RMC DISCUSSION PAPER SERIES 117

Private Financing of Toll Roads

Gregory Fisher

Suman Babbar

AuthorsGregory Fishbein, Mercer Management Consulting, Inc.Suman Babbar, World Bank, Project Finance and Guarantees Group

Advisory Committee, World Bank GroupRam Chopra (Chair)Cofinancing and Project Finance Department

Gregor DolencAsia Technical Department

Thomas DuvallLegal Department

Michael KleinPrivate Sector Development Department

Amnon MatesInternational Finance Corporation

Hans PetersTransport, Water, and Urban Development Department

Graham SmithEurope and Central Asia–Middle East and North Africa Technical Department

Lou ThompsonTransport, Water, and Urban Development Department

Private Financing of Toll Roads

Acknowledgments v

Foreword vii

Abstract ix

Why Private Financing? 1

Project Economics 3

Country and Concession Environment 6

Public-Private Risk Sharing 10

Financing Structures and Sources 14

Policy Issues 20

Future Developments 29

Notes 31

Annex 1 Summary of Debt and Equity Terms 32

Annex 2 Critical Terms and Conditions of a Concession Agreement 34

References 37

FiguresFigure 1 Private infrastructure projects, by sector 1Figure 2 Project economics of the eight projects 6Figure 3 Project development timetable 15Figure 4 Government risk assumption and financial support 17Figure 5 Concession program structure 21Figure 6 Concessioning decision process 22Figure 7 Alternative concession approaches 25Figure 8 Examples of public-private revenue sharing 27Figure 9 Range of options for government support 28

TablesTable 1 Characteristics and costs of the eight projects 4Table 2 Market demand characteristics of the eight projects 5Table 3 Concession policy and process environment of the eight projects 8

Contents

Table 4 Economic and political context in year of financial close 9Table 5 Local capital markets 10Table 6 Overall ratings for country and concession environment 11Table 7 Public and private risk sharing 12Table 8 Financing arrangements 16

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v

Acknowledgments

This study, sponsored by the World Bank’s Project Finance and Guarantees Group and produced in collaborationwith Mercer Management Consulting, Inc., was guided by an Advisory Committee that was formed in December1995 and chaired by Ram Chopra, Director of the Bank’s Cofinancing and Project Finance Department. The

Advisory Committee included representatives from the Bank’s Transportation, Water, and Urban Development Department,the Latin America and the Caribbean, South Asia, Europe and Central Asia, and Middle East and North Africa Regions,the Legal and Private Sector Development Departments, and the International Finance Corporation.

The principal authors of the report are Gregory Fishbein of Mercer Management Consulting, Inc. and Suman Babbarof the Bank’s Project Finance and Guarantees Group. Other important contributors to the report include Alan Kaulbach,Tom Morsch, and Shelby Sax of Mercer Management Consulting, Inc. and David Baughman of the Project Finance andGuarantees Group. The report benefited from the comments of several Bank staff, including Gregor Dolenc, TomDuvall, Tomoko Matsukawa, Nicola Shaw, and Graham Smith. Alex Mirkow, of the Bank, facilitated document process-ing and production and Nancy Mensah, also with the Bank, assisted with word processing. The text was edited by PaulHoltz and laid out by Glenn McGrath, both with American Writing Corporation.

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Foreword

The trend toward greater private participation in infrastructure development is firmly established in many devel-oping countries, and the benefits of the initial wave of privatizations and new investment are becoming appar-ent. The move to private infrastructure, launched in the mid-1980s, began primarily in the power sector, especially

power generation facilities undertaken as build-own-operate (BOO) or build-operate-transfer (BOT) projects. Morerecently, investors have become active in other types of infrastructure as governments promote private involvement inwater, transport, and other sectors.

Although much has been written about the evolution of private involvement in the generation, transmission, and dis-tribution of electric power in developing countries, much less has been written about how other private infrastructureprojects are financed and about the risk-sharing issues that are critical for these investments. Indeed, for private toll roadsthe universe of successfully financed projects has until recently been somewhat limited, making this study timely in itsreview.

This study examines the global experience with private toll roads and reviews eight projects, six in developing coun-tries and two in industrial countries. Like most private infrastructure projects, toll roads require a partnership betweenthe public and private sectors, making the allocation of responsibilities critical for the success of the project. The studyexamines common elements in toll road financings and highlights key public-private risk-sharing issues relating to thelarge amounts of private financing required for these investments. These findings have implications for both policymak-ers considering private toll road programs and private investors seeking to finance a project.

Ram Chopra Nina ShapiroDirector ManagerCofinancing and Project Finance Department Project Finance and Guarantees Group

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Abstract

This study provides an overview of the issues and challenges related to private toll road development by consider-ing the experience of eight privately financed toll road projects. The projects selected represent a range of phys-ical and market characteristics, country and concession environments, public-private risk-sharing arrangements,

and financial structures.After reviewing the history of toll roads, the study examines the public policy and financing approaches used to

develop private toll road concessions and to mobilize capital for their construction and operation. It analyzes key aspectsof private toll road development for each of the eight projects selected, including project economics, country and con-cession environment, risk sharing between the public and private sectors, and financing structures and sources. The studyalso discusses the main public policy issues in toll road development and briefly assesses the future outlook for the pri-vate toll road industry.

The findings suggest that: • The economics of toll road projects vary widely depending on their function, physical characteristics, and traffic profile.• The public sector generally is responsible for right-of-way acquisition and political risk and in some cases shares

traffic and revenue risk, while the private sector generally bears primary responsibility for remaining project risks. • Project economics and the country and concession environment are key factors that influence the level of govern-

ment support required for a toll road to attract financing. • Funding for private toll roads is primarily in the form of commercial bank loans and sponsor equity—few facilities

have been able to access public capital markets. • Large toll road financings in countries with undeveloped capital markets have relied on foreign capital, while

smaller financings and financings in countries with highly developed capital markets generally use local capital. • Various mechanisms are available to governments to support toll road development, and the value of each mecha-

nism should be weighed against the exposure it creates before committing to a particular arrangement. • Designing the bidding process for a toll road concession involves tradeoffs between transparency and competitive-

ness versus flexibility and private sector innovation. The study concludes that while private toll road development is likely to experience modest growth in the near future,

public resistance to tolling, the time and cost of implementing concessions, and other factors will probably limit industryactivity.

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Expanding global demand for infrastructure is dri-ving an emerging industry for the private provisionof roads, power, water and sanitation, telecommu-

nications, and other services. Interest in private toll roadsis particularly strong because governments require alter-native methods of financing their extraordinary transportneeds. Tolling has also become an attractive option for man-aging traffic demand on increasingly congested highways.

Many of the challenges to developing and financing tollroads are similar to those faced by other infrastructure pro-jects, which are typically capital-intensive and share certainrisks, including construction risk, political risk, currency risk,and force majeure risk. But toll roads face greater risks in cer-tain important areas, including acquisition of long segmentsof right-of-way, unforeseen geological and weather condi-tions that may increase costs and cause delays, and, perhapsmost important, the unpredictability of future traffic and rev-enue levels. Power projects, for example, may face fewer risksthan toll roads because the physical plant is in one location(which facilitates land acquisition) and future revenues aregenerally secured by a long-term power purchase agreement.

Because of the unique challenges facing toll road pro-jects, the toll road industry is less developed than otherprivate infrastructure sectors, most notably the private powerindustry. The World Bank estimates that private toll roaddevelopment accounts for 8 percent of the $60 billion annualmarket for private infrastructure projects worldwide (fig-ure 1). If private toll road development is to expand andprovide a more significant portion of highway funding, theconsiderable challenges to toll road development must beunderstood and overcome. This study reviews eight pri-vately financed toll road projects, discusses public policyissues relating to toll road concessions, and assesses futuredevelopments in the private toll road industry.

The projects reviewed are Chile’s South Access toConcepción (Forestry Road), Colombia’s Buga-TuluáHighway, Mexico’s Mexico City-Toluca Toll Road, China’sGuangzhou-Shenzhen Superhighway, Malaysia’s North-South Expressway, Hungary’s M1/M15 Motorway, theUnited Kingdom’s Dartford Bridge, and the United States’SR-91. These projects are among a select group of road pro-jects that have been successful in attracting private financ-ing over the past decade. Collectively, they represent a broadrange of project types, including different physical and mar-ket characteristics, country and concession environments,public-private risk-sharing arrangements, and financialstructures.

Why Private Financing?

Governments are facing dramatic growth in highway needs,both for new facilities and for maintenance and rehabilita-tion of existing facilities. This demand is particularly strong

Private Financing of Toll Roads

Private infrastructure projects, by sectorFIGURE 1

Source: World Bank, Private Infrastructure Project Database.

Water and sanitation18%

Road transport8%

Power30%

Telecommunications28%

Rail transport2%

Water transport5%

Air transport3%

Gas6%

in congested urban areas and regions experiencing rapideconomic and population growth. Governments worldwidespend an average of 4 percent of GDP a year on trans-portation infrastructure (Klein and Roger 1994). In theUnited States alone an estimated $55 billion a year will berequired over the next twenty years simply to maintain high-ways and bridges in their current condition—considerablymore than the $34 billion that was spent on highway andbridge improvements in 1993 (USDOT 1995).

The highway needs of developing countries are evenmore acute. According to World Bank data, these coun-tries have about 1,000 kilometers of paved roads per mil-lion people (compared with more than 10,000 kilometersper million people in industrial countries), and many ofthese roads require substantial investment. For example,in Argentina, Chile, and Colombia less than half the pavedroads are in good condition. Indonesia needs to build 28,000kilometers of national and provincial roads by 2004 to relievetraffic congestion. And China’s most recent highway devel-opment plan targets 92,000 kilometers of new highway con-struction.

Highway infrastructure traditionally has been fundedthrough general government budgets and dedicated taxesand fees rather than tolls. In most industrial countries 90percent or more of highway kilometers are publicly funded;in developing countries governments often bear the entirecost. However, the limited resources available through tra-ditional government funding sources has led to increasinginterest in private toll roads as an alternative way of meet-ing highway needs.

Several additional factors have contributed to therenewed interest in private tolling, including a worldwidetrend toward commercialization and privatization of state-owned enterprises; the success of public toll roads in rais-ing capital; and advances in tolling technology, making tollingmore efficient and convenient.

Private toll roads have a long history in the United Statesand Europe. In the United States the concept of privatetoll roads is gaining renewed interest after decades of inac-tivity. In the first half of the nineteenth century private tollroads outnumbered public roads in the United States. Bythe mid-nineteenth century more than 10,000 miles of pri-vate toll roads were in operation (Meyer and Gomez-Ibañez1993). The public sector provided support through land

grants and subsidies, and public roads were built primarilyto support the network of private roads.

During the late nineteenth and early twentieth centuriesthe growth of rail transport and problems with toll evasioncaused a decline in private toll roads. In the 1930s, how-ever, some states began developing public toll road pro-grams in response to the growing needs of commerce, thedramatic growth in automobile ownership, and the absenceof a major federal highway program. Most of these roadswere on the East coast, where the concentration of urbanareas and high traffic densities made tolling more eco-nomically attractive.

Toll road development slowed after 1956, when theFederal Aid Highway Act established a federal gas tax tofund the interstate highway system and prohibited tollingon new, federally funded highways. But in the 1980s pub-lic funding constraints and increasing infrastructure needsled to a renewed interest in public and private toll roads.By 1993, 4,000 (7 percent) of the 55,000 public express-way miles in the United States were publicly tolled (Meyerand Gomez-Ibañez 1993). That same year, California’s SR-91 and Virginia’s Dulles Greenway became the first tollroads in modern U.S. history to be privately financed.

European countries have had more experience withprivate toll roads in recent years, but with mixed results.Toll financing developed in Europe after World War II, whenbudget constraints and rapid traffic growth made privatetoll financing attractive. In France public toll financingwas used in the late 1950s and early 1960s, and private tollfinancing was introduced in the late 1960s and early 1970s.Only one of four private French concessionaires has sur-vived, however. In Spain private toll financing was usedfor the intercity autopistas in the late 1960s and early 1970s.Nine of the twelve original concessions remain private andcontinue to have a major presence in the Spanish road sys-tem. In Italy more than 5,000 kilometers of toll roads havebeen constructed by more than twenty concessionaires,although the central and regional governments retain major-ity ownership. The largest of the Italian concessionaires,Autostrade, operates most of the highway network. Overall,private tolling appears to be gaining popularity in Europeonce again, with new projects being pursued in France,Germany, Hungary, the Netherlands, Poland, Portugal,Spain, and the United Kingdom.

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Developing countries became interested in toll financ-ing during the 1980s, when economic and population growthled to increasing demand for infrastructure. In MexicoPresident Salinas established a national highway buildingprogram that relied heavily on private toll financing. InIndonesia expected traffic growth and projections of highconstruction costs led the government to launch a joint ven-ture private toll financing program to fund and managetoll projects. Private tolling is now being pursued in a widevariety of countries, including Argentina, Chile, China,Colombia, Ecuador, Hong Kong, Hungary, India, Indonesia,Malaysia, Mexico, the Philippines, and Thailand.

Project Economics

Project economics refers to the cost of developing, con-structing, and operating a project relative to the revenue itgenerates. This is typically measured in terms of net pre-sent value or internal rate of return on investment. The pro-ject economics of a toll road are determined by a numberof factors, including the toll road’s function, physical char-acteristics, and market demand. The predictability of mar-ket demand is a particularly sensitive variable for toll roadeconomics because of the difficulty of forecasting trafficand revenues on previously untolled highways. There is nostandard project in the private toll road industry; rather, tollfacilities exhibit widely varying characteristics and projecteconomics.

Function

Toll roads can be classified as congestion relievers, inter-city arteries, development roads, or bridges and tunnels. Afacility’s function is a major determinant of its physical char-acteristics and cost, as well as its market demand and rev-enue potential.

Congestion relievers are relatively short roads that areconstructed to relieve heavy traffic congestion on existingurban routes. Examples include the Mexico City-Toluca TollRoad and the United States’s SR-91. The Toluca Toll Roadconnects the western suburbs of Mexico City with theprincipal east-west highway from Mexico City to Toluca,an industrial city of more than 500,000 people. SR-91 addstwo lanes in each direction in the median of an existing four-

lane highway in Orange County, California. Both roads com-pete with heavily congested public roads for traffic.Congestion relievers are generally inexpensive to build rel-ative to their revenue potential because they tend to beshort and to serve heavy traffic demand.

Intercity arteries are built to improve access betweenmajor metropolitan areas. Four of the projects studiedhere fall into this category: the Buga-Tuluá project, whichrehabilitates and expands a section of highway connectingColombia’s three largest cities; the Guangzhou-ShenzhenSuperhighway, which connects the Guangzhou ring roadto the city of Shenzhen in southern China; Malaysia’s North-South Expressway, which completes the link from the Thaiborder through Kuala Lumpur to Singapore; and Hungary’sM1/M15 Motorway, which connects Budapest with Viennaand Bratislava. Intercity arteries are generally expensive toconstruct because they are often long, high-capacity roads.However, they may benefit from heavy traffic in certaincorridors.

