A Study on Legal Aspects of Private-initiated Infrastructure Financing

Recently not a single day passes without the mention of project finance, which refers to the financing of a particular project in which a lender is satisfied to look initially to the cash flows and earnings of the project as the source of funds for the repayment of the loans. So the project financier is restricted to recourse to shareholders of the project company in the event that the project fails to generate sufficient revenues.

As the lender usually takes a large part of the risk of the success or failure of that project which demands a huge sum of money with a long maturity, it is important to allocate the risks through the various provisions of the project related contracts to other parties most willing to participate in the project and to accept the risks. Therefore, a credit agreement should reflect the lender's position with respect to the identification and mitigation of project risks.

When a proposed project proves to be feasible in technical and financial terms, the lender looks to the structure of the project to see if it is conducive to the preservation of its legal rights and the repayment of the loan and, accordingly, acceptable to the lender. This means bankability, a deal-specific concept. For example, if banks should take the risk of a change in law, or if sponsors might extract distributions prior to the first repayment date, that project turns out to be unbankable to the lenders.

In Korea, the Act on Private Investment in Social Overhead Capital Facilities came into force as from April 1, 1999. The newly amended Infrastructure Law has introduced a BOT (build-operate-transfer) approach in building up infrastructure in Korea. In fact, the BOT scheme is very useful for Korean contractors to provide SOC facilities and to succeed in bidding for large-scale overseas contracts.

On the other hand, the United Kingdom introduced a PFI (Private Finance Initiative) scheme in the early 1990s. Under the PFI mechanism, the government becomes a client ready to pay tolls to qualified private suppliers who design, build, finance and operate the public infrastructure and services. In that sense, the PFI might ensure a reasonable profitability to the private providers of public facilities and services.
In July 1999, Japan established its own PFI Act to invigorate its sluggish economy. In order to break through the current doldrums in privately financed SOC buildups in Korea, we have to pay more attention to new approaches like BOT and PFI. In particular, the PFI arrangement will be an efficient instrument to reform the public sector of the nation.

In this regard, it is important to discard the stereotyped way of thinking that only the public sector shall provide public goods and services to the public. An effective solution has to be sought to alleviate civil servants' sensitivities to job security. At the same time, far-reaching deregulation should be implemented to facilitate and augment the managerial initiatives and creative skills of the private sector. We should learn the lessons from the United Kingdom, in which private specialists were allowed to form a PFI taskforce in the government and become a prime mover of public sector reformation through in-depth education and training to public employees.

This dissertation examines the current status of infrastructure financing in Korea and suggests some useful solutions.
Chapter 1 presents the scope and method of study.
Chapter 2 explains the general definition of project finance and the respective role of its participants.
Chapter 3 compares the newly introduced BOT and PFI methods and studies the probability of adopting such arrangements to the Korean situation.
Chapter 4 conveys the UNCITRAL survey on the BOT regulations around the world, and deals with the particulars of the infrastructure laws and regulations of the Far Eastern countries - Korea, Japan and China.

Chapter 5 discusses the identification, allocation and mitigation of project risks, and major checkpoints of various project-related agreements to ensure the so-called bankability.
Chapter 6 introduces a new financing tool, i.e., asset-backed securitization in the context of project financing. If some revenues from a project are set aside to asset-backed securities holders, this scheme secures a new source of fund in project financing.
Finally, Chaper 7 provides above-mentioned BOT and PFI methods can be applied to improve the quality of infrastructure in Korea, in particular, in the unification era. In the long run, by way of BOT and PFI, we will be prepared to rehabilitate and renovate the ill-conditioned infrastructure of North Korea after the two Koreas have been unified. These new methods can be expected to curtail the unification costs to a controllable limit.

Original text in Korean
The foregoing is the abstract of the Author's thesis for Ph.D. in law which was awarded by Kyung Hee University in February 23, 2000.