Singapore Management University

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Research Collection School Of Economics School of Economics

1-2022

Sustainable strategies for Mass Rapid Transit PPPs

Sock Yong PHANG
Singapore Management University, syphang@smu.edu.sg

Bin Chye TAN

Land Transport Authority Singapore

Follow this and additional works at: https://ink.library.smu.edu.sg/soe_research

Part of the Asian Studies Commons, Public Economics Commons, and the Transportation Commons

Citation
PHANG, Sock Yong and TAN, Bin Chye. Sustainable strategies for Mass Rapid Transit PPPs. (2022).
Handbook on Public Private Partnerships in Transportation. 1, 153-174.
Available at: https://ink.library.smu.edu.sg/soe_research/2533

This Book Chapter is brought to you for free and open access by the School of Economics at Institutional
Knowledge at Singapore Management University. It has been accepted for inclusion in Research Collection School
Of Economics by an authorized administrator of Institutional Knowledge at Singapore Management University. For
more information, please email cherylds@smu.edu.sg.
 1

Sustainable Strategies for Mass Rapid Transit PPPs

Sock-Yong Phang and Bin Chye Tan
S. Y. Phang Singapore Management University, Singapore

B. C. Tan High-Speed Rail Group, Land Transport Authority of Singapore, Singapore

Published in S. Hakim et al. (eds.), Handbook on Public Private Partnerships in Transportation, Vol I,
pp. 153-174. Springer. DOI: 10.1007/978-3-030-83484-5_9

Abstract:
Mass rapid transit (MRT) PPPs have proliferated in the past two decades. This chapter provides a
framework to categorise and understand alternative PPP designs. As MRT systems are inherently
large, unprofitable and risky projects, PPP design is critical to project success and sustainability. We
study the experiences of MRT PPPs in London, Hong Kong, Singapore and Beijing to understand
factors underlying success and failure and to arrive at policy recommendations for PPPs. Policymakers
need to have additional governance improvement and risk mitigation measures in place when tied
supply chains are utilised. Hong Kong’s experience illustrates that ‘Rail plus Property’ strategy can
facilitate synergies and cross-subsidization of rail from land value capture. Appropriate mechanisms
for allocation of revenue risks are key to financial sustainability. The government should own MRT
systems, but there are benefits of design-build-finance-operate-maintain-transfer PPPs for lines,
private financing of rolling stock and private sector maintenance of assets and operation of train
services.
Keywords:
MRT, PPP designs, Risk allocation, Land value capture, Vertical integration

Abbreviations
BIIC: Beijing Infrastructure Investment Corporation
BMTRC: Beijing MTR Corporation
CNY: Chinese Yuan
DBFOMT: Design-build-finance-operate-maintain-transfer
E&M: Electrical and mechanical
ISC: Infrastructure Service Charge
JICA: Japan International Cooperation Agency
LTA: Land Transport Authority, Singapore
LUL: London Underground Limited
MRT: Mass rapid transit
MTR: MTR Corporation Limited, Hong Kong
PTC: Public Transport Council, Singapore
SMRT: Singapore Mass Rapid Transit Limited
TfL: Transport for London
UITP: Union Internationale des Transports Publics (The International Association of Public Transport)
UKNAO: UK National Audit Office
URT: Urban rail transit
XRL: Express Rail Link, high-speed rail in Hong Kong
 2

Introduction

With rapid urbanization in developing countries, the number of urban rail transit (URT)
systems completed, undergoing construction or expansion has increased dramatically in the
past decade. The term URT includes a broad range of urban and suburban electric passenger
transit systems including trams, light rail, monorail, magnetic levitation (maglev) and mass
rapid transit (MRT). For procuring less complex tram, monorail and light rail transit projects,
several governments have chosen to use PPPs (Carpintero & Petersen, 2015). In this chapter,
the focus is on MRT (metros, subways) where underground construction is often involved.

From 2010 to 2019, 45 new metro systems were constructed, mostly in China and India
(UITP XE “Union Internationale des Transports Publics (The International Association of
Public Transport)”, 2019; Xue, 2018; Xinhua, 2018; Global Construction Review, 2019).
Several Latin American cities are starting new projects, and those with existing systems are
expanding them. The World Bank Group recently published The Urban Rail Development
Handbook to provide policymakers with practical recommendations to improve URT
implementation (Pulido et al., 2018).

Several cities have embraced the PPP approach for these costly, risky and complex
developments (Xue, 2018). The most cited objectives for using PPPs were access to technical
and/or operating expertise, private sector cost efficiency and private capital. The design of
MRT PPPs has been varied (Phang, 2007; Chang & Phang, 2017; Ke et al., 2017; Pulido &
Mandri-Perrott, 2018; Bray & Sayeg, 2013). The experiences of the cities that have utilized
PPPs provide useful lessons for transport policymakers new to MRT development.

Notable failures have tainted MRT PPPs (Hall, 2015). A common belief is that private sector
involvement in URT is problematic as it is an unprofitable and risky activity (Gomez-Ibanez
& Meyer, 1993). Detractors of URT PPPs often cite the persistent dominance of government-
owned metro systems in the USA (Pulido & Mandri-Perrott, 2018) to support their view that
it is not feasible to privatise URT.