Development roads link relatively remote areas targetedfor economic development with urban centers or majortransportation routes. For example, Chile’s South Accessto Concepción project involves rehabilitating existing roadsections and constructing two urban bypasses to link aforestry region with metropolitan Concepción and the Pan-American Highway. This road will facilitate the movementof forestry products to the port at Concepción and thePan-American Highway. Development roads can providea significant economic stimulus to the regions they serve.However, they often require future economic developmentto generate sufficient traffic in order to be economicallyviable. Thus development roads are often speculative froman economic standpoint. The Chilean project is somewhatof an exception because it is primarily a rehabilitation ofan existing road, which substantially limits its constructioncost.

Finally, bridges and tunnels are considered in a sepa-rate category because of their unique characteristics. Theyare typically very short, very expensive to build per kilo-meter relative to roads, and serve high volumes of captivetraffic. Bridges and tunnels can be thought of as extremeexamples of congestion relievers, and like congestion reliev-ers they tend to have strong economics as a result of theheavy traffic volumes served. The Dartford Bridge, for

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example, was built to relieve congestion in the two tunnelscrossing the Thames river as part of the M25 ring roadaround London.

Physical characteristics and project costs

A project’s physical characteristics are the primary deter-minants of its cost. Important characteristics include whethera project is a new facility or an expansion of an existing facil-ity, as well as its length and capacity (that is, number oflanes), geography, and toll collection mechanism (table 1).

New facilities involve substantially higher costs per kilo-meter than do rehabilitations and expansions of existing facil-ities. Rehabilitations and expansions not only require lessconstruction work than new facilities, but projects involving

existing tolled facilities can use the toll revenues during con-struction to offset construction costs, thereby lowering financ-ing requirements. For example, the Buga-Tuluá project usedabout $16 million in toll revenues during construction to con-struct a highway costing $47 million, resulting in a financingrequirement of $31 million. The Dartford Bridge used about$32 million in toll revenues from the existing tunnels duringconstruction, although the project was also required to assume$76 million in debt from the tunnel facilities.

Capacity and geography are also important determinantsof cost per kilometer, since wide roads and roads constructedacross difficult terrain (such as mountains and swamps)are more expensive than narrow roads and roads built acrossflat, dry terrain. The toll collection mechanism has a muchsmaller effect on costs then these factors.

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TABLE 1

Characteristics and costs of the eight projectsTotal cost

Length, Toll Total cost per kilometerinitial collection (millions of (millions of

Country, project Project scope capacitya Geography mechanism U.S. dollars) U.S. dollars)

Chile, Rehabilitation of existing 112 km, Forest with moderate hills Manual, 27 0.2South Access roads and construction 2 lanes opento Concepción of two new urban bypasses

Colombia, Rehabilitation and expansion of 23 km, Flat Automatic and 47 2.0Buga-Tuluá existing two-lane road into a four- 4 lanes electronic, openHighway lane highway; revenue from existing

toll used to finance construction

Mexico, Securitization of 22 km, Traverses mountainous region Manual and 313b 14.2Mexico City-Toluca existing facility 6 lanes between Mexico City automatic, hybridToll Road and the plain to the west

China, New facility 123 km, Runs parallel to Automatic and 1,922 15.7Guangzhou-Shenzhen 6 lanes Pearl river delta; electronic, closedSuperhighway experiences frequent

rains and flooding

Malaysia, Construction of 500 km of new 870 km, Difficult terrain: rugged Manual and 3,192 3.7North-South road and rehabilitation of 370 km 4–6 lanes mountains, swampy areas, electronic, hybrid Expressway of existing facilities and soft soil

Hungary, 42 km extension of M1 highway 59 km, Flat farmland and Manual, 440 7.5M1/M15 to the Austrian border (M1); 4 lanes small forests closedMotorway construction of 15 km branch from

M1 to the Slovak border (M15)

United Kingdom, New facility; revenue 2.8 km, Crosses Thames river Manual, automatic, 247 88.2Dartford Bridge from existing tunnels 4 lanes and electronic;

used to finance construction closed

United States, New lanes in the 16 km, Mountainous area Electronic, 126 7.9SR-91 median of an existing facility 4 lanes closed

a. Total number of lanes in both directions.b. Amount of bond issue, not original project cost.

The range of outcomes that can result from differentproject characteristics is demonstrated by the South Accessto Concepción project, which cost just $0.2 million per kilo-meter, and the Guangzhou-Shenzhen Superhighway, whichcost $15.7 million per kilometer (see table 1). TheConcepción project primarily involves rehabilitation of exist-ing roads through forested land, with new constructionrequired only for two new urban bypasses. The Guangzhou-Shenzhen project involved new construction of six lanes.Moreover, it experienced substantial cost overruns result-ing, in part, from frequent rains and flooding in the right-of-way. As a result its cost per kilometer was about 65 timesthat of the Concepción project.

By far the most expensive project studied here is theDartford Bridge. With a project cost of $247 million for just2.8 kilometers of route length, the cost per kilometer reached$88 million. As noted earlier, bridges and tunnels tend tobe very expensive to construct on a per kilometer basis rel-ative to roads because of the engineering challenges asso-ciated with crossing water and other geographic barriers.

Market demand

Market demand can be measured in terms of actual orexpected traffic levels, predictability of expected traffic,and willingness of users to pay tolls. Each measure is crit-ical in demonstrating a revenue stream of sufficient mag-nitude and predictability to obtain financing. Because ofthe inherent difficulty in accurately projecting toll revenues,the predictability of an expected toll revenue stream isparticularly important for attracting capital (table 2).

Traffic levels (with toll rates held constant) are affectedby the markets served, the competitive alternatives, and theroad’s links to the broader transportation system. The Chileproject, for example, serves a market with limited demandand is expected to attract only 1,200 vehicles a day, despitelimited competition. The Dartford Bridge concessionaire,by contrast, controls all the bridge and tunnel crossings fromthe heavily used M25 ring road and serves 120,000 vehi-cles a day. SR-91 provides additional capacity in a heavy-demand corridor. Despite direct competition from theuntolled parallel lanes, it is expected to attract 37,000vehicles a day. All the projects studied, with the exceptionof the Dartford Bridge, face significant competition fromother roads, although these alternatives are often slower,less convenient, and less safe than the tolled alternative.

The predictability of expected traffic on a toll road canbe assessed on the basis of existing traffic levels on the cor-ridor (if any) and on the competitive alternatives available.An existing toll road, such as Toluca, or one with nearly cap-tive traffic, such as the Dartford Bridge, is considered to havehighly predictable traffic patterns, reducing the risk involvedin project financing. Traffic projections for improvements toexisting roads have moderate predictability, while new roadshave the least predictable traffic, since speculative judgmentsmust be made about their ability to draw traffic from exist-ing alternatives and to generate new traffic. The potentialfor inaccurate traffic forecasts for new roads is illustrated bythe M1 project in Hungary. In its first six months of opera-tion the M1 attracted only about 50 percent of the expectedtraffic. The Dulles Greenway, located in the state of Virginianear Washington, D.C. provides another example of the dif-

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TABLE 2

Market demand characteristics of the eight projectsAverage daily traffica Predictability of Passenger vehicle Average toll rate

Country, project (vehicles a day) expected trafficb toll ratesc per kilometer

Chile, South Access to Concepción 1,200 (projection) Medium $3.70 $0.03Colombia, Buga-Tuluá Highway 10,000 (actual) Medium $2.37 $0.10Mexico, Mexico City-Toluca Toll Road 22,000 (actual) High $4.86 $0.22China, Guangzhou-Shenzhen Superhighway 50,000 (actual) Low $6.14 $0.05Malaysia, North-South Expressway 250,000 (actual) Low $25.00 $0.03Hungary, M1/M15 Motorway 11,000 (projection) Medium $2.59 $0.03United Kingdom, Dartford Bridge 120,000 (actual) High $1.35 $0.48United States, SR-91 37,000 (projection) Medium $0.25–$2.50d $0.02–$0.16d

a. Traffic levels are estimates and may not be comparable due to differences in measurement techniques. In addition, traffic may not travel the entire length of the facility.b. High for existing toll road or captive tolling of existing traffic stream; medium for improvements to existing roads; low for primarily new road.c. All nondollar amounts were converted at the prevailing exchange rate.d. Tolls vary depending on day and time.

ficulty of predicting traffic levels. Originally predicted toattract 34,000 vehicles a day within a year of operation, itattracted only 11,500 a day, on average, in its first six months.After the toll was cut from $1.75 to $1.00, however, usageincreased to 23,000 vehicles a day by September 1996 (Carrand Wright 1996; Reinhardt 1996)

The Dartford Bridge project is unique in that it has a nearlycaptive traffic base. The M25 ring road is one of the mosttraveled routes in England. Motorists crossing the ThamesRiver on the M25 must pass over the bridge or through oneof the two tunnels, all of which are operated by the DartfordBridge concessionaire. Although alternative river crossingsare available on local roads, long-distance traffic demandfor the Dartford Bridge and tunnels is highly inelastic.

Users’ willingness to pay tolls is largely a function of theirwealth, the value they assign to time savings and other tollroad benefits, and the cost and quality of competitive alter-natives. The projects studied charge toll rates for passen-ger vehicles of $0.03–$0.10 per kilometer —compared withthe U.S. average public toll road charge of $0.03—withthree exceptions: the Toluca project, which charges $0.22and is widely regarded as a high-priced facility; the DartfordBridge, which charges $0.48 and is a short facility with nearlycaptive traffic; and SR-91, which has a rate structure rang-ing from $0.02–$0.16 per kilometer. SR-91 is perhaps themost interesting example of users’ willingness to pay tolls,since the rates will vary by time of day and day of the weekin order to manage congestion on the facility.1

Overall assessment

Project economics are typically measured in terms of netpresent value or internal rate of return on investment. Actualnet present value and internal rate of return data for theprojects studied are not available; however, project eco-nomics can be approximated by placing each project on amatrix that reflects the cost per kilometer, average dailytraffic, and an assessment of the predictability of expectedtraffic (figure 2). Although this is an imprecise method ofmeasuring project economics (for example, it does not takeinto account the toll rates charged), it does provide a basisfor making general observations.

Three of the projects are considered to have strong pro-ject economics: the North-South Expressway (because it

has high traffic relative to its costs) and the Dartford Bridgeand Mexico City-Toluca Toll Road (because they both haverelatively predictable demand). Because the data on theremaining projects are inconclusive, they are categorized ashaving moderate project economics.

A project’s ability to obtain financing however is notdetermined solely by its economics. The country and con-cession environment and public-private risk-sharing arrange-ment also have important effects on financing.

Country and Concession Environment

A favorable country and concession environment can becrucial to attracting financing and limiting the need for gov-ernment assumption of risk, while an unfavorable envi-ronment may preclude financing without substantialgovernment support. The three principal components ofthe country and concession environment are the conces-sion policy and process environment, economic and polit-ical context, and local capital markets.

Concession policy and process environment

The concession policy and process environment refers to thepolicies, laws, and procedures a country has in place to sup-port the implementation of a concession program, including:

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Cost per kilometer(millions of U.S. dollars)

Project economics of the eight projectsFIGURE 2

a. Based on bond issue amount, not on original project cost.

0 10 20 30 40 50 60 70 80 90 100 110 1200

2

4

6

8

10

12

14

16

90

Low Medium High

Average daily traffic (thousands of vehicles)

South Access to Concepción

Buga-Tuluá Highway

M1/M15 Motorway

SR-91

Mexico City-Toluca Toll RoadaGuangzhou-Shenzhen Superhighway

Dartford Bridge

Predictability of expected traffic

250

North-South Expressway

• Overall road concession policy. Is the government com-mitted to a sound concession program that is coor-dinated with its broader transportation policy? Hasthe government successfully concessioned otherroads?

• Concession legislation. Has the government enactedlegislation to encourage concessions generally andto authorize toll road concessions specifically?

• Concession process. Are the concession term and reg-ulatory mechanism conducive to attracting long-termprivate capital? Is the process competitive, transpar-ent, and based on reasonable evaluation criteria?

The countries studied were categorized qualitatively ashaving either more or less favorable concession environ-ments. Of the eight countries, Chile, Colombia, Hungary,the United Kingdom, and the United States scored high interms of concession environment, while China, Mexico,and Malaysia were considered to have less favorable envi-ronments (table 3).

All of the favorably rated countries have specific con-cession legislation, sound concession policies, and com-petitive concession processes. Although the concessionenvironments in these countries vary in other respects,the variations were not considered detrimental. For exam-ple, Chile has an ambitious national program for conces-sioning roads, with the Concepción project the second tobe concessioned. In the United States, by contrast, roadsare concessioned at the state level, and SR-91 was the firstprivate toll road to be financed in modern U.S. history.

Mexico’s concession environment is considered lessfavorable because the concession process has been prob-lematic. The Mexican program concessioned toll roads onthe basis of the shortest proposed concession term. Althoughthis structure supported the government’s objective of trans-ferring control over the roads back to the public sector assoon as possible, it resulted in extremely short concessionterms (initially 4.5 years in the case of the Mexico City-Toluca Toll Road), extremely high toll rates (and resultinglow traffic levels), and difficulty with servicing debt. In addi-tion, the program did not encourage concessionaires to con-duct adequate traffic and revenue studies or other formsof due diligence during the concession process. As a resultmany Mexican projects have experienced severe financial

problems. For example, the Mexico City-Toluca Toll Roadproject was eventually restructured, and the concessionterm was extended to eleven years.

China’s concession environment is considered less favor-able because of the relatively informal process used toconcession roads. No specific concession legislation autho-rizes the program, and there was no competitive processfor tendering the Guangzhou-Shenzhen project. Althoughto some extent these practices may reflect cultural differ-ences between China and the other countries studied, thelack of clear legal authorization and a transparent conces-sioning process may be of concern to some investors.

Malaysia also lacks specific concession legislation autho-rizing the program for the North-South Expressway. In addi-tion, issues have been raised about the transparency of thebidding process because of the close ties between the win-ning concessionaire and Malaysia’s leading political party.

Prior experience with toll roads was not a good indica-tor of the favorableness of the concession environment.Most countries have only recently begun implementing pri-vate toll road programs. Of the eight projects studied, sixwere either the first or among the first private initiativesthe country had undertaken, yet four of these countrieswere categorized as having favorable concession environ-ments. Mexico, on the other hand, is one of two countriesthat had prior experience with concessions (Chile is theother), but Mexico was categorized as having an unfavor-able concession environment.

All the projects, with the exceptions of those in Chinaand the United States, involve maximum toll rate regula-tion. In Chile, Colombia, Mexico, Malaysia, and the UnitedKingdom these toll rate ceilings are indexed to local inflationto compensate for local cost increases and to provide indi-rect protection against exchange rate movements (relativeinflation between currencies and movement in theirexchange rates are correlated when purchasing power parityholds). Toll rates in Hungary are indexed to local inflationand to the devaluation of the currencies of the project’sforeign loans, should devaluation exceed the inflation dif-ferential between the Hungarian forint and the respectiveforeign currency.

