people out of the world's population of about 6 billion. Despite thefact that ADB lending to the energy sector totaled almost US$1.14 billion lastyear, this represents less than 2% of requirements of Developing Member
Countries (DMCs) of ADB. The task of finding sufficient financing for necessary
capacity expansion is, therefore, truly daunting, but the economic penalties that
accompany failure to meet power demand are worse. ADB economists estimatethat around 20% of all industrial equipment in the Region is lying idle due to alack of power. The economic and social cost of unserved energy needs in Asia is
up to 10 times the cost of supply. ADB is headquartered in Manila. Each andevery member of the Bank's staff and each of the other 8 million residents ofMetro Manila can testify to the costs of brown-outs. During the critical power
shortages of 1993 much of Manila had power for only a portion of each day andthere were severe disruptions of industrial production and of most large-scalebusinesses; modern skyscrapers turned into solar ovens in the tropical heat.
Any manufacturing project proposal in the Philippines which reached the Bankfor loan assistance could not be entertained without standby captive power
generators incorporated into the project. This additional investment cost madeprices of the final products uncompetitive in the international market.
III.

Private Sector Participation

The Asia-Pacific Region has been a leader in the developing world inrecent years in effecting a dramatic shift in the development of infrastructure
into the private sector. Traditionally, infrastructure development has been the
responsibility of governments. In each country of the Region infrastructure
investment has failed to keep pace with the requirements of expanding
economies. Most countries of the Region currently are suffering an
infrastructure gap between demand and installed infrastructure; in somecountries of the Region the gap is already so large as to constitute an
infrastructure crisis. The requirements for the expansion of infrastructure are
fueled by growth of the underlying economies and, at the same time, it isrecognized that the expansion of infrastructure is a pre-condition to further
growth. Given the size of the financial requirements for such infrastructure andthe budgetary constraints which most governments of the Region face,
governments have come to realize that such infrastructure requirements cannot
be met or financed by the public sector alone. The question of how best to
finance infrastructure requirements is being addressed by such governments ina broader policy framework of economic liberalization, which contemplates amore limited public sector role in the economy generally, the encouragement ofprivate sector economic activity, opening of the economy to international tradeand foreign investment, and the development of deregulated domestic financial
and capital markets.

4

Also contributing to the movement towards permitting private
development of infrastructure in these countries has been the recognition thatthe performance record of such governments in public sector infrastructuredevelopment, construction, operation and maintenance has not beenoutstanding. Cost overruns, project delays, poor operation and maintenance andrecurring operating losses have often plagued publicly-managed infrastructure
projects. Many governments have concluded that private sector participation
has become essential. However, due to the magnitude of the individual project
costs, the long gestation periods for such projects, the need for large amounts offoreign debt and equity financing, and the shortness of the path of accumulated
experience for such projects in the countries concerned, the new breed ofinfrastructure project presents a particular mixture of risks and a particularchallenge to project finance professionals.
Having said that the Asia-Pacific Region has been a global leader
within the developing world of the private sector development of infrastructure,
the trend began with the first projects in power generation in People’s Republic
China (PRC) and the Philippines in the late-1980s. There have been more than
thirty private infrastructure projects in the Philippines which have either been
completed or are currently under implementation, most of which are in the
power sector. The Malaysian market also has been quite active, with more thantwenty toll roads, water supply and sewerage treatment projects financed in theprivate sector using Build, Own and Transfer (BOT) arrangements. The
Bangkok Expressway Project has been completed and a rural
telecommunications project, also in Thailand, was completed; both projects
utilize BOT arrangements, and both are backed by Japanese sponsors. There
are a number of completed highway projects in Indonesia funded by the private
sector, and the financing for a major power project was concluded and the
project has been completed and is now in operation. It has been estimated thatabout two-thirds of the private investment in infrastructure in East Asia is byinvestors from within the Region.
Private sector infrastructure projects financed by ADB have included
the Navotas, Pagbilao and Batangas Power Projects, and the North Luzon
Expressway Project all in the Philippines, Meghnaghat Power Project andGrameenPhone Project in Bangladesh, Kelanitissa Power Project in Sri Lanka,
the Chengdu Water Project and Meizhou Wan Project in PRC, the Bangkok
Expressway Project in Thailand, and the Fauji Kabirwala Power Project inPakistan. In addition, the ADB has been a co-sponsor and investor in some of
the investment funds established by institutional investors to invest in private
sector infrastructure projects within the Region.
In other parts of the developing world, the focus has been on theprivatization of existing public sector monopolies providing infrastructureservices. In the Asia-Pacific Region the principal focus instead has been on
private sector development of new projects. Today, the global action in power
development is in the Asia-Pacific Region, and it is in the private sector.

