ISE15/14-15

• In March 2015, the Chief Executive in Council granted approval to proceed with the implementation of the proposed three-runway system project. The project is estimated to cost HK$141.5 billion in money‐of‐the‐day prices, to be self-financed by the Airport Authority Hong Kong ("Airport Authority"). In addition to raising revenues from user fees and charges and external borrowings, the Airport Authority also plans to retain all profits earned from 2014-2015 onwards without declaring dividends until the full commissioning of the three-runway system expected in 2023-2024.
• The Airport Authority is a statutory body established in 1995 and wholly-owned by the Government. Under the Airport Authority Ordinance (Cap.483), the Airport Authority may pay dividends on its shares. According to its annual reports, the Airport Authority started to make profits in 2000-2001. During the initial profitable years, no dividend was declared. It was only in 2003-2004 that a dividend of HK$380 million was proposed for the first time. Since then, the Airport Authority has declared and paid to the Government dividends annually. Reflecting profit growth, the dividends surged to HK$2 billion for 2007-2008, HK$3.1 billion for 2010-2011, and HK$5.3 billion for 2013-2014.
• This issue of Essentials aims to discuss the option of financing infrastructure projects with retained profits without paying dividends by government-owned authorities or corporations ("government-owned enterprises"), and give a brief account of the former two cases of the Kowloon-Canton Railway Corporation ("KCRC") and the Mass Transit Railway Corporation Limited ("MTRCL"), in which the Government had foregone dividends as part of the funding means for the railway projects.

Financing infrastructure projects with retained profits

• In many places, government-owned enterprises play a core function of providing infrastructure and utility services. These enterprises may deploy a variety of funding sources to finance public infrastructure projects. The funding sources may include capital contribution from the government, internal resources such as retained profits and proceeds from the sale of assets, and external borrowings. The relative importance and funding mix depend on numerous factors such as the business nature, operating environment, government budgetary resources and political landscape. In developing economies with limited access to private financing sources, public funding through government contribution and internal resources typically form a majority part of infrastructure expenditures.
• Broadly speaking, retaining profits for reinvestment instead of paying them out as dividends is seen as a readily accessible and low-cost source of financing. This financing option nevertheless depends on the level of the enterprises' profits and dividend policy. According to the Organisation for Economic Co-operation and Development ("OECD"), how governments set dividend levels or communicate dividend expectations to their enterprises vary greatly across jurisdictions and individual enterprises. For example, in places like Australia, government-owned enterprises are expected to make annual dividend payments and there are established guidelines for dividend determination; whereas in some other places like Finland and Germany, government-owned enterprises generally do not have explicit dividend guidelines/targets. Notwithstanding the varying practices, according to OECD, having a formal dividend policy in place is certainly useful to guide negotiations on the level of dividends to be paid.
• In overseas developed economies, there are cases in which governments surrender dividends that they are entitled to for infrastructure investment by their government-owned enterprises. For example, in the Australian state of Tasmania, the government agreed to forego dividends to enable its state-owned port operating company, TT-Line Company Pty Ltd., to retain its profits for meeting the cost of replacement and/or refurbishment of its vessels. In Canada, the Ontario Power Generation Inc., the electricity generating company wholly-owned by the state government, has not declared and paid dividends during periods of high capital expenditures. It is also noted that in Singapore, its national water agency - the Public Utilities Board - has deployed the net profits for capital investments and no dividends have been declared and paid to the government as a shareholder.^{1Legend symbol denoting While the Singaporean government as a shareholder is entitled to receive dividends, the Public Utilities Board is required by the Public Utilities Act to finance a reasonable proportion of its capital expenditure from internal resources.}