Given the enthusiasm, scepticism and controversy, the objective of this chapter is to examine
notable MRT PPPs to glean important lessons for policymakers on PPP design. While some
studies use ‘success’ to mean technical/operational success and delivery of projects
(Dehornoy, 2012; Halcrow, 2004), this chapter adopts a more stringent definition and
includes financial sustainability of the PPP for the duration of its tenure as an additional
criterion. We first provide an overview of the complexity and risks for metro development, as
well as the forms of PPPs that have been utilised. We then select four cases (Singapore,
London, Hong Kong and Beijing) for more in-depth analyses and conclude with suggestions
and practical recommendations for MRT PPPs.

Key Challenges in Designing MRT PPPs

In high-density cities, MRT or metros represent the most cost-efficient mass transit mode for
moving large numbers of commuters along transportation corridors. Although there are risks
associated with all infrastructure projects, metro projects are particularly risky (Pulido &
Rios, 2018). Construction involving tunnels and underground stations in densely populated
urban areas is challenging even in the best of circumstances. The costs of undertaking the
construction of tunnels, tracks and stations and procuring electrical and mechanical (E&M)
assets such as rolling stock, power supply and signalling systems are in many cases in the
billions of dollars.
 3

For a sample of 44 urban rail projects located across the world and completed between 1966
and 1997, Flyvbjerg (2007) estimated that 75% had cost escalations or overruns of at least
33%, and 25% had cost escalations of at least 60%. The need for lengthy approval processes
that could span several jurisdictions and government agencies as well as the need to engage
with numerous stakeholders are also contributory factors to unanticipated cost escalations.

Once in revenue service, maintenance and operation costs are above fare revenue for most
systems and increase significantly with age of the system (Levy, 2017; Shang & Zhang,
2013). Fare revenue for transit could be low for a number of reasons: ridership, fare
regulation, fraud and free fares in some cities for selected categories of users. For greenfield
projects, there has been a long history of ridership failing to meet predevelopment forecasts
(Bray & Sayeg, 2013; Siemiatycki & Friedman, 2012). For a sample of 22 urban rail projects
completed between 1969 and 1998 and located in North America, Europe and developing
countries, Flyvbjerg (2007: Table 6) estimated that 75% had actual ridership at least 40%
lower than forecast, and 25% had actual ridership at least 68% lower than forecast.

Phang (2007) categorized the risks intrinsic to a metro rail project under the four main project
tasks: design, finance, construction and operations. Pulido and Rios (2018) highlight the
common risks URT projects face that are magnified by their scale and long implementation
periods. Table 1 is a compilation of the list of the numerous risks involved (Phang, 2007;
Pulido & Rios, 2018), many of which may not be appropriate to be transferred to the private
sector. The Beijing Line Number 4 PPP, discussed later in this chapter, is a good example of
appropriate risk sharing allocation.

Table 1 Nature of risks (is risk usually better allocated to private sector?)
 4

Given the numerous risk factors and the complexity of risk allocation, it is not surprising that
well-funded governments that have developed capital delivery and operational management
expertise prefer to adopt a traditional public works approach where a government agency
undertakes to finance, deliver and operate the entire project. For the same reasons, there is
growing interest from the governments of cities requiring URT systems that do not have
adequate technical expertise locally and/or face fiscal constraints, to utilize PPP procurement.

In designing a PPP, risk identification and assessment need to be carried out early in project
development and risk allocation given special attention throughout the PPP design phase
(Pulido & Rios, 2018; Bray & Sayeg, 2013). The tasks and risks allocated to the private sector
are key factors in determining the eventual success and sustainability of the PPP. The private
sector partner will require compensation for any risk that it is required to bear, and the risk
premiums will form part of the project’s costs.

There are a few critical factors to consider when deciding if a particular risk should be
transferred to the private sector: the degree to which it is able to influence or control the
outcome that is risky and its ability to bear the risk. The public sector partner needs to
consider if the private sector partner can potentially benefit by taking on the risk and if there
are net efficiency improvements to be gained from the risk transfer or sharing. This requires
the public sector to have adequate institutional capacity to conduct risk assessment and
negotiate with private sector contractors and partners to determine fair risk premiums (Pulido
& Rios, 2018).

Based on experiences of URT PPPs in four Southeast Asian cities, (Bray & Sayeg, 2013)
concluded that ‘operating risk should be transferred to concessionaires to the greatest extent
possible, followed by equipment supply risk to support transfer of operating risk, design risk
to allow system life-cycle costs to be minimized and construction risk to ensure efficient
delivery of the rail system’.

If risks are not appropriately allocated (and subsequently mispriced), it can lead to adverse
selection and moral hazard problems that undermine the benefits of the PPP. It is possible to
allocate tasks such as metro operations to the private sector partner, while retaining or sharing
the revenue or ridership risk with the public sector through guarantees. Government
guarantees however can impose hidden costs on the public sector, consumers or taxpayers,
some of which may not be immediately apparent at the early stages of the project. Using the
case of an urban railway project in Seoul, Kim et al. (2019) analysed how minimum revenue
guarantees can pose a significant financial burden to the government.

Closely intertwined with the issue of risk allocation is the task or combination of tasks to
allocate to the private sector in the PPP (Carpintero & Petersen, 2015). There are multiple
PPP designs in the metro systems sector. The next few paragraphs summarize the more
extensive discussion found in Chang and Phang (2017). Table 2 illustrates the heterogeneity
of metro PPP design in the tasks separated or bundled and allocated to the private sector
partner.
 5

Table 2 Varied structures of MRT PPP

Row A in Table 2 shows the London Underground PPPs where in 2003, the government-
owned Transport for London (TfL) separated out its ownership of the infrastructure and
awarded them to two private companies to upgrade and maintain. Row B of Table 2 shows
examples of systems where the public sector owns rail infrastructure and rolling stock assets
and privatises operations and maintenance functions as in Stockholm and in Latin American.

