Overview of Negotiation

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					Major Issues in Negotiations
       - Focused on BTO projects-

        Korea Development Institute
   Public & Private Infrastructure Investment
              Management Center
1. Negotiation Overview

2. Major Issues in BTO Negotiations

3. Major Issues in BTO Concession Agreement
         - Focused on road projects -

Part-01   Negotiation Overview

                1. 협상단계 업무
   Negotiation Process

               Preparation of
             실시협약 작성

              Organization of
              협상단 구성
             Negotiation Party

                                                                     Conclusion of
                Negotiation                                         실시협약 체결

Request for Review
   실시협약                     Breakdown of    차순위협상대상
                                           Negotiation with Next
  of Concession              협상결렬
   Agreement                 Negotiation        자 협상
                                           Concessionaire in Line

Result of Concession                        Cancellation of
                                           협상대상자 취소
 Agreement Review                             Negotiator

                1. 협상단계 업무
  Legal Basis for Negotiation

                Related Laws                              Major Contents

                                   ▶The consultation with potential concessionaires about the
                                    terms in concession agreement for project implementation

                                        • Obligations and burdens of SPC and Government

                                        • The scope of project

                                        • Free usage period

              Basic Plan for PPP        • Handling of risks due to forces majeure and so forth
                                        • Total project cost and rate of return

                                   ▶Organize the negotiating party and hold negotiations

                                   ▶Establish detailed negotiation implementation plan including
                                    negotiation strategy and negotiation schedule

                                   ▶ If negotiation breaks down, negotiate with the next
                                    concessionaire in line or notify again
                 1. 협상단계 업무
   Legal Basis for Negotiation

                  Related Laws                                 Major Contents
                                      ▶The agreement that specifies the rights and obligations
                                       between competent authorities and designated potential
                                       concessionaires for total project cost, project period, etc.

                • Article 13 of Act   ▶Confirmation of detailed project terms (size of government
                  on PPP               payment, scope of project operation, project termination, etc.)

Conclusion of   • Basic Plan for      ▶Basic matters such as project implementation method, rights
 Concession       PPP Project          and obligations relationship, etc.
                • General             ▶Matters related with construction such as starting time,
                  Guidelines for       construction period, supervision, damages for delay, etc.
                  PPP Project
                                      ▶Matters related with total project cost, fees, rate of return,
                                       and operating expenses

                                      ▶Matters related with the inspection and evaluation of results
                 2. 일반적 사항
  Principle of Negotiation

 Maintaining consistency of negotiation and uplifting efficiency
  (Shortening negotiation period)
       Competent authorities shall publically announce the terms and conditions as
        well as concession agreement (draft) in advance in Request For
       The more specifically they state their requests, the less disputes may arise in
        negotiation and afterwards (State requests as specifically as possible to
        reduce occurrence of disputes during negotiation and afterwards)
          Provide information about total project cost, construction subsidy, and fees
            acceptable to the competent authorities

       Confirm negotiation conditions such as total costs and rate of return
        temporarily in the course of selecting potential concessionaires to shorten the
        negotiation period as much as possible
          Suppose the potential concessionaire accepts the conditions suggested in Request
            For Proposal(RFP)
                  2. 일반적 사항
   Principle of Negotiation

 Maintaining consistency of negotiation and uplifting efficiency
  (Shortening negotiation period)
       The concessionaire cannot make proposals or suggest conditions against the
        publically announced RFP
          Unless there are feasible reasons, the potential concessionaire cannot suggest
            conditions more advantageous than the provided conditions

       Specify negotiation period in the RFP
          If there are no problems in implementing the project during negotiation, the detailed
            design can be prepared in order to shorten project period
Principle of Negotiation

Basic Attitude of Negotiators

 Both parties negotiate in the same position as partners instead
  of in a superior or inferior position
 Use of respectful languages regardless of age and rank
 Submit related materials and data as much as possible,
  explain the basis for the arguments rationally
 Take extra caution for decisive remarks in order not to alter the
 Maintain security for internal information such as negotiation
 Building of unnecessary personal relationships prohibited
 As negotiation has no right or wrong answer, we should
  prepare logics to prove validity of negotiation results             9
            3. 협상 근거 자료 및 내용
  Principle of Negotiation