Except in Malaysia, toll rate indexation adjustments arebased on a formula and do not require government approval(all toll rate increases in Malaysia require government

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TABLE 3

Concession policy and process environment of the eight projectsPrior

experience with

private Contractual Country, Government experience Concession toll Bid process and Concession regulatory project with toll roads legislation roads? evaluation criteria term mechanism Ratinga

Chile, Second concession of ambitious Yes Yes • Open, competitive process 25 years Maximum toll rate +++South Access government toll road program based on minimum toll, indexed to localto Concepción minimum one-time subsidy, inflation

and other factors • No contract negotiations

Colombia, One of the first toll road Provincial: Yes No • Open, competitive bid process 15 years Maximum toll rate +++Buga-Tuluá concessions in Colombia; Federal: No based on design, construction, indexed to local Highway concessioned by the Province and rehabilitation plan, operating inflation; maximum

of Valle del Cuaca in advance plan, and financial plan traffic ceiling of 125% of a coordinated national toll (including toll rates) of base case scenario road concession program above which revenues

are transferred to the province

Mexico, Ambitious private and public toll Yes Yes • Open, competitive process 4.5 years, Maximum toll rate +Mexico City- road program; several conces- based on shortest concession later indexed to localToluca sions experienced financial term at a fixed toll rate extended inflationToll Road problems due to short conces- • Negotiations permitted to 11 years

sion terms and high toll rates

China, Substantial number of toll No No • No competitive tender 30 years None (Hopewell +Guangzhou- road concessions under devel- receives 50% Shenzhen opment; coordinated largely of joint venture profits)Superhighway at the city and provincial levels

Malaysia, First private toll road; No No • Open, competitive bid process 30 years Toll rates specified +North-South concessioned to • One of five submitted proposals through 1996 andExpressway complete failed public project selected based on undisclosed indexed to local inflation

criteria thereafter. All increases• Negotiations permitted must be approved

by the government;compensation is paid by the government if toll increases are deferred

Hungary, First private toll road; Yes No • Open competitive process 35 years Maximum toll rate +++M1/M15 intended to set a prece- based on construction cost, indexed to localMotorway dent for future roads equity commitment, financial inflation and devaluation

plan, sponsor qualifications, of foreign loan currenciesand other factors

• Negotiations permitted for two finalists

United Kingdom, First private toll facility; Yes No • Open, competitive process 20 years Maximum toll rate +++Dartford Bridge intended to set a precedent in which bidders propose the maximum, indexed to local

for future roads projects likely to end inflation• Negotiations permitted for 6 years early

three finalists

United States, One of the first state-led State: Yes No • Open, competitive process in 35 years Ceiling on return to +++SR-91 initiatives on private toll Federal: No which bidders propose the total capital (debt

roads projects and equity combined).• Selection on basis of best No toll rate regulation.

technical and financial proposal • Negotiations permitted

a. + is less favorable; +++ is more favorable.

authorization). In most cases a consumer price index is usedas the inflation index and adjustments are made accordingto a fixed schedule (usually once or twice a year). Adjustmentsmay be more frequent if the index increases beyond a spec-ified amount (for example, 10 percent).

Economic and political context

A stable economic and political environment is critical forattracting investment to a project. The environment canbe evaluated on the basis of macroeconomic stability, coun-try risk ratings, and sovereign debt ratings (table 4).

Of the countries studied, Hungary and Mexico were cat-egorized as having less favorable economic and politicalcontexts because of high country risk ratings, below–invest-ment grade sovereign debt ratings, and generally weakereconomies. The United Kingdom and the United States havecountry risk ratings of 5 percent or lower and AAA-ratedbonds, as well as stable economies, and were rated the mostfavorable. The other four countries were rated in the mid-dle because they combined high country risk ratings withinvestment-grade sovereign debt ratings and strong economicgrowth.

Local capital markets

Countries with local capital markets that are capable of pro-viding long-term financing for toll road projects have sev-eral advantages in supporting toll road concessions:

• Financing denominated in local currency avoidsexchange rate risk because payments to capital arein the same currency as the toll revenues generatedby the project.

• Local financial institutions and investors may havea better understanding of project economics andgovernment policies, and be more willing than for-eign investors to assume local economic and polit-ical risk.

• Unlike some infrastructure sectors (such as power),the labor, materials, and equipment required for tollroad construction can largely be provided locally,which obviates the need to fund construction costsin foreign currencies.

Useful measures of the depth of capital markets to fundtoll road projects are the types of financial instrumentsand volume of funds potentially available for such pro-jects, the length of the term available on project debt, andthe interest rates charged on debt. An analysis of each ofthese items for each project country is beyond the scope ofthis study. As a proxy, however, the study examined thelongest term available on local currency government debtand its associated Standard & Poor’s sovereign rating, todetermine a rating for local capital markets (table 5).

The countries were placed in three categories rangingfrom less favorable to more favorable. The United Kingdomand the United States are considered to have more favor-able capital markets because they are both AAA-rated with

9

TABLE 4

Economic and political context in year of financial closeAnnual Local Change in

Year of Country Standard Annual GDP interest currency relative Economicfinancial risk & Poor’s inflation growth rate to the U.S. dollar and political

Country, project close ratinga ratingb (percent) (percent) (percent) (percent) context ratingc

Chile, South Access to Concepción 1994 25 BBB+ 12.0 (1993) 6.0 (1993) 20.3 4.0 ++Colombia, Buga-Tuluá Highway 1994 36 BBB– 21.7 (1993) 5.3 (1993) 40.5 –2.1 ++Mexico, Mexico City-Toluca Toll Road 1992 36 BB+ 9.7 2.8 18.9 2.6 +China, Guangzhou-Shenzhen Superhighway 1991 25 (1992) BBB (1992) 4.9 8.0 (1989) 11.2 (1989) 11.3 ++Malaysia, North-South Expressway 1988 28 (1990) A (1991) 2.4 8.9 7.3 4.0 ++Hungary, M1/M15 Motorway 1993 34 BB (1992) 22.6 –2.7 25.0 16.4 +United Kingdom, Dartford Bridge 1988 5 (1990) AAA 5.3 5.0 10.3 –8.2 +++United States, SR-91 1993 4 AAA 2.9 3.1 6.0 — +++

a. Lower number indicates higher ranking and less country risk; based on a ranking of countries by Institutional Investor.b. Rating of government-issued debt.c. + is less favorable; +++ is more favorable.Source: Institutional Investor; UN Statistical Yearbook, 40th issue; IMF, various years.

government debt terms as long as twenty-five to thirty years.China, Colombia, and Mexico have less favorable capitalmarkets because they have low sovereign ratings and gov-ernment debt terms of five years or less. Chile and Malaysiaare in the middle because they have investment grade rat-ings and government debt terms as long as twenty years.Hungary was also placed in the middle category becauseof its ten-year term on government debt.

Overall assessment

Considering the above factors in combination, the eightcountries studied exhibited a wide range of ratings (table6). Not surprisingly, the United Kingdom and the UnitedStates received the highest overall ratings. China andMexico scored less favorably in most areas and were ratedas having less favorable environments overall. Chile,Colombia, Hungary, and Malaysia had mixed ratings andwere therefore ranked in the middle category.

Although all the projects were able to attract private cap-ital, projects in less favorable country and concession envi-ronments generally require stronger project economics orgreater government support to compensate for the addi-tional risk.

Public-Private Risk Sharing

Private toll road development requires that project risksand responsibilities be assigned to the public or privateentity that is best able to manage them. The private sectoris generally better at managing commercial risks and respon-

sibilities, such as those associated with construction, oper-ation, and financing. But in order for a project to obtainfinancing, public participation may be required in areas suchas acquisition of right-of-way, political risk, and, in somecases, traffic and revenue risk.2

Project responsibilities

The principal responsibilities for toll road developmentinclude design, construction, maintenance, toll collection,arranging financing, and legal ownership. The build-oper-ate-transfer (BOT) model is the most common approachused to assign responsibilities in toll road projects. BOT isa broadly defined term that includes build-own-operate-transfer (BOOT), build-lease-transfer (BLT), rehabilitate-operate-transfer (ROT), lease-rehabilitate-operate (LRO),and similar arrangements that are used to develop new facil-ities or improve existing ones.

Under the BOT model a private consortium receives aconcession to finance, build, control, and operate a facil-ity for a limited time, after which responsibility for thefacility is transferred to the government, usually free ofcharge. The private party typically assumes primary respon-sibility for constructing the project, arranging financing,performing maintenance, and collecting tolls, while the pub-lic sector retains legal ownership. In most projects designresponsibility is shared, with the public sector taking thelead in the preliminary design (including route alignment,number of lanes, interchanges, and other high-level designspecifications) and the private sector completing the detaileddesign, subject to government approval.

10

TABLE 5

Local capital marketsLongest term Assessment of

Year of of local currency Standard & Poor’s local capitalCountry, project financial close government debta ratingb markets

Chile, South Access to Concepción 1994 20 BBB+ ++Colombia, Buga-Tuluá Highway 1994 3 BBB– +Mexico, Mexico City-Toluca Toll Road 1992 2 BB+ +China, Guangzhou-Shenzhen Superhighway 1991 5 BBB (1992) +Malaysia, North-South Expressway 1988 21 A (1991) ++Hungary, M1/M15 Motorway 1993 10 BB (1992) ++United Kingdom, Dartford Bridge 1988 25 AAA +++United States, SR-91 1993 30 AAA +++

a. Terms given are for 1995, excludes index-linked bonds and private investments.b. Rating of government-issued debt (in year of financial close unless otherwise noted).c. + is less favorable; +++ is more favorable.

The projects studied generally follow the BOT modelfor assigning project responsibilities. In all the projects theprivate sector was primarily responsible for construction andtoll collection, while the public sector retained legal owner-ship of the facility. Design responsibility was generally shared.Only in the Buga-Tuluá Highway and the Dartford Bridgedid the private partner have primary responsibility for design.Arranging financing was largely a private sector responsi-bility, except in China and Malaysia, where state-ownedfinancial institutions were significantly involved in the financ-ing package. In most cases the private sector is also respon-sible for maintenance. The exception was SR-91, where theprivate consortium contracts the California Department ofTransportation to maintain the lanes for a fee.

Project risks

The main risks facing private toll road projects includepre-construction, construction, traffic and revenue, cur-rency, force majeure, tort liability, political, and financial(table 7). These risks must all be addressed in a manner sat-isfactory to debt and equity investors before they will com-mit to project funding.

Pre-construction. Right-of-way acquisition, environmen-tal compliance, and other project requirements before theconstruction period may cause delays and cost overrunsduring project development. The private sector usually bearsthe risk of delays associated with right-of-way acquisition,environmental compliance, and other pre-construction activ-ities. The public sector, however, often takes responsibilityfor acquiring the right-of-way, using its power of condem-nation. The public sector also often bears the cost of acqui-

sition. In most of the projects studied the government pro-vided the right-of-way at no cost. For example, in Malaysiathe government made all land required for highwayconstruction available to the concessionaire free of charge.In California the concessionaire was authorized to use themedian of an existing highway free of charge. In Chile, how-ever, the concessionaire was responsible for right-of-waycosts totaling $230,000.

Construction. During the construction period, designchanges, unforeseen geological and weather conditions, andthe unavailability of materials and labor can cause delaysand cost overruns. The private sector typically takes pri-mary responsibility for cost overruns and delays during theconstruction period and often allocates these risks to a con-struction contractor through a fixed price contract. Thepublic sector often supports the project during the con-struction period by assuming specific construction periodrisks. For example, the public sector is usually responsiblefor those activities or risks under its control, including com-pleting any facilities that it contributes to the project (suchas connecting roads or interchanges) and cost increasesassociated with major design changes.

In some cases the public sector may share the responsi-bility for cost increases due to unforeseen geological con-ditions and other high-risk aspects of the project. Roadswith relatively predictable construction costs, such as thosedeveloped on existing right-of-way or through low-risk ter-rain, may involve very limited public sector risk sharing. Butroads that face substantial uncertainties during the con-struction period, such as longer roads that pass throughhigh-risk terrain (for example, mountains and rivers), mayrequire the public sector to share construction period risk

11

TABLE 6

Overall ratings for country and concession environmentConcession policy and Economic and Local capital Overall

Country, project process environment political context markets rating

Chile, South Access to Concepción +++ ++ ++ ++Colombia, Buga-Tuluá Highway +++ ++ + ++Mexico, Mexico City-Toluca Toll Road + + + +China, Guangzhou-Shenzhen Superhighway + ++ + +Malaysia, North-South Expressway + ++ ++ ++Hungary, M1/M15 Motorway +++ + ++ ++United Kingdom, Dartford Bridge +++ +++ +++ +++United States, SR-91 +++ +++ +++ +++

Note: + is less favorable; +++ is more favorable.

in order for the project to attract private partners.Construction risks may be lower for extensions, expansions,or rehabilitations than for new projects.

In most of the projects studied the private sector tookprimary responsibility for construction period risk and usedfixed price construction contracts to protect investors.Construction risk did not create problems for most of theprojects, which were completed close to the original costestimate, with the important exceptions of the China andMalaysia projects.

In China design changes (including construction of addi-tional interchanges and the need to elevate more than 30kilometers of roadway) and problems with right-of-wayacquisition caused project costs to run 60 percent higherthan was originally anticipated. The concessionaire bore theprimary risk for cost overruns, resulting in an additional$700 million equity investment by the sponsors. In returnfor the additional investment, the sponsor negotiated anincrease in the profit sharing agreement (from 42.4 to 50percent) for the first ten years of operation, with similarincreases for subsequent years (Reinhardt 1996).

Costs for the Malaysia project increased by more than70 percent for a number of reasons, including soil condi-tions and design changes. Although the government did notexplicitly assume construction risk, extensive governmentfinancial support for the project mitigated the concession-aire’s exposure to these increases.

Traffic and revenue. Traffic and revenue risks are per-haps the greatest risks faced by toll road projects. Theseare defined as risks associated with insufficient traffic lev-els and toll rates too low to generate expected revenues.The treatment of traffic and revenue risk ranges from fullprivate sector assumption of the risk to government-providedminimum traffic and revenue guarantees.

The SR-91, Dartford Bridge, M1/M15 Motorway, andGuangzhou-Shenzhen projects allocated full traffic and rev-enue responsibility to the private sector. For projects thatincluded minimum traffic and revenue guarantees, the actualform of the guarantee varied widely. For example, the min-imum traffic guarantee for the Mexico City-Toluca Toll Roadprovides for an extension of the concession term in the

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TABLE 7

Public and private risk sharingOverall

assessment Traffic and Force Tort of public

Country, project Pre-construction Construction revenue Currency majeureb liabilityb Politicalb Financial sector risk

Chile, South Access to Concepción Nonea Medium

Colombia, Buga-Tuluá Highway Nonea Medium

Mexico, Mexico City-Toluca Toll Road None None Low(securitization) (securitization)

China, Guangzhou-Shenzhen Superhighway High

Malaysia, North-South Expressway High

Hungary, M1/M15 Motorway Low

United Kingdom, Dartford Bridge Nonea Low

United States, SR-91 Nonea Low

Note: major risk to private sector; major risk to public sector; risk shared.

a. Indicates all or nearly all financing is in local currency. b. A general assessment of the risk allocation was provided by project sponsors or advisers. Detailed analysis of these issues was not possible because of the confidentiality of manyof the concession agreements and the limited scope of this study.

event traffic falls below minimum levels. However,concession term extensions are of limited value in provid-ing cash flows to make debt service payments in the eventof low traffic volumes. The South Access to Concepciónproject uses a minimum revenue guarantee with cash com-pensation if revenue falls below the minimum level. TheBuga-Tuluá project includes a minimum traffic guaranteewith cash compensation and a maximum traffic ceiling abovewhich all revenues are transferred to the government. TheNorth-South Expressway includes standby governmentloans to support traffic and revenue risk. The policy issuesinvolved in addressing traffic and revenue risks are dis-cussed in the section on policy issues.