Row C shows the case of Singapore which relied on private firms to operate trains services
between 2000 and 2016. Row D shows mixed systems for cities which have experimented
with unbundled PPPs. The government remains the principal owner but introduces PPPs for
one or more lines or functions. Cities with such mixed systems include Barcelona, Beijing,
Hangzhou, Shenzhen, Seoul, London, Lima and Bangkok.

Row E shows the privatised vertically integrated design-build-finance-operate-maintain-

transfer (DBFOMT)-bundled approach utilised in Hong Kong and Hyderabad. This strategy
represents the greatest degree of transfer of tasks, control and risks to the private sector
partner. Hong Kong’s Mass Transit Railway (MTR) is a regulated monopoly provider that is
also involved in real estate development; it also operates in several other cities globally as the
private partner in PPP projects.

For the construction of a new metro system, there are advantages (and disadvantages) in
splitting a mega-project into several smaller components or combination of components and
different phases, instead of bundling several projects into one large procurement or PPP
contract. While this splitting allows for greater flexibility, could reduce risk, increase
competition and is lower in costs to taxpayers, it requires the public sector project owner to be
responsible to manage and integrate the multiple contracts and bear the interfacing risk
(Pulido & Mandri-Perrott, 2018). Regardless of bundling or integration of tasks, ridership
demand risk for URT PPPs can be considered separately, and there are different models
internationally that have been used to transfer or share demand or revenue risk (Siemiatycki &
Friedman, 2012). We will contrast the experiences in Singapore and Beijing in the next
section.
 6

Analysis of Two Failed MRT PPPs

In this section, we analyse the factors behind the failures of MRT PPPs in Singapore and
London that eventually led to re-nationalization. Specific details of the Singapore and London
systems such as ridership, fares and other relevant variables are summarised in Table 3.

Table 3 Description of cities and MRT PPP, 2019

 7

Revenue Risk in Singapore’s Urban Rail System

Fare revenue (farebox) is a function of ridership and fare levels. This section considers the
treatment of fare revenue risk in Singapore’s MRT system. The first two lines of Singapore’s
MRT system were built and financed by the government in the 1980s. The government
funded the cost of building the civil infrastructure1 and the first set of operating assets. In
1987, when the first lines began operations, the government established the Singapore MRT
Limited (SMRT), wholly owned by Temasek Holdings (a government-owned investment
holding company), as the operator. The government leased the running of the rail system to
SMRT for an initial 10-year period; there was no competition for the concession. The
government had expectations for the MRT operator to be financially self-sufficient (as was
the case then for the bus operators) and to cover its operating and maintenance costs including
provisions for eventual rolling stock replacement from fare revenues.

However, it soon became clear that one of the government’s financial criteria, of full farebox
recovery before it granted the go-ahead for a project, would require MRT fares to be much
higher than bus fares. This criterion hindered the approval of new lines and extension of
existing lines. The uncertain future costs of replacing operating assets (of which rolling stock
was the largest component) was also a risk that the private operator had little control over. In
1996, the Land Transport Authority2 (LTA), a government agency, relaxed the cost recovery
criterion and announced that it would provide for rail infrastructure and the first set of
operating assets as well as the inflationary component of subsequent sets of operating assets
(Looi & Choi, 2016). This transferred the rolling stock replacement cost risk from the
operator to the government. In 1999, LTA awarded the concession to operate the new North-
East Line to the dominant bus company, SBS Transit, breaking the monopoly that SMRT had
on MRT operations. This was after the LTA had called a closed tender for the concession and
had only invited the then two major bus operators to submit proposals—conspicuously
keeping the SMRT and foreign operators out (Phang, 2007).

In 1998, the LTA signed a new 30-year licence and operating agreement with the SMRT.
SMRT leased the tracks and stations and purchased the operating assets (including rolling
stock) from the LTA at net book value (S$1.2 billion) to operate the MRT services. SMRT
was listed on the Singapore stock exchange in 2000 (at S$0.61 cents per share) becoming the
first MRT operator to be privatised via a public share issue (Phang, 2007). This was a case
where a contract was signed between two public sector agencies, and one was subsequently
privatised such that the contractual relationship became a PPP.

The Public Transport Council (PTC), an independent public agency established by parliament
in 1987, regulates fare adjustments for both rail and bus through a price cap formula. It also
determines minimum standards for service delivery and service obligations for bus services.
The operators however are still required to apply annually for fare revisions, with the PTC
having the discretion to approve the amount and structure of the increase. The price cap
formula is subject to periodic review. For the 14-year period, between 1998 and 2011,
approved fare increases up to the cap permitted by the fare formula occurred in only 2 years,

1
Civil infrastructure refers to the different structures and buildings within a system that serve a community’s
needs and activities. It includes the infrastructure for supporting, for example, electric power, oil and gas, water
and wastewater, communications and transportation. Civil works refer to any building or civil engineering works
that address the construction of roads, pavements, surfacing, railway infrastructure, underground works, special
foundations, marine works and hydraulic works.
2
The Land Transport Authority of Singapore, a statutory board under the Ministry of Transport, is responsible
for land transport developments in Singapore.
 8

2005 and 2006 (Chang & Phang, 2017). If fare increases had been at the price cap between
1998 and 2011, fares would have increased by 35.0% (average of 2.2% per annum) over the
14-year period; the PTC however approved increases that raised nominal fares by only 6.9%
(average of 0.5% per annum) over the same period. Inflation averaged 1.6% per annum over
the same period, so that real fares decreased at an average rate of −1.1% per annum. Private
sector operators in Singapore were thus exposed to regulatory risks that led to declining profit
margins as costs increased.