                    Basis for Negotiation Criteria

Request for         Project         Value for Money         Performance of
 Proposal          Proposal           Test Results          Similar Projects

     Project IRR        Financing    Cost of Construction
                           Cost        and Operation
 Overview of Negotiation

Purpose of Negotiation

 Designation of concessionaire for PPP project

 Agreement on basic matters required for project implementation
      Confirmation of demand, project cost and operating cost,
      determination of rate of return and user fees
      execution of ancillary project
      clarification of the rights and authorities of concessionaires and competent

 Conclusion of concession agreement

    Overview of Negotiation

 Interest between Negotiators

Division      Competent Authorities           Concessionaire         Financial Institution

              •Early construction of
                                            •Maximization of rate   •Maximization of rate of

                                             of return               return
              •Introduction of creativity
                                            •Increase of added      •Timely recovery of
               and efficiency in private
                                             value of SPC            principal and interest

              •Securing economic            •Management of          •Profitability of project
               feasibility                   demand risk            •Risk of construction &

              •Reduction of                 •Construction and        operation
               government charges            operation risk          •Credit of
              •Transfer of project risks    •Various civil petitions concessionaire

 Overview of Negotiation

Negotiation Procedure

           Designation of Potential Concessionaire

             Selection of Negotiating Institution

             Establishment of Negotiation Plan


            Preparation of Concession Agreement

             Review by PPP Review Committee

            Conclusion of Concession Agreement
 Overview of Negotiation

Designation of Potential Concessionaire
 Competent authorities conduct evaluations according to the
  request for alternate proposals, and designate and notify the
  potential concessionaire based on the evaluation

Selection of Negotiating Institution
 Evaluation and Negotiation can be performed by the
  competent authorities or consigned to an outside professional
       When consigning to an outside agency, select group candidates to
        secure expertise and objectiveness and conduct a written investigation
        for expenses and period

Overview of Negotiation

Establishment of Negotiation Plan
 Prepare negotiation plan
 Organization of negotiation team: Main negotiation team,
  working-level negotiation team
        The person in competent authorities must participate
        Experts from related fields: Professors, professional engineer,
         accountant, lawyer, and those with 10 years of experience or longer
        Exclusion: Interested parties of this project

 Review project proposal, alternate proposals, evaluation
  reports, and feasibility test report
 Summarize key elements in project implementation
 Set negotiation goals for each field before negotiation, hold
  strategy development meeting
Overview of Negotiation

Considerations in setting negotiation goals
 Minimize burden on user and competent authorities
 Set goals as high as possible, but prepare alternatives
 Conform to the Act on Public-Private Partnerships and related laws
 Maintain coherence with previous evaluation outcomes
      Value for money test, alternate proposals, evaluation report

 Adjust overall negotiation goals according to competitiveness and
      Competitive: Respect the concessionaire’s suggestions and focus on
       whether they conform with regulations
      Noncompetitive: Make efforts to maintain the average level of other
      Cost reduction is important, and securing the level of quality and service
       is also important

 Analysis of various risks in the project implementation
      Risks of Financing, Construction period, Civil petitions, etc.               16
Overview of Negotiation

Hold Negotiation

 Negotiation Period: Approximately 6-10 months
 Negotiating teams
       Main negotiating team and working-level negotiating team
 Role of Negotiation teams
       Working-Level Negotiation: Reach agreements on details in each area
        through mutual consultations
       Main Negotiation: Confirm the agreements made between working-level
        negotiating parties and adjust unresolved matters
 Negotiation Order
       Determined through consultation between negotiating parties
       Appropriateness of design (VE) ⇒ traffic demand ⇒ total project cost ⇒
        operating cost ⇒ rate of return, fee, construction subsidy ⇒ government
        support ⇒ provisions of agreement ⇒ initializing of agreement (draft)
 Overview of Negotiation

 Working-Level Negotiation
      Competent authorities and potential concessionaires each organize their
       negotiation team
      Both parties have negotiated each item until they come to conclusion
      For each negotiation item 3-4 meetings could be held
      For each negotiation item, both parties prepare materials for the meeting
      After negotiating meeting both parties take minute and keep it
      If there are unresolved issues they would be discussed in main

 Main Negotiation
      Both parties confirm each negotiation item that has been agreed
      Both sign the draft concession agreement
 Overview of Negotiation

Major Contents of Negotiation (1)

