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International Journal of Engineering & Technology, 7 (4.3) (2018) 573-577
International Journal of Engineering & Technology
Website: www.sciencepubco.com/index.php/IJET
Research paper
Infrastructure Bonds as a Funding Tool for Attracting Financial
Resources for Financing Railway Modernization Projects within
the Framework of PPP in Ukraine
O.A. Yermolenko1*, О.О. Kokovikhina1, D.І Boiko1, N.M. Lysonkova1
1 Ukrainian State University of Railway Transport, Kharkiv, Ukraine
*Corresponding author E-mail: yermolenko@kart.edu.ua
Abstract
The article concerns the analysis of the funding sources for modernization projects at OJSC Ukrzaliznytsia (UZ). Moreover, it has been
proved that the self-financing enterprises of UZ in the process of expanded creation are inefficient. It is noted that infrastructure bonds
within the framework of public-private partnership (PPP) may become a new promising form of financing infrastructure projects in
Ukraine. The analysis of the international practice made it possible to identify some of the features functioning infrastructure bonds and
its specifics for the railway industry. It has been established that advantages of this type of securities cause increased interest to them
from the stock market participants, both nonprofessional and portfolio investors, which include insurance companies, investment funds
and pension funds. It is proposed to the issuance of infrastructure bonds with the rate of return "average deposits rate of Ukrainian banks
plus 3%". Such a rate of return in the conditions of existence of state guarantees would interest to potential investors. The purpose of the
article is to reveal the content and features of the use of infrastructure bonds in financing public-private partnership projects in the
railway industry and to substantiate the practical recommendations for their application.
Keywords: institutional investor; infrastructure bonds; project funding; Public-Private Partnership (PPP); railway.
.
1. Introduction
European integration remains one of the main priorities of the
state policy of the Ukrainian government. However, the national
transport network, including railway industry, still fails to meet
the standards, norms and requirements of the European Union
and Council of Europe. There is a significant delay in the
legislative, regulatory and technical basis, infrastructure and
quality of the traction rolling stock. The property, plant and
equipment of the railways are in critical condition, and the ways
and methods used by the railways to stop their critical wear and
tear are ineffective. The main reasons for the ineffectiveness of
self-financing include high level of physical or other
depreciation and expiring depreciation period the consequence
of which is the railway transport requiring considerable
borrowed funds. [1]. With regard to the railway infrastructure,
trunk network with overdue capital repairs make up 27% of the
total length, travel equipment with the lifetime above the rated
one is 78% of the total, the wear of traction substations is 67%
and the wear of contact network is 55%.
2. The Sources of Financing of the
Modernization Projects of UZ
The analysis shows that UZ most often uses its own funds and
bank loans for modernization projects (Fig. 1).
However, using predominantly foreign bank loans for railway
projects creates a risk of losing financial independence of UZ
and its bankruptcy [2].
Among other sources, leasing may be used for modernization of
fixed assets of UZ. UZ concluded a framework agreement with
the GE Transportation for a partnership in upgrading the rolling
stock traction in terms of 15 years and worth about $ 1 billion.
The first stage of the modernization project is the delivery of 30
diesel locomotives GE Te33a late in 2018 and in the first quarter
of 2019 with a localization level of 10%. GE and Ukreximbank
signed an agreement worth $ 140 million on the sale of traction
rolling stock. The State Bank will further transfer the
locomotive to the financial lease of UZ
For this purpose, in 2018 UZ predicted attracting investment of
UAH 18.7 billion, including through issuing domestic bonds for
UAH 2 billion. [3].
On October 30, 2010, the Law of Public-Private Partnership
came into effect, which defined the organizational and legal
framework for an interaction of state and private partners and
defined basic principles of public-private partnership. This law
has defined new approaches of the partnership between the state,
local self-government and private business in the
implementation of infrastructure projects that are important for
the development of the economy, ensuring the proper level of
social life, improving the quality of people’s life [4].