5

There is much activity, and most of the principal players on the global scene areworking on projects in the Region, with American and British power companies
and power packagers being particularly active.
This is not, however, a full descriptive picture of private
infrastructure activity in the Asia-Pacific Region. The euphoria which existed in
1994 over private development of infrastructure in the Region is today balanced
by a more sober assessment by many potential project sponsors and financiers,
who have seen a lack of progress on many proposed projects and significant
implementation problems with other projects, particularly in India and PRC.
PRC's progress with private power appeared to be quite promising during 1992
and 1993, when around 40 investment proposals involving foreign firms were
put forward. This followed on from the first private power project in PRC, Hong
Kong based Hopewell Holding's Shajiao B power station in Shenzhen, whichcame on stream in 1987. To date, however, no significant progress has beenachieved with new projects though the effectiveness on 1 April 1996 of an
Electric Power Law and the recent relaxation of inflation-dampening project andcredit controls may signal a revival. In India, more than 200 memoranda ofunderstanding for private power projects have been executed, but most arestalled in protracted negotiations and policy differences between the State andCentral governments. Of the eight projects designated in 1994 for "fast track"approval, only two have reached financial closing, one of which has been thetroubled Dabhol (Enron) Power Company project.
To complete this overview of the landscape of infrastructure finance in
the Asia-Pacific Region, it is necessary to describe the principal sources offinance which have been available to the projects which have to date reachedfinancial closing. The single largest source of finance for the private power
projects in the Region has been the traditional export credit agencies of Japan,
the United States and the principal European countries. What is notable about
their support is that much of it has been on a project finance basis rather thanwith the support of sovereign guarantees of the host country which, at an earlier
time, were a pre-condition to export financing. Thus commercial lenders andother project financiers have found the export credit agencies sitting on thesame side of the negotiating table, assessing project risks and expecting toparticipate fully in the security of the project collateral. International
development finance organizations – ADB and the International FinanceCorporation, a private sector arm of the World Bank - have been active as seniorlenders and equity investors and, at times, as subordinated lenders. The WorldBank itself has also been a participant as a guarantor of commercial lenders on
at least one Asian power project and has other, similar projects underconsideration.
International commercial banks still have a rather cautious appetite
for financing such infrastructure projects and are particularly concerned aboutsovereign risks. This caution reflects the stringent capital adequacy
requirements under which such banks now operate, broad diversification ofdeveloping country risk in such banks' loan portfolios which limits individual

6

country exposures, close monitoring of such banks by their rating agencies after
the recent period of financial restructuring at many such institutions, and somesobering experiences with developing country debt in the past.
Local financial institutions such as industrial development banks andcommercial banks are often equity participants as well as project financiersthough, given the current state of development of the financial and capital
markets in many countries of the Region, their participation is often smaller
than that of foreign financial institutions and is almost always in the form ofshort- and medium- term financing. A notable exception to this generalization is
Malaysia which has financed the overwhelming majority of its private
infrastructure projects domestically, with the Employees Provident Fund
playing a prominent role. Thailand has also raised more of the financing for its
private infrastructure projects domestically than is the norm for the rest of theregion, primarily through syndicates of Thai commercial banks.
Special purpose infrastructure investment funds have mobilized
several billion dollars (US) of resources for infrastructure projects. Some areregional in focus (such as the AIG Infrastructure Fund, the Asian Infrastructure
Development Company (AIDEC) and the Peregrine-sponsored AsianInfrastructure Fund.2/) Others are country funds focusing on infrastructure in aparticular country.
The bond and private placement markets have to date been used only
modestly in infrastructure financings in the Region. Two Enron power projects the Dabhol Power Company project in India and its Hainan Island project in
PRC - were to be financed by Rule 144A private placements in the United States.
Both transactions were withdrawn when the Mexican financial crisis of 1995
caused an allergic reaction among institutional investors to all emerging
markets debt instruments. The ADB used its guarantee facility to assist the
National Power Corporation (NPC) of the Philippines to tap the long-term
Euroyen bond market with a Yen 12 billion 20 year issue to finance a public
sector power project. As institutional investors increase their appetite forlonger-term Asian risk and as the domestic and regional capital markets within
the Asia-Pacific Region mature, greater use of capital market instruments tofinance private infrastructure can be expected to develop. In the immediate
future, most forays into the international capital markets by project-relatedcompanies will require credit enhancement by project sponsors, international
financial institutions such as ADB and the World Bank, or by financial
guarantee insurers.
IV.

Project Setting in Asia

The essential techniques of due diligence, project finance analysis andproject design - risk identification, risk mitigation and risk allocation among the
project parties - are characteristic of project finance transactions globally, andthe current infrastructure project financings in the Asia-Pacific Region are no
exception. Virtually all of the private infrastructure project financing

7transactions in which ADB has been involved have common features. In the caseof a power project, for the sake of illustration, the project would be conducted
and financed through a distinct legal entity formed and operating in the project
country. The shareholders may be primarily foreign parties3/ though mosttypical is a joint venture of foreign and local interests. The shareholders may be
a combination of power industry players (such as a joint venture between aforeign power company and the local electric utility), prominent local companies
just entering the power sector and looking to the foreign power company forrelevant technical expertise, local and foreign institutional investors.4/ It is not
unusual to find that the project sponsor has required an equity investment by
the principal equipment supplier, engineering firm or construction company as acondition of their being retained to work on the project.
The financing package will typically involve 20-30% shareholder
equity and significant leverage, with the debt being provided by export credit
agencies, international financial institutions such as ADB or the International
Finance Corporation, foreign commercial banks as lenders, and local financial
institutions. The security for the senior lenders is based upon the assets of the
project, including contract rights and cash flows. There is no offshore, hardcurrency revenue stream generated by export sales which can serve as the coreof the debt service package and of the security. Infrastructure projects are moredifficult in part because they are based on local currency revenue streams paid
for their output, such as purchases of power by the local electricity company or
tolls paid by local motorists. Lenders of foreign currency debt and foreign projectsponsors are dependent upon the host government to assure convertibility of
local currency receipts into foreign currency to meet payments due to suchlenders or the sponsors.
Sponsor support is common, often in the form of subordinated funding
to cover cost overruns or periodic cash-flow shortfalls and in the form ofcompletion guarantees. Increasingly, project risks are sought to be ameliorated
by fixed-price, date-certain turnkey construction contracts with explicit
performance guarantees and liquidated damages provisions; by contracts withequipment vendors which contain workmanship warranties and guarantees; andby other firm, third-party contractual obligations, both on the "supply" side,
such as for the supply of goods or services to the project, and the "delivery" side,
such as off-take or take-or-pay arrangements.
Governmental support is also common, but policies differ significantly
between countries. To facilitate the limited recourse financing of projects andrecognizing the limited financial strength of some of the governmental entities
contracting, for example, to purchase power or to provide fuel, governments
have been prepared to guarantee the performance of such governmental entities
in the Philippines, Pakistan and in India for eight so-called "fast track" projects.
In Malaysia, Thailand and Indonesia government guarantees have generally
been unavailable for private infrastructure projects.