 Review of the appropriateness of design (VE) and unit price
       Executed after the negotiation begins (Public Procurement Service,
        Korea Expressway Corporation, Environmental Management
        Corporation, other research institutes)
       Competent Authorities bear the cost of review
       Negotiation teams consult in advance about the direction of negotiation
        based on the result of review

 Traffic demand
       Check conformity to preliminary demand forecasting results
       Whether recent basic data and development plans are reflected
       Direct impact on the rate of return and user fee
 Overview of Negotiation

Major Contents of Negotiation (2)
 Total Project Cost and Operating Cost
      Total Project Cost: Survey cost, design cost, construction cost, land
       acquisition cost, ancillary cost, operation facility cost, taxes and charges,
       SPC operating cost
      Operating Cost: Labor cost and overall expenses, maintenance and
       repair cost, insurance, power charges, facility replacement cost
      Adjust proposed cost reflecting design VE outcome and cost of similar

 Rate of Return, Toll, Construction Subsidy
      Carry out after negotiation on traffic demand and expenses ends
      These 3 subjects are related with each other  negotiate collectively
      Respect the evaluation result if reflected as major evaluation item during
       competition with a 3rd party
      If there is no competition, maintain the level of recent similar projects       20
Overview of Negotiation

Major Contents of Negotiation (3)

 Government Supports
      Provision of construction subsidies
      Land acquisition
      Handling civil petitions
      Whether VFM is secured

 Provisions of Agreement
      Designation of concessionaire and approval of the implementation plan
      Change of total project cost and handling method
      Matters related with Construction and operation
      Change of equity investor, and investment stakes
      Matters related with the support of competent authorities
      Sharing of refinancing gain
Overview of Negotiation

Post Negotiation

 When both negotiation parties agree on the provisions of the
  agreement reflecting major negotiation items, the head of the
  government’s negotiation team and the head of the potential
  concessionaire’s negotiation team shall sign the agreement
  (draft) to end the negotiation

 The agency for negotiation shall send an official letter to the
  competent authorities notifying the end of negotiation by
  attaching the concession agreement (draft)

 Preparation of Negotiation Result Report

Part-02   Major Issues in BTO Negotiations

Major Issues of BTO
Major Issues of BTO Negotiation         Negotiation

Demand forecasting

 Basic element of the negotiation linked with rate of return and
  construction subsidy

 Check coherence with previous research and evaluation results
       Value for money test(VFM test), evaluation report, etc.
       Change in demand in each results

 Check whether any large scale development plans which have not
  been approved are reflected

 Discuss how to reflect the demand impact of competitive facility

 In BTO project Concessionaire entirely shoulders the demand risk
  due to the abolition of minimum operating revenue guarantee
Major Issues of BTO
Major Issues of BTO Negotiation          Negotiation

Total Project Cost (1)

 Considerations for Total Project Cost and Operating Cost
       For expenses items same as those in government projects, negotiate
        on the level of government projects
       For additional items, maintain the level of expenses in the existing
        agreement considering the characteristics of the PPP project

 Survey Cost: Survey, Soil Quality, Cultural Assets Survey
       For soil survey cost, calculating the actual survey area is important
        since it is difficult to change the confirmation items unlike government
       Take cautions in setting the scope of cultural assets survey

 Design Cost
       Check whether the project reflects basic design cost
       Calculated based on the agreed construction fee and standard
        engineering fee
Major Issues of BTO
Major Issues of BTO Negotiation          Negotiation

Total Project Cost (2)
 Construction Cost
       Apply design VE or the Public Procurement Service price review result
 Land Acquisition Cost
       The land acquisition is generally consigned by concessionaires to
        competent authorities and the cost is also shouldered by the competent
       If the concessionaire is shouldering the cost in whole or in part,
        measures for increase and decrease (Consider ways to reflect the
        increase or the decrease in cost if the concessionaire agreed to bear all
        or part of the land acquisition cost)

 Ancillary Costs: Design VE, Supervision Cost, Impact Assessment
 Cost, Construction Insurance, Ancillary Financial Costs
       Apply the average level of the similar project
       Calculate ancillary financial costs by applying the rates applied to
        similar projects
       Apply standard fees for engineering
       However, settle construction supervision cost later.                        26
Major Issues of BTO
Major Issues of BTO Negotiation         Negotiation