Currency. Currency risk is a major issue for toll roadsfinanced with foreign capital because a project may be unableto pay a return on foreign currency–denominated capital iflocal earnings are not convertible at the expected exchangerate. Projects can avoid this risk by tapping local capitalmarkets for funding.

For projects involving foreign capital, the private sectorgenerally assumes the exchange rate and inconvertibility risk,although in some cases political risk insurance may be avail-able to cover inconvertibility. The exchange rate risk is oftenmitigated by indexing the toll rates to local inflation or tothe exchange rate of the foreign currency–denominatedcapital. Large foreign currency debt service reserves canalso be used (as in Mexico) to protect against the risk ofexchange rate fluctuations and inconvertibility, although tyingup capital in reserve funds is expensive.

The SR-91, Dartford Bridge, South Access to Concepción,and Buga-Tuluá projects avoided exchange rate risk by usinglocal capital to fund nearly all capital costs. In Mexico andChina full risk was allocated to the private sector. In Mexicothe devaluation of the peso two years after the internationalbond issue has resulted in a substantial decline in dollar rev-enues, although the project has been able to continue mak-ing debt service payments. In Hungary the European Bankfor Reconstruction and Development (EBRD) provided cur-rency convertibility guarantees for the debt through its B-loan program (described in the section on financing structuresand sources), and in Malaysia the government assumedexchange rate risk by providing standby loans to compen-sate for unanticipated exchange rate movements.

Force majeure. Force majeure involves risks beyond thecontrol of a project’s public and private partners—such asfloods, earthquakes, or war—that impair the facility’s abil-ity to generate earnings. Force majeure risk is assigned pri-marily to the private sector, which in more developedcountries generally can cover natural force majeure risks(such as floods or earthquakes) through private insurance.Political force majeure risks (such as riots or wars) may notbe insurable, and for some projects the public sector maybe willing to assume these risks when such protection isrequired to attract capital on reasonable terms. The pub-lic sector also may extend the concession term if any forcemajeure event disrupts the operation of the facility. Exceptfor Hungary’s motorway, all the projects studied appear tohave assigned force majeure risk primarily to the privatesector. To the extent, however, that minimum traffic orrevenue guarantees continue during a force majeure event,the government implicitly covers this risk. It could not bedetermined from available information if this is the casefor the projects in Chile, Colombia, or Malaysia, which allhave some form of minimum traffic or revenue guaranteefrom the government.

Tort liability. Tort liability relates to the risk of having topay substantial legal awards as a result of accidents on thetollway. All the projects studied assigned tort liability pri-marily to the private concessionaire. Such liability is gen-erally covered by private insurance.

Political. Political risk concerns government actionsthat could impair a facility’s ability to generate earnings.Such actions could include terminating the concession orimposing taxes or regulations on the project that severelydamage its value to investors; not allowing the private part-ner to charge and collect tolls as specified under the con-cession agreement; preventing investors from transferringearnings out of the country; or not allowing for contract dis-putes to be settled fairly under neutral jurisdiction.

Governments generally agree to compensate investorsfor termination of the concession and violations of theconcession agreement, including agreed toll rates. However,private concessionaires generally assume the risk associatedwith dispute resolution and the ability to obtain compen-sation in the event of a government violation of the

13

concession agreement. Government assumption of politi-cal risks has value to investors only to the extent that thereis a fair and timely process for compensating the conces-sionaire for contract violations. The issue of meeting finan-cial obligations while a dispute is being resolved can beaddressed through such measures as debt service reservesand standby financing, provided that disputes are resolvedwithin a reasonable period of time.

The contractual obligations, willingness, and creditwor-thiness of governments to provide compensation to coverpolitical risks are critical issues for attracting private capi-tal. This is especially true for foreign capital, which is per-ceived by investors as being more vulnerable to politicalrisks. Some of the relatively risky countries that hope toattract private financing of toll road programs may requiresupport from multilateral or bilateral financial institutionsto mitigate political risks. For example, multilateral andbilateral credit enhancements that guarantee the govern-ment’s obligations under the concession agreement can pro-vide important protections for investors by ensuring thatcash will be available to pay debt service should certain con-tractually defined circumstances occur. In addition, polit-ical risk insurance can provide protection to investors againstcertain political risks, such as confiscation, currency con-vertibility, and repatriation of profits.

Financial. Financial risk is defined as the risk that pro-ject cash flows may be insufficient to pay an adequate returnon the private debt and equity invested in the project. Theprivate sector is generally responsible for financial risk,although in some cases governments may provide debt guar-antees, equity guarantees, and other types of financial guar-antees. Governments also may provide cash grants, equity,or subordinated loans, which improve the expected rate ofreturn on private capital invested. The Guangzhou-Shenzhenproject includes a government cash flow deficiency guar-antee for the $800 million in senior project debt. The cash-flow deficiency guarantee covers any difference betweenproject cash flows available to pay debt service and requireddebt service payments. In Chile the government providedan up-front cash grant of $5 million, or almost one-quarterof total project costs, while in Malaysia the government pro-vided $634 million in loans, or about one-quarter of theproject’s total debt.

Overall assessment

In most of the projects studied, the government took pri-mary responsibility for political risk and right-of-way acqui-sition, while the private partner took primary responsibilityfor pre-construction (excluding right-of-way acquisition),construction, force majeure, and tort liability risk. Thearea with the greatest divergence among the projects stud-ied is the treatment of traffic and revenue risk, althoughthere were also differences in the approaches to currencyand financial risks.

The China project is considered to have a high share ofpublic sector risk assumption because of the government’sextensive involvement in supporting financing for the pro-ject. The Malaysia project is also categorized as having a highshare of public sector risk assumption because of the gov-ernment’s support for traffic and revenue and currency risks,as well as its sizable financial participation in the project.

The Hungary, Mexico, U.K., and U.S. projects involvelimited public sector risk assumption because the primaryresponsibility for traffic and revenue, currency, and finan-cial risks lie with the private sector.

In Chile and Colombia the governments are consideredto have assumed a moderate level of risk because they useminimum traffic or revenue guarantees and, in the case ofChile, an up-front cash grant. The next section analyzesrisk allocation in the context of project economics, the coun-try and concession environment, and project financing.

Financing Structures and Sources

The projects studied involve various tradeoffs between pro-ject economics, country and concession environment, andgovernment support to attract private capital. The projectsalso used a variety of debt and equity instruments from arange of local and foreign sources.

Project finance approach

Most private toll roads are undertaken on a project financebasis, whereby investors rely on the performance of the pro-ject for payment rather than the credit of the sponsor. Thisarrangement is also referred to as limited recourse financ-ing, which indicates that lenders have limited recourse to

14

the sponsors for payment if the project fails to generate ade-quate returns.

A primary benefit of project finance structures is thatthey allow sponsors to leverage their resources and exper-tise with outside capital in order to undertake projects thatthey otherwise would not be able to finance on the strengthof their own balance sheet. In addition, project financeallows sponsors to share project risks with lenders and main-tain the project debt off their balance sheet. Governmentsalso seek to limit the recourse of investors to their credit,except to the extent that they provide financial supportthrough such means as minimum traffic and revenue guar-antees and loans.

Toll road project financing normally involves:

• Complete analysis of the country, economic, legal,and political environment in which the project will bedeveloped.

• Detailed studies by engineering experts and financialadvisers, including traffic and revenue projections, con-struction cost estimates, preliminary design documentsfor the project, and financial feasibility studies.

• Complex loan and security documentation, ofteninvolving multiple lenders, investors, project spon-sors, and government agencies.

• Negotiation of a concession agreement, including adetailed allocation of risks and responsibilities amongthe various project participants.

The complex financial and contractual arrangementsrequired for project financing make the closing of financ-ing a difficult and lengthy process for many toll road pro-jects (figure 3). In five of the eight projects studied, termfinancing was closed several months after the initial sign-ing of the concession. For the Mexican, Chinese, and U.S.projects, however, term financing took several years toarrange. China’s Guangzhou-Shenzhen Superhighwayrelied on sponsor equity funding to begin construction butdid not complete term debt financing until three yearslater. Mexico’s Toluca Toll Road used short-term (four-year) debt and refinanced two years after the beginningof operations. The United States’s SR-91 took more thantwo years to close financing after the concession was signed,primarily because of the extensive studies and contractualarrangements required and the lack of experience withprivate toll road financings in the United States at thattime.

The financing arrangements for the projects studiedare presented in table 8. As is the case with most projectfinancing, toll road projects are highly leveraged, with debt

15

Project development timetableFIGURE 3

Chile, South Access to Concepción

Colombia, Buga-Tuluá Highway

Mexico, Mexico City-Toluca Toll Road

China, Guangzhou-Shenzhen Superhighway

Malaysia, North-South Expressway

Hungary, M1/M15 Motorwayc

United Kingdom, Dartford Bridge

United States, SR-91

Country, project

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Year

S $ C O

S $ C O

S $ C O

S $ C O

S C O$

S $bC O

S $ C O

S $ C Oa

a. Expected to begin operation.b. Date of securitization.c. The dates for Hungary represent M1 only. M15 is scheduled to begin construction upon completion of M1.

S Concession signed$ Term financing closedC Construction beginsO Operation begins

ratios ranging from 50–100 percent for most of the projectsstudied. The one exception is the Guangzhou-ShenzhenSuperhighway, where the debt ratio was 40 percent becauseof the 60 percent cost increase that was funded with spon-sor equity.

The Mexico City-Toluca Toll Road and Dartford Bridgewere both financed with 100 percent debt. The lack of equityparticipation in these financings may appear to limit theinvestors’ financial interest in the success of these projects.However, the Toluca financing was a securitization of an exist-ing private toll road concession in which the private consor-tium, led by Tribasa, retained an equity interest. The Dartford

Bridge financing included a long-term (eighteen-year) sub-ordinated “loan stock” that was provided by the consortiummembers at interest rates above the senior debt. This quasi-equity provides a financial incentive to the consortium to per-form, although not as strong an incentive as true equity. Thegovernment chose to avoid true equity investment in theDartford Bridge in order to limit the required toll rates andaccelerate the transfer of the bridge back to the govern-ment. All debt is expected to be repaid and the bridge returnedto the government six years before the end of the twenty-year concession, as provided for in the agreement betweenthe sponsors and the government.

16

TABLE 8

Financing arrangements(millions of U.S. dollars)

Total Total Total Debt/ Foreign Government Country, project debta equity capital equity participation financial supportb

Chile, South Access to Concepción 13 9 22 60/40 None $5 million cash grant andminimum revenue guarantee

Colombia, Buga-Tuluá Highway 15 16 31c 50/50 Equity participation Minimum traffic guaranteeby Ferrovial (Spain) of 90 percent of the base

case scenario

Mexico, Mexico City-Toluca Toll Road 313 None 313 100/0 $208 million interna- Minimum traffic guaranteetional bond issue with compensation in the

form of concession extension

China, Guangzhou-Shenzhen Superhighway 800 1,122 1,922 40/60 $800 million loan Government cash-flowfrom international deficiency guarantee for banks, $922 million $800 million loan andin foreign equity government equity

of $200 million

Malaysia, North-South Expressway 2,416 775 3,192 75/25 Foreign banks partici- Government loan of $634 pated in $870 million million and soft loan facilitiessyndicated loan available to support

minimum traffic levels and currency fluctuations

Hungary, M1/M15 Motorway 352 88 440 80/20 $58 million EBRD NoneA-loan, $163 millionEBRD B-loan syndi-cate, and $88 million in equity

United Kingdom, Dartford Bridge 292 0.002 292d 100/0 None None

United States, SR-91 107 19 126 85/15 Equity participation $7 million in subordinated by Cofiroute (France) debt from Orange County

a. Total debt may not equal the sum of the debt instruments because of rounding.b. Does not include in-kind contributions of right-of-way, existing facilities, and pre-construction studies. Includes support by host government only and does not reflect participationby multilateral financial institutions.c. Total capital is $16 million lower than the construction cost because toll revenues contributed to construction financing.d. Total capital includes cost of assuming tunnel debt, net of toll revenues during construction.

Government financial participation

Governments often provide financial support to toll roadprojects in the form of cash grants, loans, and in-kind con-tributions, in addition to assuming various project risks. InChile the government provided a one-time up-front cashgrant of $5 million to the concessionaire in addition to aminimum revenue guarantee. (The size of the grant, whichis 23 percent of total capital, was one of the criteria forawarding the concession.) In China and Malaysia the gov-ernments provided substantial loans and financial guaran-tees. By contrast, in Colombia, Hungary, Mexico, the UnitedKingdom, and the United States governments providedno or minimal project capital, although in some cases theydid provide in-kind contributions. For example, theHungarian government provided the right-of-way for theM1/M15 project and constructed about 130 kilometers oftoll-free highway that connects with the toll road.

In some cases government risk assumption and finan-cial support may be necessary to support a project that wouldotherwise be unable to close financing because of weak pro-ject economics or an unfavorable country and concessionenvironment. The relationship between project economics,country and concession environment, and level of govern-ment risk assumption and financial support for each pro-ject studied is shown in figure 4. Attracting private capital

clearly depends on a combination of these factors. For exam-ple, projects like the Mexico City-Toluca Toll Road, withstrong economics in an unfavorable country and conces-sion environment, can be financed with minimal govern-ment support. Projects like South Access to Concepción,with less favorable economics in a moderate country andconcession environment, may require moderate levels ofgovernment support. Finally, projects like the Guangzhou-Shenzhen Superhighway, with weak economics and an unfa-vorable country and concession environment, may requiresubstantial government support.

Two apparent exceptions are Malaysia’s North-SouthExpressway and Hungary’s M1/M15 Motorway. The Malaysiaproject has strong economics in a moderate country and con-cession environment and could therefore be expected torequire low to moderate government support. In reality, itreceived very high levels of government support. One rea-son may be that its sheer size (total cost of $3.2 billion) andthe risks associated with large projects led the governmentto believe that extensive government support would berequired to attract financing. The close ties between the con-cessionaire and Malaysia’s leading political party also mayhave contributed to the high level of support.

