For discussion

LegCo Panel on Transport

Privatisation of the Mass Transit Railway Corporation

PURPOSE

This paper provides the background to the proposed privatisation of the Mass Transit Railway Corporation (MTRC) and outlines the related issues which need to be addressed.

BACKGROUND AND ARGUMENT

Justification for Government Ownership of MTRC

2. Established as a statutory corporation in 1975 by the Mass Transit Railway Corporation Ordinance (Cap. 270), MTRC is mandated to construct and operate the mass transit railway having regard to the reasonable transport requirements of Hong Kong. MTRC is required under Cap. 270 to operate on prudent commercial principles.

3. MTRC is wholly-owned by the Government. Over the years Government equity helped propell the expansion of the mass transit railway network, at a cost of capital lower than otherwise would be obtainable from the capital markets by an enterprise with massive capital investment requirement and substantial initial debt. To-date, MTRC is amongst the most efficiently and profitably run railway system in the world with credit rating identical to the sovereign rating of HKSARG. The original reasons for 100 percent Government ownership of MTRC are no longer valid.

Benefits of Privatisation of MTRC

4. On 3 March 1999, the Financial Secretary announced in his Budget Speech the intention of the Government to privatise a substantial minority of the MTRC shares through an Initial Public Offering.

5. MTRC has demonstrated how a Government-owned entity can be run successfully under prudent commercial principles. We believe the introduction of private ownership will reinforce MTRC's commitment to competitiveness and efficiency. Privatisation will strengthen the market discipline in the running of the railway. It will also broaden MTRC's access to sources of capital and reduce its reliance on Government equity injection or loans for new railway extensions.

6. Privatisation of MTRC will also offer a prime opportunity for the people of Hong Kong to invest in a successful business with strong growth potentials. The floatation of a high quality, heavily capitalized stock like the MTRC will add stability and diversity to the Hong Kong stock market. A high profile and successful public offering will help buttress Hong Kong's status as an international financial centre. In addition, the public offering will provide a useful boost to Government finance in the medium term.

Government to Retain Majority Shareholding

7. The Government will remain as the majority shareholder after privatisation. We believe Government shareholding will be reassuring to the commuting public who rightfully expects the Government to be the steward of public interest in making sure that the privatised entity continues to provide safe, reliable services at affordable fare levels. Government's shareholding will be seen by local and overseas investors as our support for MTRC's continuing role in the expansion of the transport infrastructure in Hong Kong. Such investor confidence will help the Government realize the maximum commercial value of its MTRC holdings. In this connection, we intend to privatise MTRC on an "as-is" basis with its full business portfolio and undertakings. There will be no unbundling of assets.

Competition with Other Public Transport Modes

8. The public transport service sector in Hong Kong operates under a highly competitive environment and rail service is no exception. The MTR operates in districts where other public transport service, franchised bus service in particular, provide parallel and competing service. After privatisation, we expect that the MTR will continue to have to compete against buses, which are generally cheaper and more flexible, through MTR's inherent advantages of safety, reliability and efficiency. Other modes of transport, such as taxis and PLBs, will continue to compete with the MTR as well as to provide feeder service to it. Taxis, for example, have been an effective siphon of short trip passengers and this will be so especially if we relax kerb side activities for taxis, as we have started to do recently. Such competition will provide a major incentive to MTRC to keeping fares competitive and maintaining a high standard of service, in terms of quantity and quality, to maintain and capture market share. Competition also puts a cap on prices.

REGULATORY ISSUES

Safety

9. All the powers of the Hong Kong Railway Inspectorate in the existing Mass Transit Railway Corporation Ordinance (Cap. 270) which covers all aspects of monitoring of railway safety and investigation of railway incidents will be preserved in the Bill :-

1. enter the railway premises at any reasonable time;

2. call, by summons if necessary, any person to provide information;

3. carry out tests or inspection on railway plants and equipment, on and off railway premises; and

4. require railway employees and contractors to assist in tests and inspections and furnish any necessary documents for the purpose.