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International Journal of Engineering & Technology
66 33 1
010 20 30 40 50 60 70 80 90 100
%
own funds loan investment
43 36 8 5 4 4
010 20 30 40 50 60 70 80 90 100
%
Eurobonds (USD) Ukrainian banks (USD)
Export-Import Bank of Korea (USD) Ukrainian banks and others (UAH)
Fig. 1: The sources of financing of the modernization projects of UZ
3. Infrastructure Bonds within the Framework
of PPP in Ukraine
Infrastructure bonds might become a new promising form of
financing infrastructure projects in Ukraine. On October 10, 2013,
the Verkhovna Rada adopted changes in some laws regarding the
issuance of securities, which regulate the issue of infrastructure
bonds for financing of infrastructure modernization within the
framework of public-private partnership [5].
The development challenges of public-private partnership are
discussed in the works by V. Bazylevych, E. Bondarenko, V.
Varnavsky, S. Gatti, V. Grimsey, D. Delmon, M. Deryabin, T.
Efimenko, I. Zapatrina, M. Lewis, Yu. Petlenko, A. Piltya, V.
Rebok, Yu Sizov, Y. Tkachenko, N. Khangzhenkova, E.
Cherevikova, P. Shilepnitsky and others.
3.1 Public-Private Partnership in World Practice
The practice of economically developed countries shows that
ensuring high and sustainable rates of the country's development is
impossible without the effective partnership of state authorities
and private business. In foreign literature, this term is used in all
forms of partnership between private business and the state. The
historical origins of such partnership date back to Medieval
France, where the agreement of this type was first introduced,
such as concession agreement [6].In the world practice, public-
private partnership is interpreted in such aspects as:
system of relations between the state and business, which
is widely used as an instrument of economic and social
development at the international, national, regional, local
levels;
specific projects implemented jointly by state authorities
and private companies on the basis of objects of state and
municipal property [7, p. 12].
The public-private partnership is a universal system for achieving
a number of long-term targets. The purpose of the partnership is
total benefit from pooling the public and private sectors. The
participation of the private business in the implementation of
socially significant innovation and investment projects will
become active and effective only if the state provides a balance of
risks and benefits.
On August 1, 2012, the National Commission on Securities and
Stock Market of Ukraine published a draft law "On Amendments
to the Law of Ukraine" On Securities and the Stock Market
"regarding the development of the bond market." This document
introduces the concept of "corporate bonds" and their types:
infrastructure, stock exchange, concession. On November 10,
2013, this draft was adopted by the Verkhovna Rada of Ukraine in
the first reading as the basis of the law "On Amending Certain
Legislative Acts of Ukraine regarding Issuance of Securities" [8].
Under this law, infrastructure bonds are corporate bonds placed by
the enterprise with the purpose of attracting funds intended to
finance the creation and/or restoration (reconstruction,
modernization) of infrastructure carried out in accordance with an
agreement included into the framework of the public-private
partnership.
Infrastructures bonds are bonds issued for attracting financing of
infrastructure objects. Typically, infrastructures bonds have a
maturity of at least 5 years with turnover times near 15-20 years,
i.e. their terms are comparable with terms of retirement
obligations.
The attractiveness of infrastructures bonds in comparison with
other instruments is caused by tax privileges and state guarantees
provided both on the principal amount of the debt on bonds and in
relation to the corresponding income received by investors for the
provision of funds for the implementation of the project. The
experience of other countries proves that the advantages of such
documents attract increased interest on the side of stock market
participants.
Infrastructure bonds are widely used in many countries, such as
the USA, Australia, Chile, India, etc. [9].
Issuing infrastructure bonds meets the demand in investment
resources for the state and private business, as well as offers new
kind of long-term, guaranteed paper for a market.
3.2 Features of the Use of Infrastructure Bonds in
Financing Public-Private Partnership Projects in the
Railway Industry
The analysis of the international practice of using infrastructure
bonds functioning within the framework of PPP and the specifics
of the railways allows us to identify the features inherent to
infrastructure bonds. [9-13].