The Hungary project, which received a moderate ratingin terms of both economics and country and concessionenvironment, could be expected to require at least mod-erate government support in order to attract financing. Inreality, the project received no significant financial supportfrom the government. The project did, however, benefitfrom right-of-way contributions and the construction ofconnecting highway segments. In addition, the EBRD pro-vided substantial support in the form of a $58 million A-loan on its own account and a $163 million syndicated B-loanfor which it assumed certain noncommercial risks for themembers of the loan syndicate.3 The EBRD’s extensiveinvolvement contributed to the Hungarian government’sability to avoid extending financial support to the project.

Foreign and domestic capital

As discussed in the section on the country and concessionenvironment, accessing local capital markets for toll roadprojects has several benefits—most important, the avoid-ance of exchange rate risk between local currency toll

17

Country and concession environment

Government risk assumption and financial supportFIGURE 4

Morefavorable

Lessfavorable

Weaker StrongerProject economics

SR-91

South Access to ConcepciónBuga-Tuluá HighwayM1/M15 Motorway

Guangzhou-ShenzhenSuperhighway

Mexico City-Toluca Toll Road

North-South Expressway

Dartford Bridge

Low Medium High

Government risk assumption and financial support

revenues and foreign currency debt. In many countries,however, local capital markets are not sufficiently devel-oped to provide the long-term capital required for tollroad projects.

Four of the projects studied used little or no foreign cap-ital—those in Chile, Colombia, the United Kingdom, and theUnited States. The United Kingdom and the United Stateshave highly developed capital markets, while the projects inChile and Colombia were relatively small ($22 million and$47 million) and could be financed locally. Chile and Colombiaare currently pursuing larger road concessions and are seek-ing foreign capital to supplement locally available capital.

The Mexico City-Toluca Toll Road involved a $313 mil-lion securitization, $208 million of which was raised out-side of Mexico with no government support. This financingresulted in part from an explicit government objective toattract foreign capital to Mexico’s toll roads because domes-tic banks had become overexposed to toll road debt andwere reluctant to provide additional capital.

In China and Hungary the bulk of project financing camefrom foreign sources. As noted earlier, $1.7 billion of theGuangzhou-Shenzhen Superhighway’s $1.9 billion cost wasfinanced with foreign capital. In Hungary the EBRD lenton its own account or syndicated internationally $221 mil-lion of the $352 million in project debt.

In general, large financings in countries with undevel-oped capital markets (such as China, Hungary, and Mexico)may require substantial amounts of foreign capital, whilesmaller financings (Chile and Colombia) and financings incountries with highly developed capital markets (the UnitedKingdom and the United States) are more likely to rely onlocal capital.

Debt financing

Most of the debt for the projects studied was in the formof senior commercial bank loans (see annex 1 for a sum-mary of the debt terms). Commercial banks are the tradi-tional providers of project finance loans because they tendto be more willing and able than other debt providers tostructure acceptable debt packages in the context of com-plex and risky project finance transactions.

Institutional debt from pension funds and insurancecompanies was also used in Malaysia and the United States.

There is great interest in many countries in tapping insti-tutional debt, particularly from pension funds, to fund tollroads and other infrastructure projects. The large pool offunds available and the long investment horizons of theseinstitutions correspond with the long-term debt require-ments of infrastructure projects. Many developing coun-tries, however, do not have large institutional debt markets.Moreover, the role of pension funds and other institu-tional investors is often limited by regulatory restrictionsand modest risk appetites for investing in projects prior tooperation when the facility has no track record and facesconstruction period risks.

In Chile, for example, privatization of the national pen-sion system has resulted in tremendous growth in pensionfund savings available for private investment. But regula-tory barriers and concerns about risk have limited the involve-ment of pension funds in providing debt to toll road projects.If these obstacles can be overcome, a large pool of long-termdebt would be released for investment in private toll roads.

Public bond markets are another source of debt financ-ing. Public bond issues are the predominant method of rais-ing capital for public toll roads in the United States. Of theprojects in this study, only the Mexico City-Toluca Toll Roadwas able to access public capital markets with a bond issue,through U.S. Rule 144A.4 The Toluca financing, however,was for an existing toll road with no construction periodrisk and an established toll revenue stream, which greatlyreduced the traffic and revenue risk relative to start-up tollroads. Accessing the public bond markets will be a biggerchallenge for start-up toll facilities. As with institutionaldebt markets, many developing countries lack substantialbond markets. Where they exist, bond investors are gen-erally reluctant to assume construction and traffic and rev-enue risk. Bond issues, however, may be an important sourceof financing for securitizations or expansions of facilitiesin countries that either have substantial bond markets orare able to access international capital markets.

Regardless of the source of debt financing, one of thecritical challenges for toll road projects is obtaining medium-and long-term debt that approaches the useful lives of thesefacilities (typically ten to thirty years). In this study, debtmaturities generally reached eight to ten years for projectsin developing countries (Chile, China, Malaysia, Mexico)and ten to twenty-five years for projects in industrial countries

18

(the United Kingdom and the United States). Hungary wasable to obtain debt financing with a term of twelve to fif-teen years, although EBRD support was an important fac-tor in making that possible. The debt maturity in Colombiawas just four to five years.

The Mexican toll road program provides examples ofthe risks of financing projects with short-term debt and shortconcession terms. Many of these projects, with concessionand debt terms of less than five years, have been unable tomeet their high debt service payments. The Toluca project,for example, had an initial debt term of four years and a con-cession term of four and a half years. After two years of oper-ation, its financing had to be restructured to a debt term often years and a concession term of eleven years.

Another significant issue facing private toll road financ-ings is that, although bank loans are often the only availablesource of debt that will accept construction and traffic andrevenue risks, in many countries (such as Colombia) the termson loans are less than five years. As a result the proposedfinancing for projects in such environments often assumesbank debt through construction plus two to three years ofoperation, followed by refinancing once the project revenuestream is established. The risk of this arrangement is that ifthe project does not perform according to expectations, refi-nancing of the initial bank loans may not be possible. Thecommercial banks are implicitly taking the long-term finan-cial risk on the project, since they will have to retain and restruc-ture the loan if it cannot be refinanced. However, there is nopreestablished mechanism for addressing this eventuality.

Equity financing

All the projects studied include at least 15 percent equity,with the exceptions of the Mexico City-Toluca Toll Roadand the Dartford Bridge, which had 100 percent debt financ-ing (see annex 1 for a summary of the equity terms). TheGuangzhou-Shenzhen Superhighway was the only projectin which the government took an equity stake.

The sponsors of the projects studied were led by con-struction companies, with the exception of the Guangzhou-Shenzhen Superhighway, which was led by the Hong Konginfrastructure developer Hopewell Holdings, and theM1/M15 Motorway, led by the French toll road operatorTransroute International. A substantial equity contribution

from the project sponsor is important for toll road projectsbecause it provides a strong incentive for the sponsor tomaximize the road’s long-term financial performance ratherthan maximize earnings from the construction contract.

Several international infrastructure investment fundshave been established in recent years to invest equity andquasi-equity in private infrastructure transactions, includ-ing toll roads. Examples include the AIG InfrastructureInvestment Fund and the Asia Infrastructure Fund. Thesefunds raise most of their money from insurance companiesand other large institutional investors in industrial coun-tries. The projects studied were financed prior to the estab-lishment of most of these funds, however, and so do notreflect their activity. In the future such funds could pro-vide equity to the private toll road industry if projects demon-strate an ability to generate attractive returns and adequatelyaddress project risks. The willingness of governments toallow investors to earn the high returns on equity that theyrequire will be an important factor in the ability of toll roadsto attract equity from all sources.

Local investment funds are also increasingly importantsources of equity capital for toll road projects. For exam-ple, numerous funds have been established in Chile to chan-nel the growing pools of private pension fund savings intoattractive equity investments, including toll roads. Two ofthese funds participated in the equity financing of the SouthAccess to Concepción project, and other funds are activelypursuing additional toll road investments in Chile.

Three of the projects studied involve profit or revenuesharing with the host government that may affect returns toequity. Profits from the Guangzhou-Shenzhen Superhighwayare evenly split between the private sponsor, HopewellHoldings, and its joint venture partner, controlled by theGovernment of Guangdong. In Colombia all revenues above125 percent of the base case traffic estimates are transferredto the government sponsor. And in California half of the“incentive returns” that the investors are entitled to earn ifcertain passenger throughput objectives are met will beshared with the state of California. The investors in the Chile,Hungary, Malaysia, and Mexico projects are entitled to retainall project profits and revenues, while the Dartford Bridgeconcession requires that project cash flows be used to repaydebt, with no provision for distributions to private equityholders or the government.

19

The expected returns on equity in toll road projects aredifficult to ascertain from project sponsors because of thesensitive and confidential nature of these estimates. Althoughthe expected returns for the projects studied were unavail-able, discussions with industry participants indicate that tollroad investors generally expect annual returns on equity inafter-tax, nominal U.S. dollar terms in the range of 15–30percent. The wide variance in expected returns can be partlyexplained by the very different risk profiles of toll roadprojects. Expected returns also vary based on the charac-teristics of local capital markets, such as the return objec-tives of local equity investors and the return available onalternative investments of comparable risk within the coun-try. Local capital market characteristics are particularlyimportant for projects that obtain equity funding locally, asdid most of the projects studied.

Policy Issues

Private financing of toll roads raises several important pol-icy issues for sponsoring governments and multilateral finan-cial institutions:

• Under what circumstances should governments con-cession roads to the private sector?

• How should concessions be structured? • When and how is it appropriate for governments to

provide financial support? • What are the critical elements of a concession agree-

ment?

This section briefly reviews selected public policy issues fac-ing private toll road development. The critical elements ofa concession agreement are described in annex 2.

Private or public?

Diminishing general budgetary resources have provided theimpetus for governments to explore “off–balance sheet”methods to raise financing for infrastructure projects, includ-ing private toll roads. Before pursuing a private toll roadprogram, however, the advantages and disadvantages ofprivate tolling relative to public funding or public toll roadsshould be carefully weighed. Assessing the appropriate-

ness of private toll roads is a complex, project-specific processinvolving numerous economic, policy, and politicalconsiderations.

The primary economic benefits of tolling, public or pri-vate, are the user-based funds generated to support roaddevelopment and the ability to influence road use and traf-fic patterns through road pricing. Although certain traditionalsources of public funding, such as gas taxes and registrationfees, are also user-based, they are not collected at the pointof use and therefore are less effective in managing traffic.The primary economic disadvantages of tolling are the timeand cost required to implement toll systems and the poten-tial delays and excessive traffic diversions associated with tollcollection. On purely economic grounds, therefore, tollsshould be used when the benefits of toll revenues and traf-fic management exceed the costs of implementation andany delays and excessive diversions caused by the system.

The difference between private toll concessions and pub-lic tolling is best illustrated by considering the “value chain”for toll road development. Links in the value chain includeproject design, construction, maintenance, toll collection,and financing. The biggest difference between public andprivate tolling is in the financing arrangement, since all theother links in the value chain can be contracted to privateparties under either a public or a private tolling scheme.5

The primary economic advantage private tolling has overpublic tolling is the strong incentive for financial successcreated by the use of private debt and equity to fund theproject. In addition, in some countries a public entity maybe unable to attract capital to a project that a private con-sortium can finance because of the government’s weak rep-utation among investors. The economic disadvantage ofprivate over public tolling is the potentially higher cost ofdeveloping, implementing, and administering a private con-cession program relative to a public tolling scheme. Onpurely economic grounds, therefore, private tolling shouldbe used whenever the value of the private sector’s finan-cial incentive exceeds the additional costs associated withthe private concession process. It is important to note thatif investors assume similar project risks, the cost of capitalfor a specific project should be similar whether it is tolledpublicly or privately. Any financing advantage that a pub-lic entity may have is due to greater government risk assump-tion or distortive tax policies (as with the tax-exempt debt

20

market in the United States), not to an inherent ability ofthe public sector to access lower-cost capital.

In addition to the economic considerations discussedabove, policymakers must consider numerous noneconomicissues when evaluating toll road programs. These includepublic acceptance of tolling, the equity of charging tolls forroad use, and the impact on the government’s flexibility infuture road development. In particular, public acceptanceis one of the overriding issues in toll road developmentand may be the greatest impediment to tolling. Noneconomicissues tend to be greater impediments to private than topublic toll road development. After taking these importantnoneconomic issues into consideration, policy-makers maymake different decisions than those indicated by a purelyeconomic assessment.

In general, private tolling is preferable for projects thatare able to fund most, if not all, of their capital requirementsthrough toll revenues. Private tolling is preferable to publictolling because of the tremendous financial incentives andaccountability created by private debt and equity investment.

When the toll-backed portion of total project capital fallsbelow a threshold amount, the benefits of private tollingmay be diluted to the point that they no longer exceed thecosts. In that case public tolling may be preferable. Publictolling also may be preferable if noneconomic policy con-siderations make private tolling unattractive. Public tollingis preferable to general government funding in these casesbecause of the additional funds generated from the directbeneficiaries of the project and the ability to use tolls tomanage traffic. Projects that are unable to generate suffi-cient revenues to justify the cost of a tolling system andany delays or excessive diversions created by toll collectionshould be funded by traditional government sources.

Concession program structure

The overall concession structure can be divided into twocritical phases, beginning with the policy and legal frame-work and followed by program implementation (figure 5).

Policy and legal framework. A successful concession pro-gram requires a supportive policy and legal framework. Aprivate toll road program should be integrated with national,regional, and local transportation policies and programs andshould be enabled by a concession law. Transportation pol-icy objectives typically include providing efficient mobilityat lowest cost and with the least environmental impact,and facilitating economic development. The interactionbetween a private toll road program and the overall trans-portation policy raises several critical issues:

• What types of roads should be targeted for tolling?• Is a specific toll road concession law necessary, or

can the program be implemented under the existingcontract and investment law?

• How specific should the concession law be with respectto program structure?

• What government entity should be authorized toimplement the program?

One of the first steps in a private toll road program isselecting the roads that are the most appropriate or attrac-tive projects to concession. Because early successes areimportant in establishing credibility for future programs,the selection and design of the initial projects are critical.A country’s concession program should begin with a feasi-ble project of manageable size that carries a high probability

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Concession program structureFIGURE 5

Design the concession program

• Financial andeconomicanalysis

• Prioritizationof projects

• Public-privaterisk sharing

• Bid process

Negotiate and execute

the concession

contract

Solicit and select

concessionaire

Enact a concession

law

Develop a national

transportation plan

Policy and legal framework Program implementation

of success. For example, rehabilitation and expansion ofan existing facility with strong economics and a capital costthat can be financed in local capital markets may be a bet-ter initial candidate than a new multibillion-dollar intercityartery requiring foreign capital.

In addition, it is important to select projects that maxi-mize the benefits of private tolling relative to the costs. Roadswith strong project economics that can be financed mostlywith private funds are preferable to projects that requireextensive government financial support. The costly and time-consuming concession process may not be worthwhile fora project that requires a majority of funding from govern-ment sources. Figure 6 presents some of the questions thatshould be asked in selecting private toll road projects.

A concession policy that combines toll financing and pub-lic funds for road development should target projects withthe strongest economics for concession and fund the weakerprojects with public funds. This approach is contrary to thetendency of some governments to fund high-priority and high-demand projects with public funds, and offer low-priority pro-jects with relatively weak economics for concession.