8V.

Characteristics of Project Financing in Asia

The principal distinguishing characteristic of the project
financing of infrastructure projects in the Asia-Pacific Region is themulti-dimensional nature of sovereign risks which must be dealt with in the
project financing design and documentation. The principal task which lies ahead
for the host governments concerned, for project sponsors and their financial andlegal advisors, and for development finance institutions such as ADB is finding
more effective ways of mitigating sovereign risk in the financing of
infrastructure projects in the Asia-Pacific Region. It is only through the more
effective mitigation of such risks that it will be possible for host governments
and project sponsors to attract the very high levels of financing, and inparticular, long-term debt financing, which are required to meet the
infrastructure requirements of the Region over the next decade.
Region?
A.

What, then, are the key features of project financing in the Asia-Pacific

Local Currency Revenues

Infrastructure projects in the Asia-Pacific Region do not carry withthem comfortable foreign currency flows of export earnings. This ischaracteristic of infrastructure projects generally and distinguishes them fromthe project financing of export-oriented natural resources projects. For
infrastructure projects in the Asia-Pacific Region, the picture is complicated by
the relatively high level of participation of foreign financial institutions
providing foreign currency financing and the relative weaknesses of the hostcountry legal and regulatory environments.
B.

Sources of Financing

The second major characteristic relates to the sources of financing.
For Asian infrastructure projects there are only limited sources of long-term
debt. For example, for these projects, and whether due to country ceilings on the
exposure of individual banks or otherwise, the limited commercial bankinvolvement in Asian infrastructure projects is a significant constraint tofinancing in most of ADB's developing member countries. Very often, thecommercial banking portion is the most difficult to organize. There are not many,
if any, American, Australian or New Zealand banks involved in the provision of
long-term debt for infrastructure projects in the Asia-Pacific Region. This may
be due to pressures at home. Despite the fact ADB has made a number of forays
here to encourage these banks to become involved in cofinancing opportunities
with ADB. To date commercial bankers from these countries have not been
attracted by these opportunities.
The evidence to date suggests that international commercial banks
are still uncomfortable with the risk profile of many private infrastructure
projects in the Asia-Pacific Region. The level of their appetite will vary from

9country to country and will also be dependent on the identity of the sponsors
and of the other participating lenders. One of the principal challenges to thehost governments and to international development finance institutions such as
ADB and International Finance Corporation is to assist in mitigating the risks
which are of most concern to the commercial bankers which are sovereign risks.
Much attention is being focused in the Region on two aspects of themobilization of long-term debt. The first is on the further development of thelocal financial and capital markets to mobilize local savings and generate local
currency equity and debt for investment in private infrastructure projects.
Regulatory changes to permit domestic retirement funds and insurancecompanies to invest in, and lend to, private infrastructure projects would, inmany countries of the Region, significantly increase the amount and lengthen
the tenor of funding available for such projects. As an example, the Employees
Provident Fund of Malaysia provided one-half of the debt financing required for
the US$1.5 billion Lumut Power Project in the form of fixed-rate, long term
bonds which were locally rated; Malaysian commercial banks provided thebalance of the debt financing as 15 year floating rate debt.
The second focus of such attention is on credit enhancement of Asian
projects and related financing instruments in order to tap the institutional
investor market, particularly U.S. institutional investors such as insurancecompanies and pension funds. These investors have strict investment guidelines,
often linked to the rating of debt instruments. If credit enhancement techniques
can be applied to Asian infrastructure projects, this will open potentially large
sources of new investment funds.
C.

Internal Rates of Return

The rate of return expected by the developer of an infrastructure
project in the Asia-Pacific Region is usually significantly higher than the rate
which would be acceptable for a similar project in a developed country setting.
This is obviously a function of risk or perceived risk. The risks which areconsidered distinctive are the combination of risks; i.e. sovereign risks.
Exposure to currency risk is a critical feature of infrastructure project
investment. Project revenues are often generated in local currencies, whileservicing of foreign debt and equity involves payment in foreign currency.
Fluctuations in the exchange rate of the domestic currency, as well as capital
controls limiting currency convertibility and transferability, create risk forforeign investors and financiers. There is also some premium for what might bedescribed as "pioneer risk": the risks associated with being among the first to
attempt a complex private infrastructure financing in a country with limited, if
any, experience of such projects and in the context of a legal and regulatoryenvironment which is still emerging. The major global players in the market for
infrastructure projects are attracted to the Region because of the numbers ofprojects, their relatively large size and the prospect of high returns
commensurate with higher risks and, possibly, more limited competition forcertain projects.

10

VI.