Total Project Cost (3)
 Operating Facility Cost
       Review the appropriateness of the number of stations and lanes
        (including TCS/ETCS)
       Since the manufacturers are rare and the price fluctuates within a short
        period of time, use Public Corporation’s purchase price

 Taxes and Charges: Damage levy for development restricted area,
  Acquisition and Registration Taxes, etc.
       Expenses and taxes as compensation are excluded from negotiation
        and are calculated in the future

 SPC Operating Cost: Business Opening Cost
       Include stock issue expense and operating expense of SPC
       Calculate appropriate number of people considering the size of the
        project and construction period
       Expenses including welfare expense shall be determined at around
        00% of the total labor cost                                                27
 Major Issues of BTO Negotiation

Operating Cost (1)

 Labor Cost
      Organize teams during the operation period, and estimate the number of
       workers and the rank of each worker
      Ex) Calculation of the number of toll collectors: Consider the number of
       TCS lanes × 3 shifts × late night, peak time

 Overall Expenses
      More or less 00% of total labor cost
      Consider the average value of existing projects

 Maintenance and Repair Expenses
      Comprised of inspection cost, regular repair cost, and major repair cost,
      Need long term repair plan to calculate repair cost
      For road projects, determine by considering engineering, bridge, and
       tunnel ratio and the level of other projects
 Major Issues of BTO Negotiation

Operating Cost (2)

 Operating Insurance
      Completed contractors risk insurance, business interruption insurance,
       commercial general liability, employer's liability insurance, etc.
      Check how much covered by insurance policy
      Apply the average of similar projects for the insurance coverage and rates
       during the operation period Power Charge
      Calculate facility power volume based on the design and technical items
       and then calculate power charges based on the unit rate

 Facility Replacement Cost
      Discuss appropriate durable years
      Discuss appropriate replacement rate based on the initial cost agreed for
       the project cost such as facility operation cost

  Major Issues of BTO Negotiation

Project IRR(Internal Rate of Return)

 Rate of return is determined based on the following
      Level of average loan interest rate of domestic and foreign financial
       institutions for SOC
      Risk premium considering the risk of the corresponding project (project
       type, size, stability of operating revenue, the risk allocation of government,
      Level of the rate of return of similar domestic and foreign PPP projects

 Calculated as pre-tax, post-tax, actual, and nominal rate of return

 The level of rate of return can be suggested differently depending on
  whether there was competition during the evaluation  negotiate in
  the direction of the average of similar projects

 Rate of return determined through concession agreement cannot be
  adjusted in principle
Major Issues of BTO Negotiation

        n                           N                                  N
               CCi                       ORi - OCi                              ANRi
       ∑                   =       ∑                         +         ∑
       i=0    (1+r)i             i=n+1       (1+r) i                 i=n+1      (1+r) i
      • n/N: Completion of facilities / the period set for management and operation right
      • CCi: Total project cost put in each year for the completion of facilities (However, excluding
              government subsidies)
      • ORi: Operating revenue of each year
      • OCi: Operating cost of each year
      • ANRi : Pre-tax net revenue in each year due to ancillary project
      • r: Pre-tax internal rate of return of the project (IRR)

   Pre-tax real rate of return
   Determine fee based on constant cash flow criteria

 Major Issues of BTO Negotiation

User Fee & Construction Subsidy

 User fee
      Determine by total project cost, appropriate rate of return, free usage
       period or ownership and profit-making period
      Compare with the level of user fees of similar projects
      Compare with the level of user fees of government projects
         If the toll changes of transport facility, determine whether the demand shall be
          re-estimated considering price elasticity

 Construction Subsidy
      Check whether the level of construction subsidy in the proposal is within
       the range in RFP
      Compare that of initial proposal
      Decide by the level of similar projects and the budget conditions

 Major Issues of BTO Negotiation

Corporate Tax

 Indication of both pre-tax rate of return and post-tax rate of return
      For post-tax rate of return in the past
         Decrease of interest rate ⇒ decrease of financial expenses ⇒ increase of corporate
          tax ⇒ increase of post-tax rate of return