An additional issue in selecting roads for concession isthe possibility of concessioning a network of roads togetherrather than concessioning each road as a separate project.

An entire network can be concessioned at one time or beginwith a core segment and phase in additional segments overtime. Toll road networks are easier to finance than stand-alone projects because they rely on a diversified revenuestream from several projects rather than just one. This advan-tage is particularly strong if the concessions are phased inover time and the financing for later facilities can be secured,in part, by the revenues of the earlier segments. A potentialdisadvantage of concessioning networks is that, because oftheir size, they may be more difficult for one concessionaireto develop and finance than for several concessionaires toundertake, particularly if the network is to be constructedwithin a short period. In addition, concessioning a networkto a single concessionaire, whether all at once or over time,may limit competition for traffic. Finally, many of the ben-efits of networks are achieved by using economically strongor existing segments of the network to cross-subsidize weakor new segments. Policymakers should consider this issuewhen deciding whether to concession a network.

Once a decision has been made to pursue a private tollroad program, a concession law that specifically addressestoll roads is critical for providing clear legal authority andestablishing government support and accountability for theprogram. Although in some jurisdictions toll concessions

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Concessioning decision processFIGURE 6

Need for Highway X

Are government funds or a public toll road moreappropriate than a private toll road?

Pursue alternativefunding

Concession with nogovernment support

Concession financiallystronger roads and transfer

funding to Highway X

Pursue concessionwith public support

Reevaluate the benefits

of concessioning

Will government support be highlyleveraged by private funds?

Are there financially stronger roads in the transportation plan whose funding

could be transferred to Highway X?

Is Highway X financially viable on its own?

Yes No

Yes No

Yes No

Yes No

can be pursued under the existing legal framework, specificconcession legislation is important to encourage privateparticipants.

The concession law should explicitly assign responsibil-ity to implement the program to a single government entity.Although input and support may be required from severalgovernment entities (such as environmental and fiscal agen-cies), dividing responsibility for program implementationamong multiple entities can greatly complicate and delaythe process. In addition, the legislation should provide broadauthority to implement the program, avoiding numerousspecific or detailed requirements that could inhibit the pro-gram’s flexibility. A properly constructed concession lawwill provide private participants with a relative degree ofcomfort and help mitigate perceived risks.

Program implementation. Once the policy and legal frame-work is in place and initial projects have been selected, awell-defined and controlled process for implementing theprogram can accelerate the program schedule, improvethe quality of bids, and ensure that government objectivesare met. The objectives of the implementation phase includeachieving early successes, limiting government risk andfinancial exposure, conducting a transparent and compet-itive process, attracting qualified bidders and innovativebids, and completing the process in a timely manner.Implementing a program to achieve these objectives raisesseveral important issues:

• Who should be responsible for funding preliminarydesign, environmental, and traffic and revenuestudies?

• What bidding criteria should be used?• How should the facilities be financially regulated?• How flexible or defined should the project design be?• Should the concession contract be negotiated, com-

petitively negotiated, or fully defined prior to bidding?

Government assistance during the development stage—the riskiest phase of a project—can be critical in attractingqualified developers. Consequently, governments should con-sider funding preliminary studies for initial projects in orderto demonstrate public commitment and reduce the cost ofprivate participation in the bidding process. Governments

can facilitate private development of toll facilities by arrang-ing approvals and funding pre-construction developmentcosts, including environmental studies, traffic and revenuestudies, preliminary design, land acquisition, and local per-mits and agreements. Government participation at this stagecan also allow the government to better define the risks andresponsibilities to be allocated to the private partner.

Issues of bidding criteria, financial regulation, design,and negotiations involve tradeoffs between transparencyand competitiveness on the one hand and flexibility andprivate sector innovation on the other. The following dis-cussion presents the available options.

• Bid selection criteria. There are two broad approachesto establishing bid selection criteria. The first is basedon a qualitative scoring of technical and financial pro-posals; the second is based on objective and quan-tifiable factors such as the maximum toll rate or theminimum government contribution to the project.The qualitative scoring approach allows the selec-tion committee to consider a range of important fac-tors in choosing a concessionaire. It also affords theconcessionaire the flexibility to propose innovativesolutions. This approach, however, generally requirescomparing nonuniform proposals on a somewhat sub-jective basis, and thus reduces the transparency andcompetitiveness of the process.

The objective approach allows for a transparent andcompetitive process focused on the factors of mostimportance to the government. This approach, how-ever, requires that all other factors—such as road designand risk-sharing terms—be held constant. Doing somay limit the private sector’s flexibility to propose whatit considers to be an optimal project. In addition, whenthis approach uses numerous factors that are evalu-ated through a formula—such as in the South Accessto Concepción project, which used seven factors—thecompetitive focus on the one or two most importantfactors may be diluted. The Chilean government latersimplified the process for the North Access toConcepción concession and other concessions. Underthe North Access to Concepción process, bidders couldpropose toll rates equal to or less than the government-set maximum with no government subsidy, or pro-pose the maximum government toll rates with an

23

up-front government subsidy. Selection was based oneither the lowest toll rates (with no government sub-sidy) or the minimum government contribution (withthe maximum toll rates).

• Financial regulation. Financial regulation can employa variety of mechanisms, including a maximum toll rateindexed to inflation (or other indices), a return oninvestment ceiling, a traffic or revenue ceiling, andpublic-private profit sharing. An indexed maximumtoll rate is the most common form of regulation becauseof its ease of administration and explicit limitation ontoll rates. Regulating toll rates increases the revenuerisk of toll road projects, however, because revenuesat or below the maximum rate may be substantiallylower or higher than expected, with limited flexibilityfor adjustment. If traffic is lower than expected, ratescannot be adjusted upward to their optimal profit-max-imizing level. If traffic is higher than expected, the gov-ernment cannot limit the concessionaire’s returns bylowering toll rates. In addition, toll rate regulationlimits the flexibility of the concessionaire to managetraffic through variable-rate, market-based tolls.

Return on investment regulation with no toll rateceiling, the method used in California’s SR-91 pro-ject, is highly flexible in allowing toll rate adjustmentsto optimize revenues and profits. This type of regu-lation can also be more precise than toll rate regula-tion in limiting the returns earned by project investors.However, return on investment regulation can becumbersome to administer, since the governmentmust define and monitor all capital expenditures,operating costs, and revenues to ensure that the con-cessionaire does not exceed the return on investmentceiling. In addition, return on investment regulationdoes not provide an incentive for the concessionaireto invest and operate efficiently once it has reachedthe return on investment ceiling.

Public-private profit sharing can take many forms.China’s Guangzhou-Shenzhen Superhighway projectdoes not set a limit on toll rates, and the private spon-sor retains up to 50 percent of project profits. Thisapproach allows for a flexible toll rate policy, but maynot be effective in regulating the private return oninvestment if market demand is stronger than expected.

The regulatory approaches described above can becombined with minimum traffic or revenue guaran-tees and maximum traffic or revenue ceilings to placeupper and lower boundaries on revenue volatility. Atraffic or revenue ceiling can also be combined withprofit-sharing arrangements above the ceiling to main-tain the concessionaire’s incentive to perform once ithas reached the ceiling. These mechanisms can beextremely useful in providing comfort to investors con-cerned about downside risk while protecting the pub-lic interest by limiting private sector returns.

• Design specifications. Design specifications can rangefrom virtually no public sector responsibility for designto public sector responsibility for preliminary design(including general alignment, number of lanes, loca-tion of interchanges and crossings, environmentalmeasures, materials, and pavement cross-sections) topublic sector specification of detailed design plans.A lower level of public sector responsibility for designallows the private sector to propose innovative solu-tions and better match the design specifications tomarket demand. But allowing private sector designflexibility results in incomparable proposals, since dif-ferent bidders may take different approaches to pro-ject design.

• Negotiations. Approaches to contract execution rangefrom full negotiations (with either one party or mul-tiple parties simultaneously) to immediate execu-tion of a predefined contract with no negotiations.Because toll road concession negotiations can be com-plex and time consuming, a predefined contract canbe appealing. In addition, a predefined contract makesthe selection process more transparent and compet-itive since all proposals are subject to the same con-tract terms. Developing a predefined contract that isacceptable to all bidders may be difficult, however.This approach also limits the flexibility for structur-ing innovative arrangements for sharing project risksand responsibilities that are responsive to the needsof specific bidders and investors.

If negotiations are preferred, competitive sessionswith multiple parties can enhance the power of thepublic sector in negotiating contract terms. However,competitive negotiations require extensive resources

24

and stamina on the part of the public sector.Competitive negotiations may also reduce the inter-est and focus of the private partners in participatingin the concession program. Negotiating with one partyat a time, perhaps with a second party in reserve inthe event that the primary negotiations cannot becompleted, may achieve the objectives of competi-tion while conserving public and private resources.

Comparison of the Chilean and U.S. approaches. A com-parison of Chile’s South Access to Concepción and the U.S.SR-91 projects illustrates the tradeoffs involved in devel-oping a concession process. In Chile the government stip-ulated the preliminary design of the road and theconcessionaire was responsible for detailed design, subjectto government approval. In addition, maximum limits wereset for toll rates (indexed to inflation) and there was noallowance for negotiations with the concessionaire afterselection—the government completed the contract prior tobidding based on consultations with potential bidders. Withpotential concessionaires all bidding on the same projectwith a similar design and identical contract terms, selec-tion was based on consistent and objective criteria such asminimum government cash grant, minimum average tollrate, and other factors.

Bidders for SR-91 proposed the projects they woulddevelop and had full responsibility for all project design,subject to government approval. Toll rates were not regu-lated, but a 17 percent ceiling was placed on return oninvestment. The contract was fully negotiated only after aconcessionaire was selected (runner-up bidders were heldin reserve). The basis for comparing bids and selecting theconcessionaire was therefore somewhat subjective, sincethe government had to compare different projects anddesigns without predefined contractual terms. However,this process allowed the private sector to propose innova-tive projects and designs and negotiate risk-sharing terms.In addition, the lack of toll rate regulation allowed for vari-able-rate, market-based toll pricing.

In both cases bidding was open and competitive. In Chileflexibility in project selection and design was sacrificed infavor of complete transparency, which allowed the selec-tion process to be objective and quantifiable. The Chileanapproach ensures that the government receives the most

favorable terms based on the selection criteria. This approachalso can reduce the time and effort required for selectionand contract negotiation, limit the basis for contesting theaward, and reduce the potential for adverse political reac-tion. In California a more complex and less transparentprocess was used to stimulate innovation in project selec-tion and design, giving the government flexibility in select-ing a concessionaire and allowing for market-based tolling.

An important issue for policymakers to consider is underwhat circumstances these two approaches, or hybridapproaches, are most appropriate. Although an in-depthanalysis of the various hybrids and the appropriate condi-tions for each is beyond the scope of this study, some gen-eral observations follow.

The two critical variables for analyzing alternativeapproaches are:

• the opportunities for innovation in design, toll pric-ing, and sharing of risks, responsibilities, and otherelements of the concession process; and

• the value of transparency and competitiveness in theconcession process.

The tradeoff between these variables and the implica-tions for the preferred concession process are summarizedin figure 7.

Projects with limited opportunities for private sectorinnovation generally should use a more transparent andcompetitive concession process, perhaps drawing on theChilean model. Projects with large opportunities for inno-vation in environments where transparency and competi-tiveness are secondary priorities generally should adoptmore flexible and innovative approaches, perhaps drawing

25

Alternative concession approachesFIGURE 7

Opportunities for innovation in design, toll pricing, sharing of risks and responsibilities, and other elements of the concession process

Flexible andinnovative approach

(Example: United States, SR-91)

Hybridapproach

Hybridapproach

Transparent andcompetitive approach(Example: Chile, South Access to Concepción)

Value of transparencyand competitiveness

High

HighLow

on the California model. Projects with large opportunitiesfor innovation in environments that place a high priorityon transparency and competitiveness should develop hybridapproaches to balance their somewhat conflicting needs.The challenge of developing an appropriate concessionprocess lies in identifying a project’s position on this matrixand developing the specific hybrid features that strike a bal-ance between the critical variables.

Government financial support

As noted earlier, governments should seek to minimize theneed for public financial support for toll road concessionsin order to maximize the benefits of concessioning relativeto its costs. Public financial support may be appropriate,however, if it helps mobilize large amounts of private cap-ital. Governments involved in toll road projects shouldalso seek to limit their contingent liabilities, such as mini-mum traffic and revenue guarantees, as well as their directfinancial contributions.

If public financial support is appropriate, a variety ofmechanisms can be used to support private toll financings.These mechanisms range from revenue enhancements,which involve low risk to the public sector but may be oflimited value to investors, to equity guarantees, which pro-vide strong protection to equity investors but create highgovernment exposure. In general, the type and level of gov-ernment financial support incorporated into the concessionterms should be limited to the extent needed to attractfinancing and promote a successful project.

Equity guarantees. Of the various mechanisms availableto government, risk exposure is highest for equity, debt, andexchange rate guarantees. Under an equity guarantee theconcessionaire is granted an option to be bought out bythe government with a guaranteed minimum return onequity. Although there is no public cost under this arrange-ment as long as the project generates the minimum returnon equity, the government essentially assumes all of the pro-ject risk, and private sector performance incentives areseverely reduced. None of the projects studied includedequity guarantees, although an equity guarantee has beenused in other projects, such as the San Juan Lagoon Bridgeproject in Puerto Rico. To date, the Puerto Rican govern-

ment has not been required to make payments to supportthe project’s return on equity.

Debt guarantees. Under a debt guarantee the governmentprovides a full guarantee or a cash-flow deficiency guaran-tee for repayment of loans. As with an equity guarantee, adebt guarantee entails no public cost as long as the projectgenerates sufficient cash flow to service debt. However, itcreates extremely high government exposure and reducesprivate sector incentives. In China the government pro-vided a cash-flow deficiency guarantee for the $800 mil-lion in senior project debt.

Exchange rate guarantees. Under an exchange rate guar-antee the government compensates the concessionaire forincreases in the local cost of debt service due to exchangerate movements. Because currency fluctuations can con-stitute a significant project risk when foreign capital isinvolved, government guarantees can have a substantialimpact on a project’s ability to raise financing. Although noton the same scale as debt or equity guarantees, exchangerate guarantees can still expose the government to sub-stantial risk. They also tend to create an artificial incentiveto raise foreign capital since the exchange rate risk premiumon foreign capital is eliminated by the government guar-antee. Exchange rate guarantees were used extensively inSpain’s toll road program, resulting in large annual exchangerate payments by the government that peaked at about $500million in 1985 (Gomez-Ibañez and Meyer 1992).

Grants and subordinated loans. Equity, debt, and exchangerate guarantees all create contingent exposure of varyingdegrees, depending on the expected operational perfor-mance of the toll road project. Alternatively, governmentscan furnish grants or subordinated loans at project start-up as cash or in-kind contributions. These can provide acritical boost to project economics. In the projects stud-ied, Chile provided a $5 million cash grant—nearly one-quarter of total project capital—with no provision forrepayment. By providing a subordinated loan, a govern-ment can fill important gaps in the financial structurebetween senior loans and equity and can be repaid if theproject is successful. Subordinated loans are repaid afterdebt service on senior loans but before returns to equity.