While the first decade after listing was relatively uneventful, weaknesses in SMRT began to
surface by 2011. Singapore’s population had increased from 4.4 million in 2006 to 5.2 million
by 2011, and there was overcrowding, longer wait times and strain on existing bus and MRT
services. A series of major train breakdowns led a government-appointed Committee of
Inquiry (2012)3 to conclude that LTA’s regulatory oversight over SMRT’s rail maintenance
and capital improvement of infrastructure had been inadequate (Chang & Phang, 2017).
Service breakdowns continued with 14 major disruptions in 2014 and an additional 29
disruptions in 2015 (Gomez-Ibanez & Goh, 2016).

The government realised that a major restructuring of the sector was needed to achieve both
higher standards of rail reliability and financial sustainability of the rail operators. In 2016,
LTA re-purchased the rail-operating assets from SMRT for S$1.06 billion (net book value
plus goods and services tax) and concurrently delisted SMRT through a shareholder buyout
by Temasek Holdings at S$1.68 per share at a cost of S$1.18 billion (Chang & Phang, 2017).
This reform of the sector allowed the government to make the necessary capacity expansion
and to replace and upgrade operating assets.

After 16 years, SMRT was back where it had started: an asset-light MRT operator, 100%
owned by Temasek Holdings. SMRT’s re-nationalization illustrates the weaknesses of a 30-
year concession contract for metro operations set within a fare regulatory model used
originally for the bus sector. The combined strain of escalating rolling stock replacement costs
(the government was responsible only for the inflationary component of the costs of
subsequent sets of operating assets), increasing operating and maintenance costs and an
insufficient farebox eventually made the PPP unsustainable for SMRT.

In 2017, LTA awarded the contract to operate the new Thomson-East Coast Line to SMRT
(LTA, 15 September, 2017) after reviewing tender submissions from the two incumbent rail
operators. A number of differences in this contract from the 1998 contract stood out: the
farebox is retained by LTA; SMRT will be paid a service fee of S$1.7 billion spread over a
(much shorter) 9-year contract term; the operating assets remained under the ownership of the
government. This represents a transformation from asset heavy, capital intensive, long-term
concessions to asset-light short-term operating concessions which reduced the risk to the
concessionaire and increased competition for the contract. To incentivise performance, the
actual service fee paid to SMRT would be tied to its performance in key areas of service
reliability, customer satisfaction and operations and maintenance performance.

This approach is consistent with the use of key performance indicators for PPP transport
projects to meet specific stakeholders’ performance objectives as advocated by Mladenovic et
al. (2013). LTA further unbundled non-fare business such as the commercial spaces and
advertising spaces associated with the stations and trains through a separate tender for these

3
A summary of the Committee’s 358-page report, released in 2012, is available at the Ministry of Transport’s
website at: https://www.mot.gov.sg/news/COI%20report%20-%20Executive%20Summary.pdf.
 9

businesses. With the redesigned PPP contracts, the Singapore MRT procurement model has
evolved into one that is asset-light with no farebox risk and relies on an expanded government
role from its ownership of all assets. In Singapore’s context, the cost of government financing
is substantially lower than the cost of private capital.

This evolution is consistent with the findings of Bray and Sayeg (2013), who reviewed the
approaches used in Singapore, Bangkok, Kuala Lumpur and Manila and found that all
systems that used private sector finance for the development of initial systems had faced
financial problems. In particular, the transfer of ridership (and hence revenue) risk for an
urban rail line to a concessionaire was found to be a contributory factor. They concluded that
a gross cost,4 performance-based form of concession is most appropriate for individual rail
lines as these are part of an integrated public transport system, and the concessionaire for any
single line has relatively limited (though non-zero) capacity to modify ridership on its line.

Renationalization of London Underground Infracos

The London Underground is the world’s first underground passenger railway. Opened in
1863, the network has since expanded to 11 lines which collectively handled an average of 5
million passengers a day in 2018. In the early 1990s, after more than a century of operations,
the network began to experience frequent breakdowns and delays, caused by aging
infrastructure. The poor state of the infrastructure was due to a number of reasons ( JICA XE
“Japan International Cooperation Agency” , 2015). Firstly, London Underground Limited
(LUL), being fully owned by the central government, did not have enough allocated budget to
pursue long-term investments. Secondly, LUL was unable to manage and control
infrastructure investments, resulting in chronically underinvested infrastructure. Major
projects, such as the Jubilee Line Extension and the Central Line upgrades, were also subject
to frequent cost overruns and delays (UK House of Commons, Committee of Public
Accounts, 2005).

During the early 2000s, LUL launched the London Underground PPPs with the principal aim
of introducing additional finance, best practice and management efficiencies from the private
sector into the maintenance and upgrading of the network. The involvement of the private
sector for a 30-year period (divided into four 7.5-year review periods) was intended to ensure
that capital investment decisions were made on a long-term basis (UKNAO, 2004; Butcher,
2012a).