Sovereign Risks Associated with Private Participation

As project financiers complete their risk analysis of proposed private
infrastructure projects in the Asia-Pacific Region, the risk which they find mostdifficult to analyze, to mitigate and to allocate is that series of related risks
which describe the roles of the host government and government enterprises insuch projects and the concerns of project sponsors and lenders about the due
performance of such roles.
The roles include that of the host government as regulator of theinfrastructure sector in which the project operates and which, invariably,
involves a new and evolving regulatory regime. Private infrastructure defines
the end of the provision of services in the relevant sector by a monopolist
provider, be it a government department or government enterprise. Projectsponsors and their financiers require comfort that a regulatory regime exists forthe regulation of the project enterprise - be it a power plant, highway or urban
light rail system - in accordance with transparent rules, consistently applied,and effectively enforced. Tariff setting is an important element of such aregulatory regime, since it is the principal determinant of project economics. But
the regulatory regime must have other critical elements. It must assure
non-discriminatory treatment of market participants and the non-abuse of
dominant market position by the traditional monopolist. It must ensure theindependence of the regulator from the government's continuing interest as
owner of the traditional monopolist: the roles of regulator and market
participant must be separated within government, and the independence of theregulator assured.
In many countries of the Asia-Pacific Region the pace of developmentof infrastructure projects has outstripped the consideration and resolution by
the host governments of broader regulatory issues and the creation of effective
regulatory regimes. The licensing of private telecommunications providers inIndia, both for cellular service and for basic telephone service, has preceded theestablishment of the independent regulator which the Government's New
Telecoms Policy contemplated. The creation of private power projects in the
Region has not awaited the development of the new electricity sector regulatory
regimes in which such projects will operate. Ironically and illogically, projects
have proceeded under pressure from the sponsors and, in certain sectors (suchas telecommunications), under pressures within the governments to realize
substantial licensing fees to help reduce budget deficits, before the broader
regulatory regimes have been evolved. The project sponsors and the hostgovernments in their project documentation have attempted to insulate theprojects from the broader regulatory regime which is to follow. The ADB and theWorld Bank are working closely with a number of governments to ensure thatsuch regulatory regimes are debated, created and implemented in a timely
fashion. ADB support for new private power projects in India, for example, iseffectively pre-conditioned on the relevant state regulators have implemented a
restructuring of the state-level electricity regulatory regime and on financial

11

and management reforms to ensure the financial soundness of the state-level
electricity boards.
Private infrastructure projects in the Region reflect adoption by thegovernments of new policies to permit and encourage such projects in theprivate sector. Such policies involve, in some cases, the adoption of new laws
(such as the BOT laws in the Philippines), new administrative policies andprocedures, and the administrative implementation of such laws and policies togive them practical effect. While it may be reassured that infrastructure will
enjoy greater efficiency due to the discipline, competition andprofit-maximization of the private sector, this will not be enough. Subsequent
problems in the implementation of these new government policies in a numberof countries call into question the breadth of the consensus within government
and within the broader political system backing such new policies andprocedures. Projects have been plagued by inter-ministerial conflicts at thenational level, conflicts between ministerial policy-makers and the career
bureaucracy, conflicts between national policy-makers and administrators andtheir state or provincial level counterparts, and at times by vocal public
opposition based upon hostility towards foreign investment or on concern thatprivate infrastructure will be more expensive to the public than publicly-owned
and -operated facilities.
There is also the role in such projects of the government andgovernment enterprises as a supplier of goods and services which are criticalproject inputs, such as fuel supplies to a power project or basic utilities (watersupplies, sewerage services, electricity or steam) to a project site. Theseobligations are addressed in project documentation with the governmental
supplier of such services, with such obligations often being guaranteed bysuccessively higher levels of government to maximize the likelihood of
performance and, in the event of non-performance, to ensure recovery against agovernmental entity of financial strength.
There is the role of the government and government enterprises as acustomer for the project's outputs, for example, as the electricity purchaser froma power project. The central document in a private power project is the Power
Purchase Agreement, which sets forth the power purchase obligation and theon-going pricing formula for such purchases. The purchaser in such projects in
the Asia-Pacific Region is invariably the government electricity company. In
many cases, such companies are poorly capitalized, badly managed, overstaffedand generally inefficient. The contractual obligations under such agreements
are guaranteed by successive levels of government, as in the case of supply
agreements, to maximize the likelihood of performance and, in the event of
non-performance, to ensure recovery against a governmental entity of financial
strength (and, often, the governmental entity with which the foreign sponsor
has dealt in making the original decision to invest).
There is also the broader role of the government as a provider of alegal framework for the creation and enforcement of contractual rights relating

12

to the project, including the collateral security rights of the project lenders.
Closely related is the role of the government as a provider of a broader
regulatory and administrative framework for doing business, which includes
predictable and reasonably efficient regimes for the establishment and operationof companies and other business entities, for obtaining business licenses, fordetermining and complying with environmental standards, and for meeting the
tax obligations of the project companies and their staff.
These risks are in addition to the classic risks of governmental
expropriation (expropriation risk) or the failure of the government to makeforeign exchange available to a project to service its foreign debt and meet itother foreign currency obligations (convertibility and transfer risk). These risks
in the aggregate are sovereign risk.
Project finance transactions in general and project financetransactions in developing countries in particular are considered the mostcomplex legal transactions in the financial world today. Remedies for
deficiencies in the domestic legal and regulatory framework for a project, for
deficiencies or inefficiencies in the companies law or other laws regulating
commercial activity, and incentives for a project (be they commercial incentives
or tax incentives) are often built into the project documentation. Agreement of
the parties and the law of contract are viewed as appropriate and effectivemeans of addressing such deficiencies and inefficiencies in the legal andregulatory framework. Where possible, foreign investors insist on such contracts
being governed by the law of an established, international commercial
jurisdiction, such as the laws of New York or the laws of England, and insist on
dispute resolution taking place through international arbitration under an
established arbitral system in a recognized international center, such as at the
ICC Court of Arbitration in Paris or the London Court of International
Arbitration. Foreign lenders insist upon such a choice of foreign law and thejurisdiction of foreign courts (typically in New York or London) as a
non-negotiable condition to their participation in financing such a project. While
the foreign lenders invariably get their way in such choice of law and choice of
forum, the foreign investors' rights in respect of such a project - as shareholders
and managers of the project company and as parties to the critical project
documentation (such as a Power Purchase Agreement and the agreements
providing for the supply of critical project inputs) are most often governed by thelaws of the host country, though generally with provision for some form ofinternational arbitration. Even where local law governs, the project
documentation attempts to address, by agreement of the parties, many of the
deficiencies and inefficiencies of the domestic legal and regulatory framework.
It must, therefore, be recognized in assessing the legal risks profile ofa private infrastructure project in the Asia-Pacific Region that the effective
determination and enforcement of the parties' rights will be dependent upon thelocal courts, whether for determination in the first instance of the projectsponsors' rights, say under a Power Purchase Agreement, or in enforcement offoreign lenders' rights under the project financing documentation as embodied