Fare Regulation

10. Under the exiting Mass Transit Railway Ordinance (Cap. 270), MTRC is empowered to determine its own fares. In practice, MTRC conducts voluntary consultation with the LegCo Panel on Transport and Transport Advisory Committee on fare increases. Since the commencement of operation in October 1979, MTRC's average fare increase has been 7.5% per annum, which is lower than the average increase in Consumer Price Index (A) of 8.2% for the same period. In the light of the difficult economic conditions and low inflation, MTRC has not raised its fares since 1 September 1997. We believe that after privatisation, MTRC should continue to retain fare autonomy which will enable it to invest in the development and maintenance of the railway system and provide a reasonable return to shareholders. As set out in para 8 above, we are committed to maintaining a level playing field and competitive environment to ensure that MTRC does not abuse its fare autonomy.

New Rail Projects

11. Historically, MTRC's rail extension have been funded predominantly by various forms of Government support (i.e. equity injection and property development rights) and borrowings at sovereign ratings. Privatisation will underline the commercial practice and discipline of the MTRC to take on new rail extensions on the basis of competition with other modes of public transport and with the Kowloon-Canton Railway Corporation, as well as reasonable commercial financial returns covering the cost of capital plus a risk premium.

12. The Government will continue to have a major role to play in awarding priority to new rail projects. The MTRC and KCRC will be treated on a level playing field basis and Government will not be prejudiced against any one of the two Corporations only because of the amount of shareholding. Projects which are entirely separated from any existing networks will be awarded taking into account long term transport planning considerations and the ability of MTRC and KCRC to undertake the new project. We believe it is in the public interest to promote as far as practicable competition between the two rail operators on a completely equal footing.

Land Issues

13. Historically, property development has provided an important contribution to the financial viability of MTRC's rail projects. MTRC has played a useful role in the property development near its railway station and established new communities along its footprint. It undertakes planning for the property development, building a substantial part of the foundation and provides other common infrastructure. The property development also helps provide early patronage to the railway system. We believe MTRC should be allowed to continue its role in integrating railway and property development. The existing policy of granting property development right, where appropriate, on top of stations and depots will continue.

WAY FORWARD

The Legal Framework

14. The MTRC in its present form of a statutory corporation is not an appropriate vehicle for private ownership. Steps will be taken to incorporate a new entity, called the MTR Corporation Limited (MTRCL) as a public limited company under the Companies Ordinance (Cap. 32). All the assets and liabilities of MTRC will be vested in the new body corporate by way of the Mass Transit Railway Bill (The Bill).

15. The Bill, once enacted, will repeal the existing Mass Transit Railway Corporation Ordinance (Cap. 270). The new legislation will grant to MTRCL an exclusive franchise for running the existing MTR network. The Bill will also provide for financial penalties, suspension and revocation of the franchise in case of material breach of franchise terms by the franchisee, as in the case of other public transport franchises. Other key provisions of the Bill codify the existing regulatory powers of the Government, including the power to obtain information and records from MTRCL to ensure that it is discharging its obligation to provide a proper and efficient service.

The Operating Agreement

16. An Operating Agreement(OA) will be signed between the Government and MTRCL which will provide for the detailed terms of the franchise, including the monitoring process by the Government and fare setting process by the Corporation. The provisions in the OA for MTRCL to set fares will include the need for MTRCL to take into account the acceptability to the public gauged through voluntary consultation with the LegCo Panel on Transport and the Transport Advisory Committee. The OA will also codify the existing standards and level of service of MTRC and provide for the mechanism for the Government to monitor pre-determined service standards to be agreed between the Government and the MTRCL. There will also be other performance indicators which measure the quality of service and serve to point to areas of improvement in the delivery of service.

Progress

17. We have not decided on the timing for the Initial Public Offering, but, for planning reasons, the 1999 Budget has assumed that a cash flow totalling $30 Billion will be derived from this exercise in the two financial years 2000-01 and 2001-02. We are now working on the drafting of the Bill and discussing with the MTRC on the drafting of the OA. We will report progress to Members in due course.

CONCLUSION

18. We have to recognize that MTRC now provides one of the best examples of running an efficient and profitable railway service in the world. The privatisation exercise does not seek to alter the mode of operation of this successful enterprise. We believe the proposed legislative and regulatory framework will be effective in enabling the Government to monitor the MTR service as in the case of other public transport providers, and to ensure that MTR will continue to have a major role to play in providing the commuting public with safe, efficient and reliable services.

Transport Bureau
June 1999