The PPP procurement of the maintenance and improvements to network assets such as
stations, rolling stock, track and signalling was split into three infrastructure companies
(Infracos) each with its own PPP contract with LUL (JICA, 2015: 84). These were the
following:

• BCV contract consisting of the Bakerloo, Central, Victoria and Waterloo and City
lines
• SSL contract consisting of the Circle, District, East London, Hammersmith and City
and Metropolitan lines
• JNP contract consisting of the Jubilee, Northern and Piccadilly lines

4
The concessionaire pays for civil works and/or electrical and mechanical works and pays for O&M and
pertinent asset costs. The government retains fare and other revenue and pays the concessionaire an amount
equal to the costs the concessionaire incurs for the provision of agreed services.
 10

The three PPPs were primarily output-based contracts that intended to incentivize the private
sector to achieve certain improvements to the performance and condition of the network. LUL
retained ownership of the farebox and was responsible for driving the trains, operating the
stations, customer services and fare collection.

The Infracos’ only source of revenue, the Infrastructure Service Charge (ISC) (paid every 4
weeks by LUL), was calculated based on the estimated cost of the Infraco works at the time of
concession award adjusted by the actual performance of the Infracos during the concession.
Actual performance was determined against an agreed set of benchmarks that measured
infrastructure capability, availability and ambience. Escalations to the original costs were only
compensated (through an increased ISC) if they were incurred in an ‘economic and efficient’
manner.

In 2002, the JNP PPP concession was awarded to Tube Lines Ltd., a consortium of Bechtel,
Jarvis and Amey. The BCV and SSL PPP concessions were awarded in 2003 to Metronet Rail
Ltd., a consortium of Atkins, Balfour Beatty, Bombardier, EDF Energy and Thames Water.

By 2007, the Metronet PPPs went into bankruptcy due to massive cost escalations and had to
be re-nationalized. Estimated loses to the taxpayer of the Metronet failure have been as high
as £410 million ( UK National Audit Office (UKNAO), 2009). Due to cost escalations, the
JNP PPP also went into bankruptcy in 2010, and its shares were re-acquired by TfL,
effectively ending private sector participation in the London underground infrastructure just
7 years into what were originally 30-year concessions.

Amongst the many commonly cited reasons (Gannon et al., 2014; UKNAO, 2009; Ochieng et
al., 2013; Vining & Boardman, 2008) for Metronet’s collapse was the ‘tied supply chain’
strategy employed by Metronet. All five Metronet shareholders were also the suppliers of the
Metronet Infracos in a tied supply chain. However, by itself the tied supply chain is not an
uncommon feature, and indeed there are many successful PPPs that have utilized tied supply
chains. It is a common strategy for major infrastructure equipment suppliers and contractors
to take equity stakes in greenfield PPP projects in other infrastructure sectors, notably in
airports, roads and power generation. Rather than the ‘tied supply chain’ reason, the root
cause of Metronet’s failure was poor governance and management structures that resulted in
suppliers being favoured over Metronet Rail Ltd. (Williams, 2010). With stronger
governance, one would have expected that Metronet shareholders would have kept each other
honest. This risk could also have been mitigated by the participation of strong third party
financiers (equity and/or debt providers), but this was not the case. The recent trend of strong
‘untied’ financial investors participating in greenfield PPP projects would have been helpful
then.

Metronet had expected to spend £16 billion over the 30-year concession period (Vining &
Boardman, 2008). The expenditure was to be funded by lenders (through loans, bonds),
London Underground (through regular unitary payments) and Metronet’s shareholders
(through equity). The UK National Audit Office reported that approximately 60% of
projected capital expenditure in the first 7.5-year period were to be awarded to the five parent
companies as suppliers (UKNAO, 2009: 54). Comparing the profit margins of the value of the
work performed against the relatively low amount of shareholder funds (£350 million)
(UKNAO, 2009), the Metronet shareholders had more to gain as suppliers than to lose as
shareholders. This raises the question of whether the Metronet shareholders really lost as their
profit margins as suppliers could have more than compensate for their equity losses. In its
report on the failure of Metronet, UKNAO stated that the profit margins on £2 billion worth
 11

of sales of goods and services sold by shareholders were unknown. However, it estimated that
for the five shareholders to breakeven on work done to March 2007 and recover their equity
investment in Metronet, the minimum gross profit margins on sales required were 15% for
Balfour Beatty, 55% for EDF, 82% for Thames Water, 33% for Atkins and 27% for
Bombardier (UKNAO, 2009: 42).

Metronet was highly leveraged with 88% debt funding. In addition to the misalignment of
incentives arising from the tied supply chain and poor governance, TfL’s guarantee of 95% of
Metronet’s £2 billion debt meant that any bankruptcy would be paid for by the UK
government (Vining & Boardman, 2008). Metronet’s lenders clearly did not have sufficiently
strong incentives to protect their investment due to their limited downside exposure.

The root cause for the demise of Tube Lines in 2010 is less obvious than Metronet’s in 2007,
but it resulted in a similar outcome, albeit 3 years later—failure to control costs. Tube Lines
initially wanted £6.8 billion (later reduced to £5.75 billion) for a major programme of renewal
on the Piccadilly and Northern Lines, but the independent arbiter only granted the company
just under £4.4 billion (Williams, 2010). This shortfall led to a sequence of events eventually
resulting in nationalization. Applicable to both Metronet and Tube Lines, the cost, tenure and
complexity of the PPPs made them difficult to execute and administer.