13

in a foreign court judgment or an international arbitral award. Typically, there
will be no substantial pool of offshore assets and no pool of foreign sales
proceeds outside the host country to which the foreign lenders can look forsatisfaction. The web of legal rights and obligations governed by foreign law is
inextricably interwoven with rights, obligations and procedures governed bydomestic law and which will be determined in a domestic forum.
There is a certain leap of faith involved in proceeding with projects
and providing financing for such projects on the basis of complex legal
documentation in part governed by foreign law but which is likely to depend for
its effective enforceability on the interpretation of those agreements in thedomestic legal system of the host country and on a court system and judges withlittle experience of complex commercial transactions. It is because of theseconcerns that international financial institutions such as ADB and the WorldBank are increasingly engaged in law- related technical assistance to theirmember governments, providing consultancy services and training to enhance
the integrity of the regime of economic laws which govern private sector
economic activity (including private infrastructure projects) and to enhance theskills of government counsels and judges responsible for administering andinterpreting such economic laws and the contracts which govern private sector
economic activity.
These concerns about legal risks become more profound when one
appreciates that the host governments have multiple roles in respect of a typicalprivate infrastructure project in the Asia- Pacific Region. The government andgovernment enterprises are more than regulators, suppliers and customers: thegovernment as custodian of the law-making process and the regulation-making
process is capable of making changes in laws and regulations which are adverseto the project and which, to the extent that aspects of the project are governedby domestic law, become part of the contractual web which defines the rights
and obligations of the project parties. The exercise of such law-making andregulation-making powers by governments is constrained by principles of public
international law and by such government's bilateral and multilateral treaty
obligations. In this respect, bilateral investment protection treaties andmultilateral conventions such as that establishing at the World Bank theInternational Center for the Settlement of Investment Disputes (ICSID) provide
some protection and comfort.
To sum up these observations, the principal distinguishing
characteristic of the project financing of infrastructure projects in the
Asia-Pacific Region is the multi-dimensional nature of the sovereign risks whichmust be dealt with in the project financing design and documentation. The
principal task which lies ahead for the host governments concerned, for projectsponsors and their financial and legal advisors, and for development financeinstitutions such as ADB is finding more effective ways of mitigating sovereignrisk in the financing of infrastructure projects in the Asia-Pacific Region. It isonly through the more effective mitigation of such risks that it will be possible
for host governments and project sponsors to attract the very high levels of

14financing, and in particular, long-term debt financing, which are needed to meetthe infrastructure requirements of the Region over the next decade.
VII.

The Case of Bangkok Expressway Company Limited Project in Thailand

It may be useful to examine the case of one private infrastructure
project in the Asia-Pacific Region which has encountered major problems in
implementation, and to consider how sovereign risk has played out in respect ofthe project. Bangkok Expressway Project, in which ADB was a lender and an
equity investor is a "successful" project in the sense that the project is
operational. Most other private infrastructure projects which have not been able
to mitigate sovereign risks to the satisfaction of the project financiers are"unsuccessful" in the sense that they never reach financial closing.
On 16 October 1990, the Asian Development Bank approved an equity
investment of US$10 million in the project company, Bangkok Expressway Co.
Ltd. (BECL). This gave ADB an equity stake of around 4.5 percent in the capitalof BECL (total equity US$220 million), with the Japanese construction company
Kumagai Gumi Co., Ltd. investing US$144 million for a 65 percent stake in thecompany. Thai interests held approximately 30 percent of the equity, though thisholding was fragmented between a number of investors.
Concurrently, ADB approved a loan of US$30 million to BECL. Thisloan was part of a total long-term debt package of US$880 million. The largest
portion of the long-term debt (US$650 million) was to be provided by local banks,
an unusually large proportion of domestic financing for a private infrastructure
project in the Region; an additional US$200 million was to be provided by aconsortium of local and foreign banks.
The Bangkok Expressway Project was promoted by Kumagai Gumi
for the purpose of establishing an elevated 37 km long multi-lane toll express
system in Bangkok, known locally as the Second Stage System or "SES". The
project was to be implemented as a build, operate and transfer (BOT) scheme
under a 30-year concession agreement (the SES Agreement) between the
Expressway and Rapid Transit Authority of Thailand (ETA) and BECL. The
total cost of the Project was estimated at US$1.05 billion.
ADB was the fifth largest creditor of the project and, with its equity
investment, the project's fourth largest financier. It was anticipated that apublic offering of BECL shares would be done on the Security Exchange ofThailand after the opening of the priority component of the project and that
ADB would eventually exit as a shareholder by selling its BECL shares on themarket.
As is typical of a private infrastructure project financed on a limited
recourse basis, the financing structure and documentation were complex. The
main project agreement, the SES Agreement, became the backbone of the projectand set out clearly the rights and obligations of the parties during construction

