ICC Commission Report Construction Industry Arbitrations Part 2
Out-Law Analysis | 19 Feb 2016 | 11:25 am | 4 min. read
The past few years have seen a growing contest between China and Japan as the two use their different selling points and geopolitical influence to win high speed rail contracts in Asia. Japan has an impressive safety record, and home-grown experience in designing systems suited to seismically vulnerable regions, while China has installed more domestic high speed rail than any other country. China has also, so far, been prepared to waive the need for a sovereign guarantee from the host government looking to build a high speed rail line.
In both counties, government-led export programmes are common. The state-owned Chinese industry contrasts with the private ownership of the Japan rail companies, but the latter are still to varying degrees susceptible to pressure to advance the national interest, on top of commercial interests.
High speed rail is a particular focus in this drive because of the long-term commercial benefit that it promises from real estate and a captive audience. A typical concession tends to involve far more than just the rights to build and operate the rail line. On top of that, contractors negotiate land rights to allow them to manage retail opportunities at stations over the course of the concession period, and increasingly to build connected residential and commercial space upon the stations.
With a guaranteed market regularly delivered by the train, these opportunities can be highly profitable. The model was developed in Japan, where rail companies form just one part of conglomerates that own or operate shopping centres, department stores, hotels, tourism businesses, bus lines, leisure facilities, sports teams and of course construction companies. This business model can now be seen, albeit in less competitive forms, in Hong Kong, Taiwan and increasingly throughout the eastern seaboard of China. It's a highly successful model that promises long term business interests in the host country, and so the Chinese government is seeking to follow this path as part of its 'Go Out' policy.
Naturally, the two regional rivals are also keen to gain the influence that large infrastructure projects of this type can bring over host governments, by creating relationships of patronage and dependency. This is particularly the case in emerging economies, where the government would not be able to afford this sort of development without outside help.
Japan's success in India followed the surprise last-minute selection of a consortium of companies from China and Indonesia for the right to negotiate on Indonesia's first high-speed rail project, the Jakarta to Bandung HSR.
After believing it was in the lead, and having put a lot of work and detail into its proposal Japan was surprised to hear that the right to negotiate had gone to its rival. It is safe to say that the Chinese probably won this right to negotiate because it did not require a sovereign guarantee on the funding.
Things are not going smoothly for the consortium, however. There was a 'groundbreaking' ceremony in Bandung last month, with president Joko Widodo sounding a siren to show works had begun, but in reality things are stalled at the negotiation stage with apparent ministerial rivalry over basic concession terms. The Indonesia Ministry of State Owned Enterprises has been made the patron of the project but the Ministry of Railways and Transport disagrees with some aspects of the investment and is withholding the permits that are needed for things to proceed.
Some guarantees have yet to be resolved, concerning change of law risk and regulatory interference risk. These are important guarantees that the government says it is not able to grant.
There is also disagreement over the concession period. This is a vital point, pinpointing when the concession will start. If it is too early, and construction overruns, then there is less time to make profit through the operation of the line and any related commercial business. On top of that, the route is only 142.5 kilometres long, so it is very short for a high speed rail link and the concession will be correspondingly small.
In comparison, the Mumbai to Ahmedabad link gives a more reasonable concession, with 505 kilometres of track also with a large urban population at each end. That's an important point with high speed rail: you need a sizable population in both termini, with enough income to enable them to travel regularly between the two.
The concession may seem like a small aspect of the build, but it is actually vital to making these projects financially viable. High speed rail requires very precise and stable infrastructure; things have to run straight and true. If the topography is undulating, that involves a lot of viaducts and tunnels, so it is very expensive to build. Add the need for tolerances in unstable, seismic regions and you have an added dimension of design and cost, all of which means that more money has to be made from the whole project for it to be financially viable.
As for other Asian projects, Malaysia is now looking to build a link with Singapore. That will be an interesting one, and very rare for East Asia in that it creates a cross-border link between two sovereign territories. We don't know yet how the structure of the investment will be settled. Will it involve a single cross-border project with single or dual laws, or separate domestic projects as in the Hong Kong-Macau-Zhuhai Bridge? All of these issues have yet to be brought into the open, but it's certainly a real project with the backing of both countries and interest expressed by the rail suppliers and associated infrastructure interests. This is likely to see a contest between China and Japan again, but potentially with bidders from Europe too.
Other projects have been mooted and yet more will be announced, if only because Japan and China are so enthusiastic in promoting their technologies. China is trying to piece together its One Belt, One Road plan, although in the current geopolitical and socio-political environment this is proving a challenge.
The Hong Kong XRL gives an example of just how challenging these projects can be. This is a 26-kilometre, largely underground, section of the Jingguangshengang high-speed railway that would link the city to Beijing via other major Chinese cities. The construction of this final stage is widely known to be running late and over budget.
Japan and China will have to deal with similar complexities in the projects that they have won (or think they have won) elsewhere, and the intensity of this rivalry may change in future bids as they understand just what is involved. The potential for greater competition among the multilateral development banks with the advent of the Asia Infrastructure Investment Bank is likely to add fuel to the race.
Singapore-based Nicholas Brown is an international infrastructure lawyer at Pinsent Masons, the law firm behind Out-Law.com.
ICC Commission Report Construction Industry Arbitrations Part 2