1 The issuance of infrastructure bonds is carried out with the
support of the state. The state is interested in projects that have a
social orientation or will contribute to European integration. For
infrastructure bonds, state support may take the form of direct or
indirect guarantees. Foreign countries take all possible measures
to encourage the development of bond financing and take all
possible measures, including:
granting tax privileges for bondholders in the form of
privileges for the corporate income tax and profit tax of
individuals;
International Journal of Engineering & Technology
575
granting tax concessions to the concessionaire's, such as
land tax benefits, etc.;
granting state guarantees for the concessionaire's monetary
obligations to the infrastructure bondholders;
bonds bail as a loan collateral provided by a state bank in
order to attract credit institutions as investors.
Legislation of foreign states is also known for the support of
infrastructure bonds by local authorities. This may be in the
provision of municipal guarantees or additional tax privileges,
taking into account the territory of the implementation of the
infrastructure project [9].
2. The issuer of infrastructure bonds, in this case, maybe a joint
venture, specially created for the implementation of a specific
investment project.
3. The earmarked issuance of infrastructure bonds.
In this way, with the help of such bonds, was completed the
construction of the pipeline in Qatar ($800 million for a term of 18
years) and the construction of the railway in Hong Kong ($1000
million for a term of 10 years) [10].
One of the newly launched investment projects, where issue of
project bonds is planned, is the construction of solar power plants
in California, the USA. In December 2010, SunPower Corporation
has issued project bonds worth 195.2 million euros. This issue
consists of project bonds of two series: A1 with interest rate
5.715% per annum and A2 with interest rate 4.839 per annum. The
repayment is scheduled to 2028 [14].
4. Infrastructure bonds are less risky in comparison with ordinary
bonds. For any emitter issuing infrastructure bonds will able to
pay profit by bonds only in a situation when the project will be
profitable, and how much real cash flows will match with planned
cash flows. Obviously, the main purpose of investment activity of
any enterprise is to increase the profit from investment activities
with a minimum level of risk investment. Investment risk is the
likelihood of a loss in the form of a reduction of capital or loss of
profit due to the uncertainty of the terms of investment activity. In
practice two main types of risks are singled out: general
(systematic) risks - the same for all participants in investment
activity and which are determined by factors that the investor
cannot influence; specific risks - risks that depend on the ability of
the investor to choose the objects of investment with acceptable
risk and risk management. The main types of general risks are:
socio-political risks,
environmental risks,
risks associated with measures of state regulation,
market risks,
inflationary risks,
the risks poor environment for these areas of activity,
other risks.
5. From the experience of other countries, the presence of these
advantages in this type of securities causes increased interest to
them from stock market participants, both nonprofessional and
portfolio investors, which include insurance companies,
investment funds and pension funds.
Nowadays, pension funds have four options for financing
infrastructure: the purchase of shares of specialized companies,
investing in infrastructure funds, direct investment, and the
purchase of debt obligations. Such investments are related with
standard market risks financial capacity of issuers, negative
changes in market conditions, liquidity and dynamics of securities
value. States that are interested in encouraging investment in
institutional infrastructure invest in special funding provisions that
reduce the listed risks and/or increase the return on investment. In
the majority, they relate to the placement of debt securities -
concessional bonds or infrastructure bonds [9].
A phased scheme for the implementation loan of infrastructure
bonds, respectively, may be presented as follows (fig. 2).
Identification of potential private partners who can implement an infrastructure project under the PPP and hold a project competition
Concluding of the treaty on a partnership between public and private partners and concluding concession agreements
Preparations all documents and transfer it to National Securities and Stock Market Commission for the registration of infrastructure bonds
Presentation of information on the bond issuance to potential investors
Issuance of infrastructure bonds in accordance with the legislation of Ukraine [13] and placement for a period of time equal to construction
time and project's payback period
Direction of funding received from the placement of infrastructure bonds for the construction and reconstruction of an infrastructure
facility
Public acceptance of an infrastructure projects
Collection of payments from users of the facilities (completed or reconstructed construction objects) and funding pay to the bondholders
for the redemption of par value and accumulated coupon profit of bonds
8
7
6
5
4
3
2
1
Fig. 2: A phased scheme for the implementation loan of infrastructure bonds within the framework of PPP
Fig. 3 shows the proposed mechanism for attracting financial
resources through the issue of infrastructure bonds within the
framework of PPP. The process of implementation of
infrastructure projects under the terms of a concession starts with
the creation of a special legal entity, concessions award and
determination of the winner. After that, the concession agreement
is concluded and issuance and placement of infrastructure bonds
are carried out. Purchase of infrastructure bonds is carried out by
investors such as insurance companies and pension funds. After
that, the attracted funds are directed to the implementation of the
infrastructure project.