15

and in the subsequent 30-year period of operation. Among other things, theAgreement defined the applicable toll structure, set out the formula for revenue
sharing and explained the methodology for future toll fee revisions. The
Agreement had detailed provisions dealing with "exceptional events" which
could undermine the Agreement, including increases in inflation rates orinterest rates and the inability of the Expressway authority to effect toll fee
increases as scheduled. The validity of the Agreement was confirmed by a formal
legal opinion of Thailand's Ministry of Justice. In addition to the loan
agreements, there was extensive security documentation creating security in theshares of the project company,5/ in all relevant project documentation and in the
project company's cash-flows from toll collections; inter-creditor agreements
were in place, and there were the usual arrangements among the shareholdersof BECL. All parties were advised and represented by international and local
counsel, the documentation was heavily negotiated, and the final legal
obligations of the parties were confirmed by comprehensive legal opinions.
The project documentation eloquently confirmed the urgent need forthis major piece of transport infrastructure, as recognized by the Thaiauthorities. ADB justified its support for the project in terms of the economic
and social benefits, ADB’s endorsement promoting Government of Thailand’s
privatization efforts, mitigation of possible political risks through ADB
participation, and an envisioned catalytic role of ADB.
For all intents and purposes, the government had taken appropriate
initiatives to create a legal framework to undertake privatization or private
infrastructure in the transport sector.
The turnkey nature of the construction contracts had the projectdelivered at a target cost, within a target time, with these obligations supported
by appropriate warranties and performance bonds. Upon completion of thecomplex and demanding construction phase, BECL would assume responsibility
for operating and maintaining the expressway in accordance with the provisionsof the SES Agreement.
The project evaluation was supported with a detailed traffic analysis
and a financial analysis depending on a critical review of toll fees and revenue
sharing, which was subjected to appropriate sensitivity tests. There was also an
overall economic analysis for the sector.
In short, as a project financing exercise, the Bangkok Expressway
Project and its financing would pass any test of sound risk assessment andmitigation, supported by appropriate legal documentation. Then, what went
wrong?
(i) Tolls
According to a formula under the SES Agreement, BECL was to share

16

in tolls collected for the entire Bangkok expressway system upon theachievement of certain milestones in the construction of the SES. In addition,
the tolls were expected to be increased by the Thai authorities from Baht 15 to
Baht 30 (that was, from approximately US$0.60 to US$1.20). With the toll
increase and BECL's sharing of tolls, this was to provide BECL with appropriate
cash-flow in order to service its debt.
The proposal for toll increases became a political issue in Thailand,
and there emerged a fundamental difficulty in establishing any increase, quite
apart from the stipulated increase to Baht 30 (US$1.20). Moreover, there was a
dispute between BECL and ETA as to whether the appropriate project
milestones had been achieved, such as to commence the sharing of revenues.
(ii) Operation of the SES
Although it was clear from the SES Agreement that BECL would
operate and maintain the Second Stage Expressway, ETA contended that, due tocertain unspecified legal constraints, BECL could not operate the SES. As aresult, ETA proposed that operation and maintenance should be the sole
responsibility of ETA.
Clearly, this was inconsistent with the fundamental concepts
underlying the BOT award of contract. BECL resisted strenuously any
suggestion that it should be deprived the opportunity to operate and maintainthe SES. To the project lenders, the ETA's position appeared to be afundamental breach of the SES Agreement.
(iii) Suspension of Works
Under these rather difficult circumstances, the Thai banks whichwere providing the onshore credit facilities stipulated certain conditions forfurther draw downs of funds to BECL. The conditions related to the perceived
increase in risk as a result of the dispute between ETA and BECL. BECL could
not agree to the conditions and, as a result, further disbursements from the Thaibanks were suspended. Negotiations commenced to resume disbursements;
however, BECL remained starved of funds.
As a consequence, BECL defaulted in the payment of interest to theproject financiers, including ADB.
In view of the lack of funds (and particularly in view of BECL's
reluctance to complete the project, with the threat of a take-over by ETA), BECL
suspended further works on the project. BECL argued that it could notknowingly continue to incur expenditures where it lacked the means to pay for
those expenditures. ETA resorted to the Thai courts and was successful incompelling the opening to the public under ETA management of a completed
portion of the Expressway on the basis of provisions in the Thai Civil andCommercial Code permitting the exercise of extraordinary powers in situations

17of "national emergency". BECL initiated conciliation procedures in Thailand
under the terms of the SES Agreement, as the preliminary step towards thecommencement of international arbitration proceedings against ETA.
The financing banks, while sympathetic with BECL's position on its
right to operate the SES, believed that it would be counter-productive tosuspend works. From their perspective, it was most important to complete theworks, to make the SES operational, and to begin generating cash-flow which
would permit proper servicing of their debt.
(iv) Conflict and Resolution
The offshore financing institutions faced a number of difficulties withthe project:−The preponderant amount of financing came from the onshorebanking syndicate and, as such, the Thai banks very muchinfluenced the course of events in dealing with BECL and the Thaiauthorities.
−As there were 30 offshore financial institutions involved, individual
institutions each had quite a small stake in the total financing. It
proved difficult to achieve consensus or agreement on an action
plan among such institutions.
−Under the project documentation, the offshore financial institutions
could not unilaterally exercise rights against the project security any enforcement of security required the concurrence of the onshorebanks. The Thai banks were unprepared to declare an Event of
Default.
Ultimately the Thai banks, in conjunction with the Thai authorities,
organized a takeover of BECL by a local Thai consortium. The shares of all
foreign shareholders, including the Bank, were purchased and the outstanding
debts owed to the offshore banks were prepaid in their entirety, including
prepayment premiums. In other words, all foreign investors and foreign
financiers were taken out of the equation.
Two years later, the tolls were increased and BECL completed a very
successful initial public offering of its shares on the Stock Exchange of Thailand.
What was missing here? What might have been handled differently?
In retrospect it appears that, despite all formal legal approvals for the project
having been obtained, there was not a consensus within the Thai government as
to the role of private infrastructure or as to the appropriateness of this project
being undertaken on a private infrastructure basis with foreign investors andfinanciers. No such consensus appears to have existed within government (asevidenced by ETA's opposition to BECL operating the Expressway as provided

18

by the SES Agreement) and there was insufficient consensus to ensure
implementation of the increased tariffs contemplated by the SES Agreement andwhich were required to ensure full debt service. When difficulties arose, none of
the equity investors (including the Thai investors who were co-venturers with
Kumagai Gumi or ADB), none of the foreign lenders (including ADB) and noneof the other parties to the transaction was able to bring sufficient pressure tobear on the Government to ensure performance of the project documentation inaccordance with its terms. While legal proceedings were commenced, ultimately
the parties adversely affected by the Government's actions decided not to pursue
aggressively the legal remedies available to them under the project
documentation.
What has been the impact of this experience on the parties
concerned? The Bangkok Expressway project has been completed and is now
being operated by EAT. Kumagai Gumi remains actively involved ininfrastructure projects within the Asia-Pacific Region, as do the financial
institutions, including ADB, which participated in the Bangkok Expressway
project and whose interests were bought out. The Bangkok Expressway
experience has complicated the process of organizing the project financing ofother private infrastructure projects in the Bangkok region, notably Bangkok
Elevated Road and Train System (BERTS) which reportedly has encounteredsignificant implementation difficulties.
VIII.