Foregoing dividends from the Kowloon-Canton Railway Corporation

• In Hong Kong, KCRC, which is wholly-owned by the Government, may declare and pay dividends to the Government under the Kowloon-Canton Railway Corporation Ordinance (Cap. 372). According to the government information, in proposing the amount of dividends payable by its wholly-owned enterprises including KCRC, the boards would take into consideration the concerned enterprise's financial position, such as the business prospects, the need to meet capital and recurrent expenditure, as well as the outstanding and anticipated financing obligations of the enterprise.^{2Legend symbol denoting See LC Paper No. CB(1)1020/04-05(07).}
• KCRC had in the past deployed internal resources without declaring dividends as one of the funding means for infrastructure projects. As revealed in the annual reports of 1999, 2000 and 2001, the Government had foregone dividends to allow KCRC to devote its financial resources towards meeting the cost of the West Rail Phase I and the East Rail Extensions projects.^{3Legend symbol denoting According to the Government, no special briefing was given to the Legislative Council in respect of the KCRC dividend foregoing case at that time. It was only revealed by the Government in 2002 when the Subcommittee on matters relating to railways (formerly known as Subcommittee on matters relating to the implementation of railway development projects) under the Panel on Transport deliberated the MTRCL dividend waiver case.}
• It was noted that in addition to foregoing dividends, the Government had also injected equity into KCRC for the West Rail Phase I project during 1998-1999, amounting to HK$29 billion or about 56% of the project cost. For the East Rail Extensions projects, equity injection totalled HK$8 billion, or about 30% of the project cost.^{4Legend symbol denoting West Rail Phase I was a railway line linking Tuen Mun and Yuen Long with West Kowloon. Its project cost was adjusted downward from HK$64 billion to HK$52 billion in 2001 due to a drop in tender prices, land costs, financing costs, etc. The East Rail Extensions involved (a) Ma On Shan to Tai Wai Rail Link, (b) Kowloon-Canton Railway Extension from Hung Hom to Tsim Sha Tsui, and (c) Sheung Shui to Lok Ma Chau Spur Line. The HK$8 billion equity injection was specifically made for the implementation of projects (a) and (b).} Meanwhile, KCRC also obtained funding for these development projects through external borrowings.

The case of the Mass Transit Railway Corporation Limited

• Compared with KCRC, the case of MTRCL was a bit different as it is a listed commercial entity majority-owned by the Government. In 2002, MTRCL commenced the Disneyland Resort Line project (formerly named Penny's Bay Rail Link) costing HK$2 billion. The project was however unable to achieve an appropriate commercial rate of return with a funding shortfall of HK$798 million.^{5Legend symbol denoting The funding shortfall of HK$798 million (net present value on 1 January 2002) was derived by deducting the estimated capital expenditure from the present value of estimated revenues (net of operating expenditure) over the franchise period in respect of the Disney Resort Line project.} Against this backdrop, the Government agreed to provide financial support by waiving its claim for HK$798 million worth of dividends otherwise payable by MTRCL to the Government as a shareholder.
• The matter was discussed by the Subcommittee on matters relating to railways (formerly known as Subcommittee on matters relating to the implementation of railway development projects) under the Panel on Transport in 2002. At the meetings, some members cast doubt over the legality of the arrangement, questioning whether the Government had the power to waive its claims for dividend payable by MTRCL. The Government asserted that there was sound legal basis for the dividend waiver option under the Public Finance Ordinance (Cap.2) and the Mass Transit Railway Ordinance (Cap. 556).^{6Legend symbol denoting The Government asserted that the "claim" that can be waived under section 38 of the Public Finance Ordinance ("PFO") covered the right of the Financial Secretary Incorporated to dividends as shareholder of MTRCL. In respect of whether dividends waived should constitute part of general revenue, the Government said that under section 3 of PFO and section 58 of the Mass Transit Railway Ordinance, only money actually received by the Government would form part of the general revenue but not monies to which it was entitled but which it had not received. Thus, dividends waived would not form part of the general revenue.} It also maintained that dividend waiver was the most appropriate funding option for the railway project, having considered that other options such as granting of property development rights and equity injection were subject to varying degrees of restrictions.
• Notwithstanding that the Subcommittee showed reservations towards the Government's dividend waiver decision^{7Legend symbol denoting It was reflected in the motion passed at the meeting on 24 July 2002. The wording of the motion was in Chinese only and read as follows: "本小組委員會支持盡快興建竹篙灣鐵路線，但對於政府以豁免收取地鐵股息作為財務支持有所保留，並促請政府繼續向本小組委員會匯報工程進度。"}, the related project agreement was entered into between the Government and MTRCL. Waiver of cash dividends started from 2002 and was completed in 2004, foregoing an aggregate cash dividend amount of some HK$931 million.^{8Legend symbol denoting The aggregate amount was calculated based on a formula taking into account the funding gap of HK$798 million and the expected return of the project at 11.25%.}

Prepared by Tiffany NG
Research Office
Information Services Division
Legislative Council Secretariat
22 June 2015