      Introduced pre-tax rate of return in order to prevent the fluctuation of the rate
       of return due to the fluctuation of corporate tax (fluctuation of corporate tax
       rate, introduction of subordinated debt, etc.) while the corporate tax is
       included in the operating expenses
      Post-tax rate of return must also be indicated in order to measure corporate
       tax reducing effect of the change of corporate tax rate in the future
      Corporate tax rate reflects recent changes in the law in the financial model

  Major Issues of BTO Negotiation

Financial Model
    Basic          Construction Period         Operation Period
Assumption and                                                              Real Cash Flow
                                                                          Total private investment
                      Total project cost                                            cost
                                              Operating Income             Operating Income and

                    Government Subsidy
                                               Operating Cost             Financial Statements

                   Total private investment                                IS(Income Statement
                              cost                                              and Details)
 Price Index and                                         Nominal
      Index                                                                        BS
                                 Private Financing                         (Balance Sheet and

                      Equity & Loan           Loan Repayment               (Retained Earnings

                                                                          CF (Cash Flow Table)
          Major Issues in BTO
          Concession Agreement
           -Focused on road project -

 BTO Concession Agreement

Period for Submission of Loan Agreement

 Standard Concession Agreement
      The concessionaire should convert letter of intent of financial institution
       or letter of confirmation to lend (condition) into the loan agreement and
       submit it to competent authorities by the time of application for the
       approval of the implementation plan for a project

 Concessionaire’s assertion (Points to Consider)
      Conventionally, the financial institution approves the loan only when the
       implementation plan is approved
      It is necessary to extend the submission of loan agreements up to the
       approval of the implementation plan
      If avoidable, there may be a grace period

BTO Concession Agreement

Change of Total Project Cost (1)

 Standard Concession Agreement
      The total project cost determined in this agreement can be adjusted only
       if the followings happen and the total project cost can be adjusted
       through the mutual consultation of both parties.

       ① Construction cost is noticeably higher or lower than consumer price
         fluctuations during the construction period
       ② Total project cost is increased or decreased due to the fault of the competent
         authorities or forces majeure
       ③ Total project cost is increased or decreased due to the establishment and
         revision of the laws that directly influence the construction cost
       ④ Total project cost is increased or decreased upon the request of the competent

BTO Concession Agreement

Change of Total Project Cost (2)

 Concessionaire’s assertion (Points to Consider)
      Paragraph 4 in the Standard Concession Agreement must be specified
       considering the characteristics of the project
        4. In the following cases the total project cost increases or decreases
           A. Competent authorities requests for the change of contents of this project
              due to unavoidable reasons
           B. Construction related specifications and design standards, regulations, and
              guidelines of the government are changed
           C. The supervision cost increases or decreases due to the change of bid
              and construction cost for construction supervision contract
           D. The damage levy for development restricted area and ecosystem conservation
              fund increases or decreases, or cultural assets excavation cost is added
           E. According to traffic impact assessment and environmental impact
              assessment and the requests of related organizations approved by the
              competent authorities

      Case: Road Project                                                                  38
BTO Concession Agreement

Support of Competent Authorities

 New Construction of Competitive Road
      Concessionaire requests for the compensation for loss when the toll
       revenue decreases due to the new construction of competitive roads
          The government does not primarily consult with the concessionaire each time
           the road around PPP road project is renovated or newly constructed

 Timely Completion of Access Roads and Development
      The request for the compensation for loss is made when there was loss in
       toll revenue due to the incompletion of the access road and the
       development projects which could impact on demand of PPP project
          In this case, choose the possible completion date and reflect it in the demand
          If this completion date changes after the agreement is signed, change the
           financial model of the agreement immediately before operation begins
BTO Concession Agreement

Increase and Decrease of Corporate Tax
 Background of Dispute
      The corporate tax rate is decreasing rather than increasing, so the
       business revenue tends to increase
      The measures for the increase and decrease of corporate tax were not
       included in the concession agreement of PPP projects executed shortly
       after the Act on Public-Private Partnerships was established

 Government’s assertion
      Additional profit created through the change of tax laws instead of the
       creativity and efficiency of the private sector shall be returned to the
       In the opposite case, it shall be supplemented by the government

 Concessionaire’s assertion (Points to Consider)
      Concessionaires refuse the reflection of the effect of decreased corporate
       tax rate in the reduction of the fee
      They insist that it is unfair to reflect the revised tax rate in the financial
       model by reason of absence of regulations on the reduction of corporate          40
       tax rate in the concession agreement

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