Mitigating Sovereign Risks

Looking at private infrastructure projects in the Region, the level ofinterest of international commercial banks in such projects could be higher if
their concerns about sovereign risk could be addressed more effectively. There
are a number of initiatives by ADB which address this challenge: mitigating thesovereign risk of private infrastructure projects to commercial lenders.
The ADB is probably uniquely suited to address sovereign risk, since
the sovereigns about whose risk commercial lenders are most concerned areamong the shareholders of ADB and its principal borrowers.
The ADB is owned by its 59 member countries, 43 from the Region,and 16 from outside the Region; there are 40 DMCs eligible for ADB financial
assistance. Japan and the United States are the two largest shareholders of
ADB each holding 15.9 % of subscribed capital.
Talking about the uniqueness, it is the uniqueness about therelationship that exists between ADB and its borrowing member countries. The
relationship has been built over 35 years' experience, during which ADB has
made critical contributions to the development programs of its members. The
relationship includes long-term commitments to the development of particularsectors, and a level of knowledge of such sectors at ADB which is unparalleled in
the private sector. The relationship includes an on-going dialogue on

19government policy in such sectors which transcends even the closest
relationship which such governments have with their leading commercial
bankers and underwriters. ADB is far more comfortable with the sovereign risksof such countries than is the typical commercial banker. ADB's comfort isreflected by its AAA credit rating despite a loan portfolio full of the sovereignrisks about which other financial institutions are so concerned. It is for thisreason that ADB and comparable multilateral financial institutions may have aparticular catalytic role to play in helping other financial institutions reach alevel of comfort with the sovereign risks inherent in private infrastructure
projects.
Through cofinancing with ADB there are three approaches tomitigating sovereign risk in private infrastructure projects in the Asia-PacificRegion for which ADB can play a critical role. The first involves the prearranged
sale to commercial lenders of participation in ADB's Complementary Financing
Scheme. The second involves use of ADB's partial credit guarantee. The third
involves use of ADB’s political risk guarantee.
A

Complementary Financing Scheme

The Complementary Financing Scheme (CFS) involves theprearranged sale to commercial lenders of participation in an ADB loan. Under
the CFS, the ADB remains the lender of record, and the participating
commercial lenders have no recourse to ADB in the event of default on debt
service. In international bank loan market, these loans are sometimes referred
to as “B” loans to distinguish them from direct, or “A” loans provided bymultilateral institutions. As such, the CFS is similar to “B” loan program ofInternational Finance Corporation.
Figure 2:

The Complementary Financing Scheme of ADB

The obvious benefit of this scheme is that, though funded by commercial
lenders, CFS loans enjoy the benefit of ADB’s preferred creditor status since
ADB remains the lender-of-record. Therefore, CFS loans enjoy the same
privileges and immunities as those applicable to the Bank’s own direct lending:20such as exemption from withholding tax; exemption from restrictions on
remittance of interest and repatriation of capital; reduced likelihood ofrescheduling, in the event of an external debt crisis in the borrowing country;
and exemption from the special debt provisioning requirement of some lendercountries. Additional comfort commercial lenders may find is an optional crossdefault clause where CFS loans can be linked to ADB’s direct loan. In that adefault on the CFS loan may trigger a default on the Bank loan. Cofinanciers
providing CFS loans also benefit from ADB’s project appraisal, supervision, andloan administration services.
The maturities of CFS loans (based on a project finance) typicallyvary from seven to eight years for industrial and manufacturing projects, andfrom 10 to 12 years for BOT/BOO infrastructure projects, which generally
require longer-term financing.
For CFS loans, the Bank charges market–based fees for its account,
as well as for the account of the participating institutions (CFS lenders). These
fees are based on the estimated costs of arranging (one-time front-end fee) andadministering (annual fee) the CFS loan.
CFS loans are generally available in DMCs of ADB which have below
investment-grade credit ratings. The CFS is applicable to projects both in the
public and the private sector; but it must be used selectively for public sector
projects. CFS loans are available in private infrastructure projects in which
ADB participates. During the period 1970-2000, ADB arranged 39 CFS loans for
37 projects in 9 DMCs, for a total of US$1.17 billion. As a recent case, the first
BOT water supply project in People’s Republic of China (PRC), Chengdu
Generale des Eaux-Marubeni Waterworks Company Project, was cofinanced bycommercial lenders using the CFS for the amount of US$21.5 million out of
total US$74.5 million debt.
B

Partial Credit Guarantee.
The Partial Credit Guarantee (PCG) of ADB provides comprehensive
coverage to commercial cofinanciers of all commercial and political risks for a
specified portion of a borrower’s debt obligation and has been generally used toguarantee debt service during the later maturity of a commercial cofinancing. In
effect, with PCG the maturity of a commercial loan can be extended. This may
be appropriate when lenders are not willing or able to provide a financing tenorlong enough to match the cash flow of a project. Alternatively, PCG canguarantee a portion of principal and interest payments payable throughout theterm of a borrowing. Consistent with ADB’s risk sharing policy with cofinanciers,
the PCG is designed to cover that portion of the debt service that thecofinanciers are prepared to take, leaving the remaining portion to thecofinanciers on an uncovered basis.
There is no limit on the amount of PCGs for public sector projects;

