The plan to raise funds for Taiwan High Speed Rail Corp (THSRC) through the sale of preferred stocks has stirred up two big questions in the Legislative Yuan. First,"how much in government-owned preferred stocks should be issued?" Second, "how do we regulate the five largest THSRC shareholders' affiliated companies and their bidding for its construction projects?"
The crux of the problem is THSRC's difficulty of raising funds for the high-speed rail project, as well as the need to improve the transparency of related-party transactions.
The first cause of dispute is the amount of THSRC's preferred stocks owned by financial institutions and government-controlled banks. Financial institutions owned primarily by the government, including the Central Trust of China, have invested NT$6.5 billion in THSRC's preferred stocks. Banks with a majority of government representativeson their board of directors have invested NT$9.5 billion. Given the NT$8 billion from Executive Yuan's development funds and Taisugar's original capital, the total amount of government-owned preferred stocks is NT$24 billion, which takes up 31.2 percent of THSRC's capitalization of NT$76.9 billion.
This percentage figure goes against the regulation that stipulate funds from state-owned enterprises and non-business funds investing in BOT (build, operate, transfer) projects should not exceed 20 percent. However, if we exclude the NT$9.5 billion from banks with a majority of government representatives on their board of directors, the percentage of government shares is only 18.9 percent.
THSRC's financing entanglement is quite unique. Its special way of raising capital is based on "project financing." In the case of THSRC, project financing is based on the projected revenues from future operations, not collateral and past credit history, to raise capital from financial institutions and institutional investors.
If THSRC goes for a traditional loan agreement (in which interest and principal cannot grow with future revenues and lenders must absorb the default risk of borrowers), no financial institutions will be willing to provide debt service funds without government guarantee. This explains the failure of THSRC's plan to borrow more than NT$70 billion from foreign financial institutions.
A giant syndicated loan application of NT$308.3 billion, for example, would not have been possible in 1998 if there was no government guarantee to promise "intervention via financing" and "mandatory purchase by relevant government institutions." This loan included the NT$210 billion of transferred deposits from the postal savings funds and NT$30 billion of transferred deposits from the civil-service pension and labor-related funds.
After suffering repeated setbacks in raising capital, THSRC finally resorted to project financing. At present the investors are guaranteed a 5-percent dividend annually. After three years, these investors have the right to change their preferred stocks to common stocks. The Department of Taxation also agrees to apply preferential tax rates to 20 percent of their share value after two years.
When THSRC becomes successful in the future, the investors can convert their preferred stocks into common stocks and share THSRC's profits.
In these times of low interest rates, profitable commodities such as these preferred stocks are naturally attractive for financial institutions to invest.
Should the preferred stocks purchased by financial institutions with a majority of government representatives on their board of directors (but with less than 50 percent of government shares) be listed as government investment? THSRC excluded the NT$9.5 billion by referring to Article 47 of the Audit Law (an enterprise is considered state-owned if government owns more than 50 percent of shares).
In the Legislative Yuan, however, the opposition parties believe the decisions made by this type of financial institutions are subject to the influence of government and therefore their preferred stocks should be listed as government investment.
In light of the attractiveness of the convertible preferred stocks with stable return guarantees and tax deductibility, it would be inappropriate to conclude that these financial institutions with a majority of government shares or government representatives on their board of directors expropriate funds from the government to THSRC.
Some government departments -- Department of Taxation, Bureau of Monetary Affairs, and Department of Insurance -- have already eased restrictions, agreed to preferential taxes and allowed banks and insurance companies to invest in preferred stocks. These actions are powerful aids to helping THSRC raise capital.
The second cause of the dispute is the accusation of opposition parties that the affiliated companies of THSRC's five largest shareholders have become the main beneficiaries of the project by contracting construction work.
The opposition parties accused two of Evergreen Group's affiliates companies, Evergreen Development and Evergreen Construction, for contracting almost NT$50 billion worth of construction work and Continental Engineering for contracting approximately NT$44.9 billion worth of rail construction work. Such contracting is called related-party transactions.
Although THSRC is not a listed company, I suggest that THSRC, due to the fact that government provides guarantees and funds, follow related-party transaction regulations like a listed company. THSRC should also provide the Legislative Yuan with construction details contracted by the affiliated companies, account information and relevant documents.
In recent years, THSRC has become the opposition parties' target of criticism whenever legislature reviews government budgets. To avoid contention, THSRC should try to make information as open as possible and prevent the suspicion that some privileged parties are getting involved in government's relations with business groups.
Recently, THSRC decided to introduce corporate governance, hiring two to four independent directors and one to two independent supervisors. To meet the standard in Asia, I suggest that THSRC, without increasing the number of directors and supervisors at present (13 directors and 3 supervisors), allow independent directors (and independent supervisors) take up more than one third of the seats on the board.
The independent and original directors may together form a financial committee to assist the company in drafting financing strategies and managing financial risks. The independent directors may form an audit committee to assess the performance of accountants and internal auditors, improve the transparency of financial information and examine major transactions done by related parties for contracting construction work.
I believe that only open, sufficient information and fair, independent decisions can establish credibility just like the applause that THSRC received when it won its bid in 1997.
Otherwise, constant criticism about the manipulation of special privileges and profits can probably make a big BOT project such as this one fail in the face of continuous scandals.
Yeh Yin-hua is a professor of international trade and finance at Fu Jen Catholic University.
Translated by Grace ShaW
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