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Malaysia, for example, provided a $634 million subordi-nated loan, or about a fifth of the total project capital of$3,192 million. It also made soft loan facilities available tosupport minimum traffic levels and currency fluctuations.

Shadow tolls. An alternative structure to a one-time, up-front government payment is a “shadow toll,” whereby thegovernment contributes a specific annual payment per vehi-cle recorded on the road. The advantages of shadow tollsare that they are paid over time and therefore may be lessof a burden to the government than an up-front grant.Furthermore, they enhance the concessionaire’s incentiveto attract users to the facility.

The drawback of shadow tolls is that they may not usegovernment funds efficiently to protect investors fromrevenue risk. Government contributions under a shadowtoll arrangement are higher when traffic is high and lowerwhen traffic is low. Thus government support may inade-quately protect investors when traffic falls below expecta-tions. On the other hand government support may beunnecessarily high when traffic exceeds expectations. Inaddition, the payment of contributions over time creates acredit risk for the concessionaire that is avoided with up-front grants. The inefficiencies of shadow tolls can bereduced in a number of ways, including a declining sched-ule of shadow toll payments as traffic levels increase or amaximum traffic ceiling above which shadow toll paymentsare not paid. Shadow tolls were not used in any of the pro-jects studied. They are, however, being used in the UnitedKingdom’s Design Build Finance Operate program. TheU.K. Department of Transport concessioned the first in aseries of these concessions in late 1995.

Minimum traffic or revenue guarantees. A minimum traf-fic or revenue guarantee, in which the government com-pensates the concessionaire in cash if traffic or revenue fallsbelow a specified minimum level, is a relatively commonform of government support. Typically, the minimum traf-fic or revenue threshold is set below (for example, 10–30percent) the expected level in order to reduce governmentexposure while providing sufficient coverage to support thedebt component of the capital structure. Under such astructure the government can support private financingfor a road that it would otherwise have to fund on its own,

while limiting its financial exposure to the possibility thatrevenue may fall below the guaranteed minimum. In addi-tion, traffic and revenue guarantees retain the sponsor’sfinancial incentive in the project, provided the minimumrevenue stream does not allow for an attractive return onequity. Chile’s South Access to Concepción project includesa minimum revenue guarantee, while Colombia’s Buga-Tuluá Highway project uses a minimum traffic guarantee.

Especially if they are sharing significant “downside”risk with the private sector—for example, when extendingminimum traffic and revenue guarantees—governmentsshould also consider sharing “upside” potential with con-cessionaires (figure 8). This approach can be used by estab-lishing a revenue-sharing threshold at a specified level aboveanticipated revenues. The concessionaire retains 100 per-cent of revenues up to the threshold level, and the gov-ernment receives a percentage of any revenues above thethreshold. The Colombia project includes a maximum traf-fic guarantee above which all revenues are transferred tothe government sponsor.

Concession extensions and revenue enhancements. Two finaltypes of financial support involve very limited public sec-tor risk, but are also limited in their ability to support financ-ing. First, a government can extend the concession term ifrevenue falls below a minimum amount, as was the casewith the Mexico City-Toluca Toll Road. Term extensionsdo not impose any cash cost on the government, but theyalso do not provide any short-term protection to investorsfrom traffic and revenue shortfalls.

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Revenues

Example of public-private revenue sharingFIGURE 8

Time

Government and concessionaire share revenues above certain threshold

Concessionaire retains 100 percent of revenues

Government compensates concessionaire to extent revenues fall below minimum revenue guarantee

Revenue-sharing threshold

Expected revenue stream

Minimum revenue guarantee

Second, as part of the concession structure a govern-ment may enhance revenues by limiting competition, build-ing complementary facilities to feed traffic to the concession,and allowing for the development of ancillary facilities aboveor adjacent to the facility. The SR-91 project includes alimitation on the government’s right to construct or expandcompeting facilities, and the concessionaire received rightsfor ancillary real estate development. These approachesinvolve very limited financial exposure for the public sec-tor and may have significant value to investors. In manycases, however, these measures have a limited ability to sup-port financing because of their unpredictable revenuestreams. In addition, such agreements typically restrict pub-lic control over future development, which may be unat-tractive to the public partner.

Overall assessment

Along the spectrum of possibilities for government finan-cial support, four alternatives significantly increase a pro-ject’s ability to raise financing without creating a high levelof government exposure and distorting the concessionaire’sincentive to perform (figure 9). Grants, subordinated loans,and traffic and revenue guarantees all balance governmentfinancial exposure with their impact on a project’s abilityto raise financing. Shadow tolls can also be appropriate insome cases, although they generally involve equal or greatergovernment financial exposure and have less of an impacton a project’s ability to raise financing than the other three

approaches. Under certain circumstances revenue enhance-ments provided by noncompetition agreements, comple-mentary facilities, and ancillary development can also playan important role. In general, concession extensions andequity, debt, and exchange rate guarantees should beavoided. Concession extensions have a limited value in sup-porting financing, while financial guarantees require thegovernment to assume a high level of financial risk.

An important issue for policymakers to consider is underwhat circumstances these methods of government support,or combinations of these approaches, are most appropri-ate. A detailed analysis of the various combinations andappropriate conditions for each is beyond the scope of thisstudy. However, some general observations regarding theuse of grants, subordinated loans, and minimum traffic andrevenue guarantees follow.

There are two reasons for government to provide sup-port to toll road projects: to reduce capital requirementsor improve revenues to the extent necessary for a projectto be capable of covering debt service and to earn a rea-sonable return on equity based on the expected cash flowsof the project; and to protect investors (principally lenders)from the risk that actual cash flows will fall below expectedcash flows and be inadequate to cover debt service.

Subordinated loans are the preferred means of address-ing the first reason for government support, provided theyare adequate to achieve the objective of project feasibility.Subordinated loans improve feasibility by increasing the debtservice coverage on senior debt and reducing the need forprivate equity, which requires a higher return than debt instru-ments. Another benefit of subordinated debt is that it pro-vides for repayment of the contribution to the governmentwith a return. However, because subordinated debt requiresrepayment of interest and principal, it has less of an impacton project feasibility than grants. Grants may be the mostdirect and efficient means of supporting projects that requirea substantial boost to become feasible. Minimum traffic andrevenue guarantees are poor mechanisms for supportinginfeasible projects because they do not address the coreissue—that expected cash flows are too low to cover debtservice. If a minimum guarantee is set below expected cashflows, the project remains infeasible, while setting theminimum guarantee above expected cash flows would exposethe government to considerable financial risk.

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Range of options for government supportFIGURE 9

Impact on ability to raisefinancing

Low HighGovernment financial exposure

• Concession extension

• Revenue enhancements

• Equity guarantee

• Debt guarantee

• Exchange rate guarantee

• Grant

• Subordinated loan

• Minimum traffic or revenue guarantee

• Shadow tolls

High

Minimum traffic or revenue guarantees, however, arethe best means of addressing revenue risk for feasible pro-jects because they provide a defined floor on revenues thatis generally set at a level sufficient to cover senior debt ser-vice payments. In addition, minimum guarantees have thebenefit of requiring a government contribution only if traf-fic or revenues fall below a specified level. Grants and sub-ordinated loans can mitigate revenue risk by improvingcoverage ratios. However, these instruments may not pro-vide adequate protection when traffic is low, and they involvegovernment support even when traffic is high and govern-ment support is unnecessary.

These mechanisms can also be used in combinationwhen both of the reasons for government support are pre-sent—a project is not financially feasible on its own andrevenue risk is substantial. In such a case a grant and min-imum revenue guarantee together may allow the projectto attract private capital. The Chilean project uses such astructure.

Determining if a project requires government supportto attract financing and, if so, how the support should bestructured requires a detailed analysis of project costs, rev-enues, and risks, as well as a strong understanding of theterms and conditions required by toll road investors. Beforebidding a concession, governments should be aware of aproject’s critical elements, including environmental issues,traffic and revenue potential, preliminary design and costs,local permitting requirements, major areas of risk, finan-cial feasibility, and views of potential investors. Governmentscan greatly enhance the chances of project success by under-taking studies to review these issues and working with expe-rienced advisers, where appropriate.

Finally, the value of government support to investorsdepends, in part, on the credit risk of the government spon-sor. Investors may be particularly inclined to discount thevalue of support mechanisms—such as debt and equityguarantees, minimum traffic and revenue guarantees, andshadow tolls—that are extended over long periods. Wheregovernments are implementing sound road policies but donot have adequate credit for their support mechanisms tobe effective, multilateral financial institutions can providerisk guarantees and credit enhancements to support thecommitments of host governments during a transitionperiod, until the government sponsor has developed ade-

quate credit to support projects on its own. Such mecha-nisms have been used successfully in the power sector.

Future Developments

The private toll road industry is still in the early stages ofdevelopment. There are compelling reasons why the trendtoward private toll roads is likely to continue—most impor-tant, the severe public funding shortfalls for roadway main-tenance, rehabilitation, and construction. Nearly 300 new,privately financed or operated motorway, bridge, and tun-nel projects with development costs totaling $143 billionare currently being prepared in fifty-five countries (Reinhardt1996). But a number of factors may inhibit private tollroad development, including public resistance to tolling,the time and cost of implementing concessions relative totraditional public procurement, and the ability to attractcapital to risky projects and countries.

On balance, private toll road development is likely toexperience a modest increase over the next decade, withseveral new toll facilities financed each year. However, theinhibiting factors probably will not allow for a dramatictransformation in highway funding toward private toll roads.

Supporting factors

Continued growth in private toll road financings will besupported by a number of factors:

• Funding needs. Governments will continue to experi-ence severe funding shortfalls for road maintenance,rehabilitation, and construction. As noted in the firstsection of this report, governments have severelyunderinvested in road infrastructure. Although high-way needs are expanding, public funding sources areconstrained by limited resources and spending pri-orities in other areas. Governments have been unwill-ing and unable to raise taxes to meet highway needs.Private tolling will be an increasingly attractive optionfor closing a portion of the highway funding gap.

• Success of toll roads in raising capital. Since 1950 pub-lic authorities in the United States have sold about$40 billion in bonds to fund some thirty roads andtwenty bridge and tunnel facilities. In Europe pub-

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lic and private toll roads have raised substantialamounts of capital to fund highway improvements.The demonstrated success of public and private tollroads in raising capital will be an important contrib-utor to future toll road development.

• Privatization trends. A global trend toward commer-cializing and privatizing state-owned enterprises andreducing government’s role in the economy hasincreased support for private toll roads. Concessionsattract private capital and technical expertise and usemarket incentives (such as toll pricing) to promotemore efficient road usage.

• Electronic tolling. Advances in electronic tolling tech-nologies—such as automatic vehicle identification,which allows motorists to pay tolls without stopping—can make toll collection more convenient, lower tollcollection costs, and allow use of peak period pric-ing. The SR-91 project is an excellent example of theuse of these techniques and will provide valuableexperience for future toll road developers.

• Supportive legal and policy frameworks. As govern-ments gain more experience with toll roads and othertypes of infrastructure concessions, the legal and pol-icy frameworks for implementing toll road conces-sions should become more sophisticated andsupportive.

• Increasing sophistication of public and private partners.Both private industry and public entities are gainingexperience and sophistication in designing and imple-menting workable concession structures.

• Improved access to capital. As experience with suc-cessful infrastructure finance transactions grows,the ability of private toll roads to access a variety offinancial sources and instruments should expand. Forexample, institutional investors may become moreimportant sources of capital in the future, althoughcertain regulatory hurdles and risk issues will have tobe addressed for this to happen.

Inhibiting factors

As the body of experience with private toll roads develops,the volume of private toll road financings may be constrainedby a number of factors:

• Public resistance to tolling. One of the greatest imped-iments to toll roads is the public’s resistance to pay-ing tolls, especially on existing roads that the publicoften perceives as already paid for through tax rev-enues. Public resistance to tolling has impeded orhalted private toll road programs in environmentsranging from Washington state (in the United States)to Argentina. Advances in electronic tolling shouldreduce public resistance associated with the incon-venience of having to stop to pay tolls. However, theconcept of road pricing is still not widely accepted.Of particular concern to some opponents of tollingis the alleged inequity of charging the public, espe-cially low-income passengers, to use a vital publicfacility.

• Complexity of the concession process. The time and costrequired to establish the complex legal and policyframework required for a concession, implementthe program, and close financing is a second impor-tant inhibiting factor. As discussed in the section onfinancing structures and sources, private toll roadconcessions involve highly complex legal and finan-cial arrangements and are often difficult and time-consuming to finance. In many cases these costs mayoutweigh the benefits of private tolling, althoughincreased experience and sophistication among pub-lic and private partners may reduce these costs inthe future.

• Unsupportive legal and policy frameworks. The diffi-culty of developing private toll roads is often com-pounded by government’s failure to integrateconcessions with a broader regional or national trans-portation policy. For example, some governments fundhigh-priority roads with strong economics with pub-lic funds and leave low-priority roads with weak eco-nomics for concessions. Also, significant barriers toprivate toll road development persist in many coun-tries. For example, in the United Kingdom the absenceof legal authorization for charging tolls on existingroads has led to a program based on shadow tolls. InChina, Mexico, and other countries the legal systemmay not provide adequate assurance to investors thatthey can obtain an objective settlement of contractdisputes.

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• Private toll road failures. Notable private toll road fail-ures have made investors and governments cautiousabout pursuing such projects. For example, inThailand’s Bangkok Second Stage Expressway pro-ject the government failed to abide by an agreementto increase toll rates, causing losses for projectinvestors. And, as mentioned, in the U.S. state ofVirginia the Dulles Greenway, which has involvedsophisticated private partners and techniques forstructuring the concession and financing, is experi-encing traffic levels substantially below the levelsrequired to service debt.

• Competition for financing. Alternative investmentopportunities, including power generation and otherinfrastructure projects, will compete with toll roadsfor capital. In addition, a large portion of private tollroads are planned in relatively risky developing coun-try environments. Private toll roads will be able toattract capital only to the extent that they are able togenerate competitive risk-adjusted returns relative tothe alternatives. Although information on actualreturns to toll roads is limited, experience to date sug-gests that the risks are extremely high.

• Limited number of attractive projects. Private tolling isunlikely to become a substantial portion of total high-way funding simply because there is a limited num-ber of roads, particularly new roads, with strongenough project economics to attract private financ-ing without substantial government contributions.

Challenges ahead

The challenge to those who are working to expand the tollroad industry will be to overcome these inhibiting factors,through such measures as:

• Developing broader public acceptance of tolling asa standard method of road finance, similar to userfees for water, electricity, and other public services.

• Developing standard concession models and financ-ing arrangements that are relatively easy to replicateand tailor to specific projects in order to reduce thetime and cost required to implement concessions.

• Improving the legal and policy frameworks for private

toll roads by reducing barriers to concessions andencouraging governments to concession roads withstrong economics, including existing roads.

• Educating governments and the public about pro-ject successes and potential pitfalls.