21

however, all public sector projects must have a host government
counter-guarantee. For private sector projects, on the other hand, for which
there is no such guarantee or indemnity, ADB’s single project exposure limit,
comprising direct lending and/or equity investments and PCG support, is $50
million or 25 percent of project costs, whichever is less.
As an illustration of PCG coverage, ADB extended the guarantee to
National Power Corporation (NPC) of the Philippines to obtain the longest
possible maturity of 20 years and reducing the borrower’s all-in cost of financingof ¥12 billion fixed rate Euroyen bond for its Northern Luzon Transmission
and Generation Project in November 1995. PCG extended only to the bullet
repayment of the bond’s principal amount; interest payments on the bond wereguaranteed by the Republic of the Philippines.
C

Political Risk Guarantee

The Political Risk Guarantee (PRG) facilitates commercial cofinancing of
ADB-assisted projects guaranteeing payment of all or part of the project’s debt
service against specific political (or sovereign) risks. PRGs are only available inrespect of projects in which ADB is also a lender and/or an equity participant.
PRG coverage may include any combination of currency inconvertibility and/or
nontransfer; confiscation, expropriation, nationalization, or deprivation ofproject assets; political violence, such as strikes or civil disturbances, thatnegatively affects the project; and breach of contract, such as nondelivery bystate-owned entities of inputs (e.g., fuel supplies) or nonpayment for outputs(e.g., power or water).
PRGs are designed to mitigate political risks on which commercial
lenders require assistance from a multilateral institution or private insurer
while they are prepared to take on the commercial (credit) risks of a project.
Since the political risks covered by a PRG concern outcomes resulting fromdirect or indirect control of the host government, the government may provide a
counter-guarantee or indemnity to ADB. This indicates further assurance tocofinanciers and ADB of the host government’s commitment to the project.
Such guarantees will need to be written so as to be very specific as to
the risks covered and the trigger mechanisms for calling the guarantees. These
will vary from country-to-country and from project-to-project. In order to call apartial risk guarantee, it will be necessary to establish that (1) one of theenumerated risks has materialized in contravention of an express contractual
undertaking by the government or a government-controlled entity in respect ofthe project and (2) a debt service default has occurred as a result of thematerialization of such risk.
If the PRG is counter-guaranteed by the host government, there is nolimit on the amount of PRG. For those projects with PRG support but without
the host government’s counter-guarantee, ADB’s total PRG assistance may be up
to US$100 million or 50 percent of project costs, whichever is less.

22

The PRG fee structure has three components: (i) a front-end fee, (ii) a
standby fee and (iii) a guarantee fee. The front-end fee covers due diligence andother up-front costs. The stand-by fee applies to the amount of cofinancing
covered by the PRG that has not yet been disbursed. The amount of theguarantee fee depends on the perceived level of the risks covered, and onwhether the PRG is counter-guaranteed by the host government. If it iscounter-guaranteed, the Bank charges a guarantee fee of 40 basis points perannum on the guaranteed amount. If not counter-guaranteed, the guarantee fee
is charged at market rates.
A recent example of a PRG assisted project is Kelanitissa BOT Power
Project in Colombo, Sri Lanka which was approved in 2000 and involved acofinanced amount of US$52 million. The PRG covers breach of contract by theGovernment of Sri Lanka under the implementation and other agreements,
including payment obligations relating to currency convertibility and transfer
risk; expropriation and confiscation, change of law and events, which makeproject agreements unenforceable; and breach of fuel supply and powerpurchase agreements. The PRG support enabled the borrower to mobilize thelong-term debt from commercial lenders at significantly better terms than it
could achieve on it own credit.
IX.

Conclusion

This study of infrastructure finance in the Asia-Pacific Region has
surveyed a vast and varied landscape. The infrastructure requirements of theRegion are, as a product of the Region's dynamic economic growth, massive inscale. The related financing requirements are unprecedented.
International commercial banks and private sector institutional
investors remain highly selective in their willingness to lend long-term toprivate infrastructure projects on a limited recourse basis.
Substantial
progress in attracting greater participation by such banks and institutional
investors will require the mitigation of the risks of governmental
non-performance in respect of such projects.
Mitigation of such risks requires action by the concerned governments
in clarifying and solidifying the policy, legal, regulatory and financial
frameworks for such projects. Through government guarantees, project risks,such as the ability of a public utility to pay its private suppliers, can betransformed to sovereign risk. DMCs can reduce their exposure by replacing fullcredit guarantees with more narrowly defined guarantees such as powerpurchase agreements. Such unbundling of risks presumes that the parties canbe trusted to honor their commitments; if they cannot be trusted, investors will
prefer full guarantees.
This helps clarify why DMCs with low credit ratings rely heavily on
full financing by international development institutions and/or export credit

23

agencies, whereas DMCs with higher credit ratings offer guarantees for specificrisks. Support by international development institutions and export credit
agencies appears to substitute for an international contract enforcement
mechanism.
Greater attention needs to be given by project sponsors and theirfinancing institutions to ensuring as broad a basis of knowledge and informationas possible about private infrastructure in general and about the inherent
constraints within which financial transactions must be enacted.

24

NOTES
1/ The selected East Asian countries comprise the People’s Republic of China(PRC), Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand.
2/ The Asian Development Bank is an investor in the AIDEC and Peregrine
Funds.
3/ As was, for example, the case with the Dabhol (Enron) Power Company
project in India which was wholly foreign owned by Enron, GE Capital and
Bechtel.
4/ Such as the Asian Development Bank as an equity investor or investment
funds such as AIDEC.
5/ An agreement between the Onshore and Offshore Creditors and BECL
providing for a pari-passu sharing of security extended by BECL.

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25

Document prepared for the Trade Conference in Jakarta by Yutaka
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Address:
Yutaka Masaoka
Associate Professor
Room 628, School of Economics
Nagasaki University
2-1 Katafuchi 4-chome
Nagasaki 850-8506, JAPAN