On hindsight, was PPP the most appropriate procurement strategy for upgrading the London
Underground network? The failed PPPs can be considered as successful change agents. There
had been some undeniable benefits; the performance of the London Underground network did
improve over the first 5 years of the PPP (Butcher, 2012b). TfL, through the re-nationalized
Infracos, was better placed than in the early 2000s to execute its ambitious upgrading plans
for the network. The PPPs played a role in helping to kick-start the renewal process of a
century-old system. The failures of the PPPs caused the central government to make a
significant ‘U’-turn in its funding policy with TfL. This policy shift has removed funding
uncertainties for TfL and LUL for long-term investment (Gannon et al., 2014). However these
gains have been achieved at a very high price to the taxpayer, estimated at more than
£4.1 billion (Williams, 2010).

Despite the setbacks experienced by TfL in their experience with the London Underground
PPPs, the demand for rail connectivity and travel in London, and indeed the UK, remains
undiminished. What were the lessons and how has the structure of the UK government URT
procurement adapted?

Just as the London Underground PPPs were concluded, the £14.8 billion Crossrail programme
started to take shape. It will deliver a 117-km rail line that will link Reading and Heathrow in
west London with Shenfield and Abbey Wood in the east, including 21 km of twin tunnels
under London. There will be 41 Crossrail stations, including 10 new stations.

In addition to government grants, Crossrail will be funded by substantial contributions from

developers and the Business Rate Supplement, an increment on the rates (taxes) paid by
London businesses. More than 60% of the project cost (based on the £14.8 billion estimate)
will come from Londoners and London businesses (Greater London Authority, 2016).
Conspicuously, no commercial project finance will be utilized. As of September 2020, the
opening of Crossrail (renamed the Elizabeth Line), originally planned for opening in
December 2018, has been delayed to early 2021 and is expected to cost more than £18 billion.
 12

Analysis of Two Successful MRT PPPs

Having considered two cases of MRT PPP failures, we now turn to two successful cases: the
MRT PPPs in Hong Kong and Beijing. Specific details of the Hong Kong and Beijing systems
such as ridership, fares and other relevant variables are summarised in Table 3.

Land Value Capture in Hong Kong

Hong Kong is one of the most densely populated places in the world. Part of the reason is the
geography – 80% of the 1100 km2 land mass is mountainous, the built-up area only accounts
for 24% of the total land area, and only 7% is zoned for residential uses. Due to the limited
usable land and high population density, public transportation, of which URT is the dominant
mode, is well promoted and forms the transportation backbone of Hong Kong.

The government plans the urban rail transit system, while the railway lines are built and
operated by Mass Transit Railway Corporation Limited (MTR), a quasi-private transit
company listed on the Hong Kong stock exchange with 75% of the company’s shares owned
by the government (MTR, 2017). The MTR network has 11 rail lines, over a route length of
230 km with 93 stations. The network carried an average of 5.8 million passenger trips per
weekday in 2017.

MTR, the monopoly operator of the URT, is a super vertically integrated company
responsible for building the infrastructure and rail systems and operating the lines post
completion. There is therefore an absence of competition in the MRT sector. MTR’s vertical
integration extends from rail to real estate development (‘Rail plus Property’) of areas over
and around stations and depots.

Accompanied with the super vertical integration, the entire farebox revenue risk is transferred
to MTR for the rail business, while the government uses an annual fare adjustment formula to
set fares, balancing passenger affordability and sufficient profitability to support MTR’s rail
operations.

In exchange for bearing the cost of fully developing and operating the lines, and in addition to
the farebox, the Hong Kong government compensates MTR by exclusively granting the
company 50-year development rights over the land around or on top of railway stations and
depots. The values of the development rights granted are calculated using the appreciation in
land value attributable to the development of the rail line, effectively MTR’s development
profit.

MTR then partners with property developers to derive benefits from the property
developments through sharing profits in agreed proportions from the sale or lease of
properties (after deducting development costs), sharing assets in kind or receiving upfront
payments from the developers, taken case by case (Suzuki et al., 2015). Through these
strategies, MTR has been able to capture the land value increment due to the accessibility and
agglomeration benefits from their rail projects not only upfront but also through recurring
income and capital gains over a sustained period after the start of operations.

MTR’s real estate activities include property development, rental and management and
commercial activity within their stations. MTR’s Hong Kong property business has over
18,000 residential units under tender, manages over 96,000 residential units and owns 13
shopping malls. For 2017, MTR’s Hong Kong property-related businesses contributed 40% of
 13

the total revenue and an estimated 70% of earnings before interest and taxes. When MTR
evaluates the costs and benefits of a rail project, the increase in land values (over and above
the time savings benefits to current users) is therefore definitely a benefit that it can attribute
to the project.5

Overall, the financial performance of MTR has been robust and sound. Its business portfolio
is diversified through rail, property and through its growing global business. Local fare
revenue is relatively stable. The excellent financial performance has generated benefits for the
public in the form of affordable fares as well as dividends to the government. With its 75%
shareholding, the Hong Kong government continues to directly benefit from the financial
performance of the listed company. The rail network’s increasing ridership has also generated
social benefits though the magnitude of this is hard to quantify. Positive environmental
impacts include reduced air pollution, road congestion and energy consumption. The MTR
properties have increased density and reduced sprawl, and improved accessibility and
amenities have led to appreciation in land values.

In the case of MTR, the main objectives of its stock market listing were to further promote
efficiency and introduce market discipline to the running of the railway and also to stimulate
private sector innovation in growing its property business. These twin goals appear to have
been attained to date. However, is the current ‘Rail plus Property’ model able to sustain
MTR’s growth into the future? Part of the answer lies in the continued price appreciation of
real estate. Hong Kong’s residential property price index has tripled over the last 10 years. Is
this ‘Rail plus Property’ model sustainable? After the merger of MTR and the Kowloon-
Canton Railway Corporation in 2007 (MTR became Hong Kong’s only rail operator), the
government utilised two other financing models alongside the ‘Rail plus Property’ model for
rail expansion (Loo et al., 2018): the capital grant model and the concession model.