• Targeting projects and developing structures that gen-erate attractive returns to private investors, while ade-quately addressing project risks.

Multilateral financial institutions, such as the World Bankand the EBRD, can play an important role in supportingprivate toll road development in developing countries. First,multilaterals are in a unique position to advise governmentson the appropriate role of private toll roads in a nationaltransportation plan. Secondly, multilaterals can help gov-ernments structure and implement complex toll road trans-actions by providing technical assistance and general advice.Finally, multilaterals can support private financings usingrisk guarantees and credit enhancements that have beenused successfully in other sectors, such as power genera-tion. Multilateral institutions will most likely have to playa critical role in this early stage of private toll roaddevelopment if it is to grow into a larger, self-sustainingindustry.

Notes

1. All toll lane users on SR-91 will be required to obtain atransponder that electronically debits their prepaid account asthey pass under overhead antennae. The tolls are initially set at aminimum of $0.25 during off-peak periods and rise to a maxi-mum of $2.50 during weekday rush hours.

2. For the purposes of this report the public sector refers tothe host government for the project and does not include otherpublic or quasi-public entities, such as multilateral financialinstitutions.

3. The EBRD is “lender of record” for both the A-loan and B-loan. The EBRD provides the A-loan from its own account andassumes full project risk. The B-loan is fully syndicated to inter-national commercial banks that benefit from the EBRD’s statusas a preferred creditor.

4. Rule 144A, part of the Securities Act of 1933, permits qual-ified institutional buyers to issue, buy, and resell certain securitieswithout filing formal registration statements or transaction reports.

5. The San Joaquin Hills toll road project in California, forexample, uses private construction and toll collection on a pub-licly financed project.

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Annex 1Summary of Debt and Equity Terms

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Summary of debt termsAmount in US$ millionsa

Country, project Debt rank Source (denomination) Interest rate Debt term

Chile, South Access to Concepción Senior Banco del Estado de Chile 13 (pesos) UF + 8.5%b 8–10 years

Colombia, Buga-Tuluá Highway Senior Caja Agraria 7 (pesos) TCC + 5.0%c 4 yearsSenior Corfivalle, S.A. 3 (pesos) DTF + 5.25%c 4 yearsSenior Cofinorte 1 (pesos) TCC + 5.5%c 4 yearsSenior Institute de Fomento Industrial 4 (pesos) LIBOR + 5.5% 5 years

Mexico, Mexico City-Toluca Toll Road Senior Lehman Brothers/IFC 208 (dollar- 11.25% 10 years(underwriters) indexed)

Senior Mexican Interacciónes de Bolsa 105 (pesos)(underwriters)

China, Guangzhou-Shenzhen Superhighway Senior Banks 800 (dollars) LIBOR + 1.4% 8 years

Malaysia, North-South Expressway Senior Foreign and local banks 796 (RM) Malaysian base lending 8–10 yearsSenior Local banks and employee 807 (RM) rate + 1.5%

pension fundsSubordinated Government 634 (RM)Standby Local banks 179

Hungary, M1/M15 Motorway Senior EBRD A-Loan 58 (ECU) LIBOR + 3% 15.5 yearsSenior EBRD B-Loan syndicate 163 (ECU) 14.5 yearsSenior Private placement 33 (HUF) 12.5 yearsSenior Bank bond 33 (HUF) 5 yearsSenior Serial bond 33 (HUF)Senior Local bank 33 (HUF) 12 years

United Kingdom, Dartford Bridge Senior Bank of America Syndicate 178 (pounds) Confidential 11 yearsSubordinated Consortium “loan stock” 53 (pounds) 16 yearsSubordinated Consortium “loan stock” 60 (pounds) 18 years

United States, SR-91 Senior Citibank 65 (dollars) Confidential 14.5 yearsSenior Kiewit Diversified Group 35 (dollars) 24.5 years

(later sold to CIGNA)Subordinated Orange County (California) 7 (dollars) 8.5 years

a. All nondollar amounts are converted at the exchange rate in the year of financial close.b. UF is the inflation-indexed currency of Chile.c. TCC and DTF are variable interest rate indexes used in Colombia.

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Summary of equity termsEquity

amount Equity investors Type (US$ Profit/revenue

Country, project (country of origin)a of company millions) sharing

Chile, South Access to Concepción BELFI (Chile) Construction 9 None.Las Américas AFI (Chile) Investment fund CMB Prime AFI (Chile) Investment fundAssesorías Inversiones CMB (Chile) Private investors

Colombia, Buga-Tuluá Highway Ferrovial, S.A. (Spain) Construction 16 All revenues in excess of 125 percentConciviles (Colombia) Construction of base case traffic (specified in the Central de Seguros (Colombia) Insurance bidding documents) are transferred Corporación Financiera del Valle Financial corporation to the provincial government.(Colombia)

Instituto de Fomento Industrial Financial corporation (Colombia)

Thomas Greg & Sons (Colombia) Toll collection

Mexico, Mexico City-Toluca Toll Road TRIBASA (Mexico) Construction NA None.CIESA (Mexico) Construction

China, Guangzhou-Shenzhen Superhighway Hopewell Holdings (Hong Kong) Developer 922 Hopewell receives 50 percent of Guangdong Provincial Highway Local government 200 profits for the first ten years of Construction Company (China) operation, 48 percent for the second

ten years, and 45 percent for the lastten years. The Guangdong Provincial Highway Construction Company(controlled by the Province of Guangdong) receives the remainder of the profits.

Malaysia, North-South Expressway United Engineers Berhad/PLUS Construction 583 None.(Malaysia)

Employees Provident Fund and Pension funds 192Government Social Security (Malaysia)

Hungary, M1/M15 Motorway Transroute International (France) Operation None.Banks (France and Hungary) Commercial banks 79Subcontractors to Strabag Construction (Austria and Hungary)

Undisclosed Unknown 9

United Kingdom, Dartford Bridge Trafalgar House (U.K.) Construction <0.002 All project cash flows are used to Prudential Assurance (U.K.) Insurance repay debt; there are no distributions Kleinwort Benson Ltd. (U.K.) Investment bank to shareholders.Bank of America (U.S.) Commercial bank

United States, SR-91 Kiewit Diversified Groups (U.S.) Diversified construction 19 Consortium is limited to 17 percent Cofiroute (France) Operation base return on investment plus Granite Construction, Inc. (U.S.) Construction additional incentive return if passenger

throughput targets are achieved; 50 percent of incentive return is shared with the state; 100 percent of return above base and incentive return is transferred to the state.

a. Lead sponsor listed first.

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The concession agreement is the principal contractgoverning a private toll road project. It shouldaddress the major terms and conditions described

below, in addition to standard commercial contract terms.This annex summarizes selected terms and conditions; it isnot intended to be a comprehensive listing of all the legalprovisions required in a concession agreement.

Preamble

Listing of the parties to the contract and description of theproject background.

Concession rights and obligations

An explicit recognition of the private sponsor’s exclusiverights to design, build, finance, and operate the projectduring the concession period, including the legal autho-rization for the concession, the concession term, even-tualities under which the concession term may beextended, any payments required from the concession-aire to the government for the concession rights, and theparty that holds legal title to the facility over the life ofthe concession.

Representations and warranties

A description of each party’s additional representations andwarranties that are not addressed elsewhere in the contract.This includes a description of each party’s understandingof the background, legal authorization, responsibilities, andcommitments under the concession agreement.

In addition, this section may include a listing of covenantsfor each party. For the concessionaire these may include

requirements regarding insurance, performance bonds, min-imum equity contribution, and corporate structure. For thegovernment this may include assistance in obtaining gov-ernment approvals and permits.

Acquisition of right of way

The specific responsibilities of each party for funding, acquir-ing, and preparing the project right of way, including therisk of delays or cost overruns.

Development and construction

The specific responsibilities of each party for developingand constructing the project, including environmental com-pliance, permitting, design, financing, and construction.

The agreement should specifically address the riskborne by each party in the event of unplanned occur-rences, such as delays associated with environmental com-pliance and permitting, unforeseen soil conditions, designchange orders, and cost overruns. In addition, the agree-ment should address the eventuality that the conces-sionaire is unable to raise sufficient financing to completeconstruction of the facility on a timely basis. Finally, theagreement should address any rights and responsibilitiesof the concessionaire to modify or expand the facility inthe future beyond the requirements of the initialconcession.

Acceptance

The conditions under which the government will acceptthe completed facility and approve the commencement ofoperations.

Annex 2Critical Terms and Conditions of a Concession Agreement

Operations

The specific responsibilities of each party during the oper-ating phase of the project, including toll collection, tollenforcement, road maintenance, police services, safety, andmanagement and administration.

The agreement should specifically address the risk borneby each party with respect to technical failure of the toll col-lection system, ineffective enforcement of toll payments byusers, poor maintenance practices, tort liability, and other oper-ating risks. The agreement may also include requirements forthe concessionaire to obtain insurance to cover certain risks.

Government financial support

Any mechanisms (such as minimum revenue guarantees,cash grants, in-kind contributions, loans), committed bythe government to support the project, the magnitude andtiming of the contributions, and the recourse of the con-cessionaire in the event the government does not honor itsfinancial commitments under the agreement.

Foreign exchange risk

The specific rights of the concessionaire and any arrange-ments related to the conversion of local currency earningsinto foreign currency. Issues that may be addressed includethe right to convert local currency into foreign currency,the availability of foreign exchange at the time of conver-sion, the ability to transfer funds out of the country, andthe exchange rate at which conversion occurs.

Construction of complementary facilities

Any specific facilities, such as connecting roads or interchanges,that the government is committed to provide, including datesby which construction is to be completed and the remedy inthe event the government is unable to honor its commitment.

Limitations on the construction of competing facilities

The specific corridor, if any, within which the government isrestricted from constructing competing facilities, expandingexisting facilities, or granting concessions for such facilities.

Rights to develop ancillary facilities

Any specific rights of the concessionaire to develop spaceabove or adjacent to the facility. The agreement shouldalso specify that the financial returns generated from suchactivities are excluded from the financial regulation of thetoll facility.

Financial regulation

The approach and enforcement mechanism for financialregulation. If toll rate regulation is used, the agreementmust specify the maximum toll rate by type of vehicle, theindex used to adjust toll rates, and the time period or thresh-old that must be met for a toll rate increase to occur. Theagreement should also clearly describe the specific proce-dure for calculating and revising the toll rate schedule.

If rate of return regulation is used, the agreement mustspecify the basis for the regulation (that is, return on equityor return on total capital), the maximum rate of return allowed,and the detailed calculation used to determine whether theconcessionaire has exceeded the allowable return ceiling.

Rate of return enforcement requires a detailed descrip-tion of the items included and excluded from capital costs,operating costs, and revenues, as well as the method forcalculating the return. (The treatment of taxes and reservefunds can be a particularly complex and important issue inthis approach.) The rate of return calculation can have adramatic effect on the revenues that the concessionaire isentitled to retain under a given rate of return ceiling.

Profit sharing, revenue sharing, and financial incentives

The specific conditions under which profits or revenues areshared with the government sponsor or any other entity. Forexample, if a maximum traffic or revenue ceiling is usedwith profit sharing above the ceiling, the agreement shouldspecify the maximum traffic or revenue threshold for eachyear of the concession, the revenue sharing formula, andthe procedure for calculating and transferring the govern-ment’s share.

If incentive provisions are used, the agreement shouldspecify the events that trigger the incentive payment andthe magnitude and timing of the payments. For example,

35

if incentive payments are provided for improving the safetyrecord or occupancy per vehicle on the facility, the agree-ment must specify the basis and procedures for measuringthese variables and calculating an incentive payment basedon the observed measurement.

Reporting and monitoring procedures

The reports that the concessionaire must provide to thegovernment in order to monitor the financial and otherterms of the agreement. The financial reports will dependon the approach to financial regulation, the form of anygovernment support, and the structure of any profit orrevenue sharing and incentive mechanisms. Under tollrate regulation financial reporting and monitoring may belimited to toll rate verification. Minimum revenue guaran-tees will require reporting revenues on a regular basis. Underrate of return regulation extensive reporting is required tomonitor capital costs, operating costs, revenues, and rateof return. In addition, a procedure is required for the gov-ernment to monitor and verify the data reported by the con-cessionaire, including arrangements for auditing andchallenging the concessionaire’s reports, if necessary.

Force majeure

The allocation of responsibility for force majeure risk, includ-ing the specific division of the risk, if applicable. For exam-ple, if the private sector is allocated natural force majeurerisk and the government takes responsibility for politicalforce majeure risk, then these risks must be defined specif-ically in the agreement, including the government’s remedyin the event of a political force majeure event. The gov-ernment remedy could take a variety of forms, including

cash compensation or an extension of the concession termequal to the length of the disturbance.

Assignment of the concession

The terms and conditions under which the concession maybe sold or transferred to a party other than the originalconcessionaire.

Termination of the concession

The specific conditions under which the concessionaire orthe government can cancel the concession and the conse-quences of termination, including penalties and the sub-stitution of a new concessionaire.

Default

A listing of the events that constitute default on the part ofeach party, their remedies, and the procedures for obtain-ing compensation. In some countries violations of the agree-ment may be addressed through standard contract andtakings law. Alternatively, this section may include a listingof material adverse actions by each party and the conse-quences and remedies associated with such actions.

Dispute resolution

The procedures for settling disputes that arise under theagreement in a fair and timely manner. This section mayinclude provisions for arbitration or mediation for certaintypes of disputes. Foreign concessionaires and investorsmay prefer disputes to be resolved in a neutral jurisdictionoutside of the project country.

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37

References

The project-specific information in this study is based ona variety of sources, including project concession agree-ments, offering memoranda for project securities, IFC invest-ment memoranda, trade journals, other secondary sources,and telephone interviews with project sponsors, projectfinancial advisers and consultants, and officials of multi-lateral financial institutions.

The discussion of legal issues in this study, includingforce majeure, tort liability, and political risk, is based oninformation provided by project sponsors and advisers.Detailed analysis of these issues by the authors of this studywas not possible because of the confidentiality of many ofthe concession agreements and the limited scope of thestudy.

The general history information in this study is from sec-ondary sources, including trade magazines, books, andresearch reports, as noted.

The statistics on the country and concession environmentin each project country are from various reference materi-als, magazines, and Standard & Poor’s Ratings Services.

Carr, Julie, and Rob Wright. 1996. “U.S. Toll Road Projects HaveMixed Experiences.” Project Finance International (March 27).

IMF (International Monetary Fund). Various years. InternationalFinancial Statistics. Washington, D.C.

Klein, Michael, and Neil Roger, 1994. “Back to the Future: ThePotential in Infrastructure Privatization” World Bank,Washington, D.C.

Meyer, John, and José Gomez-Ibañez. 1993. Going Private: TheInternational Experience with Transport Privatization. Washington,D.C.: The Brookings Institution.

Reinhardt, William J. 1996. “1996 International Major ProjectsSurvey.” Public Works Financing (October).

USDOT (U.S. Department of Transportation). 1995. Status ofthe Nation’s Surface Transportation System: Condition andPerformance. Washington, D.C.