FOREWORD

There is a perception that a gap exists between the State's infrastructure requirements and its
ability adequately to finance these requirements alone.

This issue has been the subject of a major study by the Public Accounts Committee (PAC)
and resulting in a four-volume report. The last of those volumes suggested that innovative
financing methods ought to be considered to encourage alternative sources of finance
(other than State funds) to large infrastructure projects.

From an accountability and audit perspective, the proper recording of a government agency's
involvement in such transactions is a paramount objective. Understanding the substance of
those transactions is a prerequisite to this objective.

Indeed, the Roads and Traffic Authority was among a number of government agencies which
had already taken steps to finance large infrastructure projects using financing structures
such as 'Build, Own, Operate, Transfer' ('BOOT') schemes. This was the description given
to the Authority's involvement in the M4 and M5 tollways. The Sydney Harbour Tunnel,
an earlier initiative of the State, although not a BOOT transaction was, nevertheless,
proposed as a sophisticated off-balance sheet acquisition by the Authority.

This Report is the outcome of the audit to understand the substance of those three
transactions of the Authority. It has concluded that the Authority's 1993 financial
accounts did not adequately reflect that substance.

The Authority's earlier views on the Report have been included in this Report. It was invited
to provide further comment on this final version of the Report but did not do so in the
time provided. It did orally advise that it considered that this Report contravened the 
Public Finance and Audit Act 1983  by commenting on policy objectives.
In my view this judgement is incorrect.

A C HARRIS
AUDITOR-GENERAL

17  October 1994

PREFACE TO REPORT

Private sector provision of publicly used infrastructure is not a new phenomenon in New
South Wales. In the 19^th century, railways were initially established by private firms as
were some bridges and ferry services. And the provision in New South Wales of
reticulated town gas and now natural gas has always been a private sector responsibility.

However, it is true that the private sector's involvement in roadworks in Australia has seen a
resurgence following the construction of the Sydney Harbour Tunnel which opened in 1992.
The arrangements that led to the Tunnel were the first of their kind in Australia in recent
times. They were also complex and not entirely transparent.

Because of this, the relationships between the Government and private sector around the
Tunnel have not been well understood. The Roads and Traffic Authority has described the
relationships as a 'true joint venture'. It also has described the Tunnel as a 'BOOTs project',
a description accepted by the Public Accounts Committee in its report on infrastructure.
The Authority also has stated that it has no current interest in the Tunnel, other than as a
lessor of land and a regulator and it has noted that the Authority has revisionary interest in
the Tunnel on the expiration of the lease of Tunnel land which the Authority granted to the
private sector.

Perhaps it is no surprise that, in the audit opinion on the Authority's 1993 financial statements,
the Auditor-General expressed a qualification based, inter alia, on the uncertainty
surrounding the Authority's interest in the Sydney Harbour Tunnel (SHT).

Indeed, the desire to know and understand the full arrangements between the Authority and
the private sector participant in the Tunnel project, the Sydney Harbour Tunnel Company
(SHTC), led to The Audit Office review and this Report.

There was an initial belief that the arrangements might be characterised as a joint venture.
This was advanced, but only as a possibility, in the abovementioned audit opinion.

A full review of available documents, however, has led to the judgement, one now shared by
the Authority and the Auditor-General, that the SHT is, for accounting purposes, owned by
the Authority. This view is also shared by the Treasury which treated the SHT as a
Government asset in the audited whole-of-Government 1993 accounts released on
31 January 1994. This treatment in the accounts was not qualified by the Auditor-General.

The judgement on ownership is not based on form or legal concepts but on a view of the
substance of the relationships between the Authority, SHTC, the financiers of the Tunnel
and the users of the Tunnel (the public).

These relationships are examined in the following parts of this Report.

The judgements are also informed by examining the risks and the benefits that flow to
relevant entities from the existence of the Tunnel. Those risks and benefits also are
canvassed below.

In summary, the arrangements indicate that SHTC, a wholly owned subsidiary of its ultimate
parents, Transfield (and, earlier Kumagai) has no material continuing risk and little
continuing benefit, in its legal ownership of the SHT.

While SHTC and its parents bore construction risks, post-construction risks related to
inflation, financings and Tunnel viability rest with the Roads and Traffic Authority.

Similarly, SHTC has little benefit from its continuing association with the Tunnel. Models
used in the decision-making process indicated that the planned surplus for the SHTC will,
at the expiry of the leasehold in 2030, amount to about $10 million (nominal dollars).

The major agreement that insulates SHTC from these risks concerns the ensured revenue
stream obligation accepted by the Authority. This obligation requires the Authority to make
pre-defined, periodic payments to SHTC that are sufficient to meet SHTC obligations to
those private sector lenders that helped to finance the tunnel. Partly because these payments
are unaffected by matters such as the number of users of the Tunnel (or indeed of the bridge)
or the actual toll levied on users, these lenders face no private risk that their loans and
interest will not be repaid.

SHTC and its lenders are further insulated from risk because the Authority advanced SHTC
a $222.6m interest-free subordinated loan repayable in the year 2022. The character of this
loan provides SHTC and its lenders with a sizeable buffer.