The West Island Line Extension (3-km extension with three stations) costs HK$15.4 billion
and opened for service in 2015. The government provided the MTR with a capital grant of
HK$12.7 billion towards construction to close the financing gap. The MTR retained
ownership and full responsibility for the design, finance, construction, operation and
maintenance. The critical difference was that there was no property development rights from
the rail extension.

The Hong Kong government used a concession model for the two most recent and largest
value projects: the HK$84.4/US$10.9 billion (originally HK$66.9/US$8.6 billion) 26-km
Express Rail Link (XRL) and the HK$90.7/US$11.7 billion (originally
HK$79.8/US$10.3 billion) 17-km Shatin to Central Link. Under the concession model, the
government owns the railway assets, pays for the capital cost of the line and assumes the
construction risks, while MTR serves as project manager and pays service concession fees for
the right to operate the railway (Hong Kong Legislative Council, 2008).

XRL is a 26-km-long high-speed rail project that connects the West Kowloon in Hong Kong
to Shenzhen, Guangzhou and mainland China’s high-speed intercity rail network. XRL
started operations in September 2018, which was 3 years later than originally planned. The

5
Hong Kong’s MTR is in the advantageous and unique position of being the sole rail operator in Hong Kong
that was able to capture the real estate development benefits of rail. However, when evaluating a PPP rail project
versus an alternative public rail project, this benefit is not unique to the PPP but can also be enjoyed by the
alternative public rail. Such benefits for the PPP are relevant when a public rail is not an option, is less efficient,
is less innovative in promoting the synergy between rail and real estate and/or is unable to effectively capture the
increase in land values to finance the project.
 14

substantial delay and budget overrun at XRL led to key management changes at MTR in
2014.

The Shatin to Central rail project, planned for completion in 2019, also suffered repeated
delays, cost overruns and allegations of shoddy work. The opening of phase 1 of the line was
delayed from 2015 to 2020. As of September 2020, the completion date for the second phase
had been further postponed to 2022. This illustrates that although the costs of finance via
public sector debt could be lower, governments should be mindful that construction risks need
to be well managed under the public procurement strategy to avoid cost and schedule
overruns.

On 26 March 2019, the Commission of Enquiry convened by the Hong Kong government to
investigate the issues faced by the Shatin to Central Link in its interim report recommended a
number of mitigation measures (Hartmann & Hansford, 2019). The most relevant of these
measures was, The Commission further recommends that consideration should be given as to
the appropriateness of the ‘Concession’ model for future projects entrusted by the
Government to be project managed by MTRCL, or whether the Government should revert to
the previously used ‘Ownership’ model. Under the previous ownership model, MTR would
have been responsible for cost overruns. Since 1998, the MTR had delivered ten major rail
projects under the ‘Rail plus Property’ model, all within their original budgets or with only
small-scale overruns (Cheung, 2019). The use of the concession model should be viewed in
context: XRL was a strategic high-speed rail project connecting Hong Kong to mainland
China; the Shatin to Central Link project had been awarded to the Kowloon-Canton Railway
Corporation in 2002; and extensive renegotiations were necessary post-merger before the
project could proceed.

It remains to be seen if the Hong Kong government will revert completely to the ‘Rail plus
Property’ model for further urban development, but the accompanied benefits since its
implementation are undeniable. Newman et al. (2018) are supportive of the Hong Kong
approach as they advocate using an ‘Entrepreneur Rail Model’ that integrates private land
development with URT and using the land value created to fund urban rail and urban
regeneration.

Revenue Risk Sharing in Beijing Line No. 4

We next consider revenue risk sharing arrangements for the Beijing Line No. 4 PPP (Chang &
Phang, 2017). In 2001, Beijing was selected to host the 2008 Summer Olympic Games. In
preparation for the Games, the Chinese government invested heavily in new sports facilities
and transportation systems. The metro sector in Beijing was restructured, and the government
looked to PPPs for resources to help support the planned expansion of the system from two
lines (54 km) in 2000 to eight lines (200 km) by 2008. The Beijing Infrastructure Investment
Corporation (BIIC) was tasked with the responsibility of metro finance and investment.

The 29-km Line No. 4, costing 15.3 billion Chinese Yuan (CNY)/ US$2.26 billion, was
implemented using a PPP. A joint venture company, the Beijing MTR Corporation
(BMTRC), was established in 2005, and it was awarded a 30-year concession to operate and
maintain the line. There is no evidence of competition for the award of the concession
contract. The Hong Kong MTR was one of the three shareholders of BMTRC and held 49%
of the shares. The other two investors were BIIC and another state-owned entity that jointly
owned 51% of BMTRC—the minimum required under Chinese law. BIIC financed the civil
works which comprised two thirds of the total cost. Rolling stock, signalling and E&M
 15

systems, comprising one third of the cost, were entirely financed and procured by the
BMTRC (Chang, 2013).

Line No. 4 was completed within the expected time and operational by September 2009. The
Hong Kong MTR Corporation (MTR) brought in its rail and financing expertise to build,
finance and operate Line No. 4. Chang (2013) estimated that BMTRC enjoyed operations and
financial cost savings of 9.4% of expenses. Although there were no cost savings in the
purchase of rolling stock using the PPP model, BMTRC was able to reduce financing costs
through debt restructuring and currency hedging. A survey conducted by McKinsey and the
Beijing MTR also showed much higher consumer satisfaction of the No.4 line as compared to
other lines. The presence of a new private operator also generated knowledge spillovers to
other public sector-operated lines, resulting in system-wide cost savings, improved efficiency
and service quality (Chang & Phang, 2017).

