Panel on Financial Affairs (Minutes) 12 Feb 98

Provisional Legislative Council

PLC Paper No. CB(1) 1190
(These minutes have been
seen by the Administration.)

Ref : CB1/PL/FA/1

Panel on Financial Affairs and Panel on Transport

Minutes of Joint meeting held on Thursday, 12 February 1998, at 4:30 pm in Conference Room A of the Legislative Council Building

Members present :

Members of Financial Affairs Panel

Hon Paul CHENG Ming-fun, JP (Chairman)
Hon NG Leung-sing
Dr Hon David LI Kwok-po, JP
# Hon CHAN Choi-hi
Hon CHIM Pui-chung
# Dr Hon LAW Cheung-kwok

Members of Transport Panel

Hon Mrs Miriam LAU Kin-yee, JP (Chairman)
Dr Hon Raymond HO Chung-tai, JP
Hon LEE Kai-ming
Hon Mrs Selina CHOW, JP
Hon YUEN Mo
Dr Hon TANG Siu-tong, JP

Member attending :

Hon YEUNG Yiu-chung

Members absent :

Members of Financial Affairs Panel

# Hon NGAN Kam-chuen (Deputy Chairman)
Hon Eric LI Ka-cheung, JP
# Hon Henry WU
Hon Ronald ARCULLI, JP
Dr Hon Philip WONG Yu-hong

Members of Transport Panel

Hon CHENG Hon-chung (Deputy Chairman)
Hon WONG Siu-yee
Hon Edward HO Sing-tin, JP
Hon CHAN Wing-chan
Hon CHAN Kam-lam
Hon CHENG Kai-nam
Hon Andrew WONG Wang-fat, JP
Hon LAU Kong-wah
Hon CHOY Kan-pui, JP

Public officers attending :

Mr Kevin HO: Deputy Secretary for Transport(Transport Infrastructure)
Mr Martin M Glass: Deputy Secretary for the Treasury 2
Miss Jenny YIP: Principal Assistant Secretary for Treasury(Investments)
Mr Esmond LEE: Principal Assistant Secretary for Planning, Environment and Lands (Lands)
Mr C K MAK: Government Engineer/Railway Development

By invitation:

For item II
Kowloon-Canton Railway Corporation
Mr James BLAKE: Senior Director, Capital Projects
Mr Samuel LAI: Director, Finance

Clerk in attendance :

Ms Estella CHAN: Chief Assistant Secretary (1)4

Staff in attendance :

Mr Andy LAU: Senior Assistant Secretary (1)6

I Election of Chairman

Members agreed that Mrs Miriam LAU Kin-yee should preside over the election of Chairman. Mrs LAU invited nominations for the chairmanship. Mrs Miriam LAU Kin-yee was nominated by Mr LEE Kai-ming and seconded by Dr LAW Cheung-kwok. Mrs LAU accepted the nomination.

2. There being no other nomination, Mrs Miriam LAU Kin-yee was declared Chairman of the meeting.

II Equity injection into Kowloon-Canton Railway Corporation for implementation of West Rail

(CB(1)893(01) - Information paper provided by the Administration)

3. Members noted the submission put forward by a group of residents in Mei Foo, objecting to the provision of a West Rail interchange at Mei Foo. The Chairman advised that there were statutory provisions under the Railways Ordinance for dealing with objections within a period of nine months upon the expiry of the 60 days objection period. The relevant railway schemes and any unwithdrawn objections would then be submitted to the Chief Executive in Council for consideration.

4. At the invitation of the Chairman, the Deputy Secretary for Transport briefed members that following the approval of the Executive Council, the Administration had introduced the Kowloon-Canton Railway Corporation (KCRC) (Amendment) Bill 1998 (the Bill) into the Provisional Legislative Council on 11 February 1998. The Bill provided, inter alia, for a proper share capital structure and the powers to undertake authorised new railway projects for the Corporation. A draft Project Agreement was also drawn up between KCRC and Government which set out how the West Rail project would be undertaken and the respective obligations of both parties in terms of financing, design, construction and operation of West Rail. The Administration would shortly put forward a financial proposal to the Finance Committee, seeking members?approval, subject to the enactment of the Bill, of a commitment to inject equity of $29,000 million from the Capital Investment Fund into the KCRC, to allow major works on West Rail Phase 1 to proceed.

5. The Deputy Secretary for the Treasury 2 (DS for Tsy)briefed members on the cost estimates and the financing arrangements for the West Rail project as detailed in the draft Finance Committee paper. He said that the total project estimates for the West Rail project were $64 billion, which had been independently assessed by the Government's consultants to be within an acceptable range. He pointed out that KCRC operated on a commercial basis free of Government subsidy, thus avoiding an unnecessary burden on the taxpayer and ensuring the application of commercial disciplines to enhance and extend the systems for the benefit of passengers. Against these principles, the Administration and the KCRC had sought to ensure that optimal financing arrangements were in place which would allow KCRC to service its capital in the most cost effective manner. The total project costs were intended to be financed as follows:

Government would contribute an equity to the amount of $29 billion, by two equal annual installments respectively in early 1998-99 and approximately a year later;
KCRC would contribute a total of $10.1 billion from its interest earnings on cash balance and profits from property development along its East Rail and Light Rail lines; and
The balance of financing estimated at $24.9 billion would be funded by debt to be raised by the Corporation during the construction period.