3.3 The Mechanism for Attracting Financial Resources
through the Issuance of Infrastructure Bonds within the
Framework of PPP
The public partner plays a leading role in promoting the use of
infrastructure bonds for financing railways projects within the
framework of PPP. The mechanism of attracting financial
resources issuance of such bonds is based on the method of project
financing (Fig. 3).
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International Journal of Engineering & Technology
PPP
Stock market
Concedent
(State Property Fund of
Ukraine) Infrastructure facility
Concessionaire
Ministry of Infrastructure
of Ukraine
Private partner
investors
Right to construct
Transfer of
the facility
ownership
construction
safeguards
risks
financial resources
infrastructure
bonds
Fig. 3: The mechanism for attracting financial resources through the issuance of infrastructure bonds within the framework of PPP
The Infrastructure bond is debt securities issued by the
concessionaire exclusively for the financing of the
construction, acquisition or reconstruction of an infrastructure
object. They oblige the investor to pay the issuer the amount
owed within a specified period, taking into account a certain
percentage (for coupon bonds), or to make repayment bonds at
nominal value (for discount bonds). To determine the
profitability of infrastructure bonds is one of the important key
issues in this issue. The profitability of infrastructure bonds
should be comfortable for issuers and intended to provide the
investment attractiveness of this means for potential investors.
Lashevsky P. O. offers to consider the rate of return of
infrastructure bonds as a superposition of two values. The
indicator, on the basis of which one can calculate the upper
limit of the profit of infrastructure bonds, is tied to the internal
rate of return of the infrastructure project. As a lower profit
limit, it is expedient to use the indicator "the inflation plus 1%"
[16].
The use of this method in Ukraine is impossible due to the high
real inflation rate. Therefore, it is expedient to base the
calculation of the rate of return of infrastructure bonds by the
average rates of deposits of Ukrainian banks for the corporate
sector (figure.4).
Fig. 4: Dynamic of the interest rate on Corporate Deposits and the consumer price index
In our opinion, taking into account the character of the financial
market and the level of inflation in Ukraine, it is expedient to the
issuance of infrastructure bonds with the rate of return "average
deposits rate for the corporate sector plus 3%". Such a rate of
return in the conditions of existence of state guarantees would be
of particular interest to potential investors.
Copyright © 2018 Authors. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted
use, distribution, and reproduction in any medium, provided the original work is properly cited.
4. Conclusion
Railway transport in Ukraine urgently needs the renovation of the
old and the creation of new infrastructures objects. Infrastructure
bonds that are successfully used by several states to attract capital
in the transport infrastructure may be an effective instrument for
solving the problem of attracting private capital to the railway
infrastructure. In this case, PPP has advantages such as expanding
the range of potential investors and reducing the burden on the
State budget through the use of bonds.
For more efficient use of infrastructure bonds to finance PPP
projects and to ensure equal opportunities for the state and
business within the framework of innovation and investment
projects in railway transport, the following priority measures are
required:
improving the concession legislation and regulating the
mechanism of project implementation on the basis of PPP;
Government support at all the levels of the private sector in
the implementation of PPP projects;
improvement of the legal, organizational and institutional
environment for the provision of activities of participants in
PPP projects based on foreign experience;
clearly defining the procedure of interaction of participants
in the issuance, placement and repayment of infrastructure
bonds.
the increase of protection guarantees of private partners’
interests of PPP in the process of development, approval and
implementation of projects.
The implementation of these measures will help to improve the
mechanism of funding infrastructure projects of the railway
transport and the appearance of new reliable instruments in the
stock market to meet the needs of non-professional and portfolio
investors.
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