Farebox as well as advertisement revenues for Line No. 4 resided with the BMTRC. This
transfer of operational revenues provides BMTRC with incentives to reduce cost and improve
the quality of service to attract more passengers. However, BMTRC did not bear the full
farebox risk. This risk was shared with the government through a shadow price (SP) and
shadow ridership (SQ) mechanism (Chang, 2013: 155–156) that was used to establish a
revenue floor and ceiling. SP translated to a guaranteed revenue per passenger unrelated to the
actual price (AP). The parties agreed to a SP of CNY3.34 ( about US$0.50) in 2006, and this
would be adjusted every 3 years based on the Consumer Price Index. In 2010, the SP was
adjusted to CNY4. If AP fell below SP, BMTRC would be compensated by the public sector.
If AP is above SP, the extra profit allocation would be 70% public sector and 30% private
sector partner. This insulated the private sector from negative fare risk that could result from
the government’s system-wide fare policies.

The PPP contract also incorporated ridership risk. Shadow revenue was defined as shadow
price multiplied by shadow ridership (SR = SP × SQ). The daily shadow ridership numbers
were forecasted by an independent consulting firm—it was projected to be 564,000 in 2010
and to grow to more than a million by 2025. If actual ridership (AQ) fell below the SQ, the
private sector would be compensated. If AQ was above SQ, revenue would be shared with the
government. Table 4 provides the details of the formulas used.

Table 4 Ridership risk sharing for Beijing Line No. 4 PPP

 16

In 2007, the Beijing government changed the metro fares to a flat rate of CNY2.6 The public
sector subsidised BMTRC on a per passenger trip basis for the difference between the lower
AP and the agreed SP. The lower fares contributed to increased ridership numbers generating
healthy profits for BMTRC. Actual ridership in 2010 was 122% of the shadow level. This led
the government to modify the revenue sharing arrangements in 2010 to increase the public
sector share of BMTRC’s revenue when actual ridership is higher than the shadow projections
(see Table 4 for details).

The general favourable outcomes for the Line No. 4 PPP led the Beijing government to use
similar PPP structures to award additional concessions for Daxing Line, Lines No. 14 and No.
16 to BMTRC. With the rapid expansion of the metro system, average daily ridership more
than tripled from 3.3 million in 2008 to 10.5 million in 2018 (Beijing Municipal Commission
of Transport at www.bjjtw.gov.cn). Hong Kong MTRC also benefited from its PPP
experience in Beijing and has since become the private partner in contracts to invest and
operate other MRT systems in other Chinese cities as well as in London, Stockholm,
Melbourne and Sydney. The Beijing model illustrates the strength of a hybrid financing
option that unbundles upfront procurement of civil infrastructure capital expenditure from rail
systems (signalling, power, communications, track and rolling stock.) A much wider
contractor pool exists for civil works that serves to increase price competition. Rail systems
can be bundled together with operations and maintenance and privatised via a PPP to take
advantage of synergies in those functions.

Summary and Conclusions

The failed London Underground PPPs could be seen as successful change agents, kick
starting the renewal of a century-old rail system that has benefitted Londoners. Both the
London and Singapore cases also highlighted the value of setting out clear exit conditions or
unwinding of any PPP to minimize uncertainty. Recent changes in MRT PPP strategy in
Singapore also indicate a move towards asset-light operating concessions with
correspondingly shorter concession lengths to maximize contestability. Both Hong Kong and
Singapore have recently made decisions to procure and finance MRT lines and rolling stock
using lower-cost public debt.

The Beijing experience shows that there are advantages to unbundling the upfront
procurement of civil infrastructure capital expenditure from rail systems (signalling, power,
communications, track and rolling stock). Civil infrastructure works are better procured
directly by governments due to its similarity to other forms of public infrastructure (such as
roads) and access to what is usually a much wider contractor pool, which serves to increase
price competition. Rail systems can then be bundled together with operations and
maintenance and privatised via a PPP to take advantage of synergies in those functions. This
option would require less private capital, enabling cash-strapped governments to procure
MRT systems with less risk transfer to the private sector. However, in pursuing this strategy,
governments should be mindful that construction risks must be well managed to avoid cost
and schedule overruns.

Functions that the governments can undertake in the MRT system have numerous
permutations, but in general, government usage of MRT PPPs should be inversely correlated
to its agility/flexibility, fiscal surplus and project management ability. We conclude from

6
On 28 December 2014, a distance-based fare schedule for all lines replaced flat fares, with the exception of the
Airport Express. See Table 3.
 17

London’s experience that in addition to clear objectives and performance targets,

policymakers need to have satisfactory governance improvement and risk mitigation measures
in place when tied supply chains are utilised by a PPP. Hong Kong’s experience illustrates
that a ‘Rail plus Property’ strategy can facilitate synergies and cross-subsidization of rail from
land value capture. The PPP case studies illustrate that appropriate mechanisms for allocation
of financial and revenue risks are key determinants of long-term financial sustainability.
Beijing’s experience illustrates that the government should own metro systems, but there are
benefits of entering into DBFOMT PPPs for selected lines, private financing of rolling stock
and private sector maintenance of assets and operation of train services.

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