6. In response to the Chairman, DS for T clarified that for the purposes of financing, KCRC would initially be allowed to operate and maintain the West Rail for a period of 50 years. The same arrangement had applied to other rail links in Hong Kong. Thereafter, the Administration would sort out the necessary arrangements with KCRC to enable the continued operation of the West Rail.

7. A member pointed out that there was insufficient information in the paper to judge whether the financial projections were reasonable and requested for further information on the planning parameters. The Finance Director, KCRC (FD/KCRC) advised that the project estimates had been worked out on the basis of a number of technical studies on the design of both civil and system-wide elements of the proposed West Rail. In drawing up the estimates, references had also been made to the actual operating expenses of the East Rail. For the purpose of calculating the revenue for financial projections, KCRC had assumed a base fare of $21 (1996 prices) from Yen Chow Street to Tuen Mun Centre. Transport models and financial models were then developed to project the operating cash flows and financial requirements for the project. At the request of members, the Administration undertook to provide further information on the key assumptions to the financial projections when the proposal was put to the Finance Committee.

Admin

8. In view of the recent financial crisis in Asia, a member asked if this would affect KCRC's plan to tap the financial markets at reasonable costs. In reply, DS for Tsy said that the financial turbulence in the region was short term in nature. Given that the fund raising was only expected to take place from 2000 onwards and having regard to KCRC's strong financial record and Government's plan to contribute an equity of $29 billion, KCRC should be able to raise and service the proposed debt in a cost-effective manner.

9. Members expressed concern about the future fare levels for the West Rail and enquired about the implications of changing the components of the financial package on future fares (for example, increasing the Government's equity or allowing KCRC to retain the West Rail property development profits).

10. DS for Tsy advised that there was no direct correlation between future fares and the components of the financial package. The proposed financial package was already the optimal arrangement. It would not be appropriate to provide more Government equity than optimally required under the financing proposal, as over time, equity was generally a more expensive means of financing than commercial borrowing. For the purpose of calculating the project internal rate of return (IRR), KCRC had developed independently a preliminary fare structure which was used to project the operating cash flows of West Rail. The project IRR was then calculated ?without regard to potential sources of project finance ?by equating the present value of the operating cash flow to the initial investment to be made. Since the project IRR was derived independently of the financing costs, it would not be directly affected by the composition of the financial package. The project IRR was also itself a derivative of an independently developed preliminary fare structure. Therefore it was not the project IRR that influenced the fare level but vice versa.

11. Some members queried the justifications for deviating from the adopted principle whereby KCRC was allowed to retain profits generated from property developments along East Rail and Light Rail Transit to fund its expansion and improvement programmes. They were concerned that the proposal to pass on the property development profits along West Rail to Government would impose undue pressure on future fares for West Rail, affect the improvement programmes of KCRC, and undermine the potential of property developments as KCRC would have no incentive to maximize profits from such developments. They requested further information on the justifications for the proposed change and its implications on future fares, as well as the existing arrangements for the railway companies in dealing with property development profits generated along the Airport Railway and the KCR East and Light Rail Lines, when the financial package was put to the Finance Committee for consideration.

Admin

12. FD/KCRC explained that as property development profits could only be realized from 2003 onwards, it would not help to finance the construction of West Rail project. Rather, it was considered more important to have Government's equity to provide timely resources to finance the project. Given the uncertainty in the extent of property developments along the West Rail, it would be difficult to assess the exact profits that could be generated from this source. Hence, no property development profits had been factored into the cash flow projections of West Rail. Furthermore, capital revenue, due to its one-off nature, should not be applied to meeting recurrent operating expenditures.

13. DS for Tsy added that as KCRC could achieve a satisfactory project IRR without the stream of profits from West Rail developments, KCRC would require the profits neither for financing the project nor for improving the project return. In order not to freeze resources for other public uses, it was proposed that the property development profits should be passed back to the Government as soon as they were realized, rather than treating them as windfall profits. The Government would also consider the option of equity for the capital financing of other new railway projects and extensions commissioned by KCRC.

14. DS for Tsy further said that KCRC would retain an interest in the completed developments, e.g. retail podia. Government and KCRC were currently in discussion on the principles and mechanisms for giving effect to the property arrangement to ensure that it was equitable optimally developed. KCRC could also benefit from the increased ridership resulting from the property developments.

15. In response to the Chairman, DS for Tsy advised that with an equity injection of $29 billion, the gearing of the Corporation would be maintained at prudent levels. The Corporation would be able to pay dividends to Government as its shareholder. However, the requirement for the Corporation to pay dividends would have no impacts on the fare level. FD/KCRC added that the preliminary fare structure was only used to project the operating cash flows of West Rail. The exact fares would be drawn up nearer the time of opening, having regard to operating costs including finance charges, affordability to the public, and competition from other transport modes. Should there be an operating profit, the KCRC Board would then determine whether dividends should be paid to Government.

16. In response to a member, DS for Tsy advised that suitable improvement works would be carried out so as to ensure that the Mass Transit Railway's interchange station would have sufficient capacity to cater for the additional demand generated by the West Rail.

III Any other business

17. There being no other business, the meeting ended at 5:30 pm.

Provisional Legislative Council Secretariat
23 March 1998

# also a member of the Panel on Transport