That the Authority had an intimate relationship with the project is firmly evidenced by the
Authority's dealings with Westpac in its capacity as SHTC's banker. The Authority had no
legal relations with Westpac in this capacity, but nevertheless received from Westpac $3.5
million representing the profit share flowing from the reduced costs of bonds issued by
Westpac on behalf of SHTC to help finance the Tunnel.

Taken as a whole, the documents suggest that SHTC had two major roles. It was to be the
developmental vehicle for the Tunnel (constructed by SHTC's parents) and to be the
intermediary between the financial sector and the Authority for the financing of the Tunnel.
Its current role as operator and maintainer of the Tunnel is, by comparison, an immaterial
role. (It is also a role that can be assumed by the Authority under certain conditions.)
Because the principal risks and benefits in the post-construction phase of the Tunnel fall
to the Authority, the question arises as to why the arrangements were structured in this
complex way.

Another set of arrangements would have allowed the Authority to secure the financing of the
Tunnel in its own name and to enter a fixed price tunnel construction contract with SHTC.

The principal differences between this transparent set of arrangements and the arrangements
actually executed might relate to Loan Council approvals and possible taxation benefits.

If it could be held out that the private sector was the principal in the Tunnel, no Loan
Council approvals would be required (because the financial obligations arising would not
be seen as public sector obligations). Similarly, if it could be held out that the Tunnel was
a private sector venture, there would be prospects that a taxation benefit for depreciation
could be allowed by the Australian Tax Office, thus reducing the costs of the Tunnel project.

(These same two issues were in play in the development (and 'ownership') of the Eraring
Power Station - a project that commenced before the Tunnel project - and which has led
to remedial changes in the Commonwealth's Income Tax Assessment Act. In the 1992
financial statements of Pacific Power, the Eraring Power Station was, on the basis of
substance over form, recognised as an asset of Pacific Power.)

In fact, Loan Council approval for the Tunnel was not sought, notwithstanding the clear
links between the Authority's obligation to pay an 'ensured revenue stream' to SHTC
and SHTC's own obligation to meet principal and interest owing to bondholders.

It is also not clear that the envisaged tax benefit will be available to SHTC. Under
agreements between SHTC and the Authority, the Authority must make good the loss
of the expected tax benefits, unless SHTC agrees otherwise.

The complex arrangements that support the development and operation of the Tunnel did
expose the State to some risks that would not have existed under more conventional
arrangements. The most important of these was the unconditional nature of the financial
transactions between SHTC and the financial market on the one hand and between SHTC
and the Authority on the other.

Thus, the agreements in place meant that SHTC's banker could issue bonds up to the
maximum extent, notwithstanding that the Tunnel project might not have proceeded.
Similarly, the Authority's obligation to pay the ensured revenue stream was not conditional
on the Tunnel being constructed.

The documents cited in this Report show that the Authority had some concerns about some
of the unconditional obligations and rights but was unable to modify them, other than with
general, non-binding understandings.

The very complexity of the documents adds its own level of risk, including risks that may or
may not become evident over the life of the agreements. For example, the recent reduction
in company income taxation rates is a change that potentially benefits SHTC even though the
reverse, an increase in rates, need not have cost SHTC. In other words, there is a potential
mismatch between company tax rate risks and benefits, to the Authority's disadvantage. It
is not clear that this issue was addressed by the Authority in the development of the
agreements between it and SHTC.

In many senses the Sydney Harbour Tunnel project was merely a more sophisticated
construction - financing agreement that that model used in the Eraring Power Station
project.

It allowed the possibility of tax benefits, notwithstanding the post-Eraring changes to tax
legislation and it offered the appearance that the project was a private sector project. And
by securing a fixed price Tunnel construction contract, albeit without the advantages of
tendering, it passed to SHTC some construction risks (presumably matched by construction
profits attainable by SHTC's shareholders, Transfield and Kumagai).

The arrangements did not, however, require the private sector to assume any risks associated
with the economic viability or non-viability of the Tunnel. In other words, SHTC is indifferent
to whether the Tunnel is not used or is used to capacity.

Assessing market risk is an attribute that the private sector claims as a comparative advantage.
Indeed, the principal advantage of private sector equity in or ownership of a project is that
the private sector has taken a market risk. Where that risk is evidently not assumed by the
private sector, prima facie, it should not be the equity participant.

Other advantages that the private sector might claim over the public sector (that it is the
more efficient designer, constructor, project manager, operator, maintenance provider)
can be achieved by the Government through public sector ownership and the issue of
contracts following a tender process.

Although public sector ownership is not compatible with obtaining tax benefits, or with
sidestepping Loan Council rules, private sector ownership cannot be justified on those
factors alone.

And if the private sector wishes to claim ownership in substance as well as form, it must
also take the risks that are normally borne by proprietors.

A most undesirable outcome, arguably in evidence in the Sydney Harbour Tunnel project,
occurs where there is the appearance that the private sector has taken risks which it has
not, and the concomitant appearance that the public sector has avoided risks which it
has not.

As Part 3 of this review suggests, road infrastructure projects that followed the SHT such as
the M4 and M5 do not adopt in full the model used for the SHT. The private sector involved
in those projects take some measure of the risk normally taken by equity holders. The extent
of this sharing of risks and benefits between the public and private sectors and its
relationship to ownership is discussed in that volume.

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