Airport Tariff Regulations: Case Studies and Ideal Regimes

1. PPP AMERICAS 2010 Regulatory Regimes on Airport Tariff ADC & HAS AIRPORTS INC. MICHAEL HUANG

2. INTRODUCTION • This presentation will focus on regulatory framework on airport tariff • Tariff setting is one of the most fundamental and usually most controversial aspect of the concession • Four case studies involving privatised airports in which our company participated as equity investor and operator over the past 20 years • These four airports had completely different tariff regimes • Is there an ideal regime?

3. SETTING OF AIRPORT CHARGES • Airport revenues: aeronautical and non-aeronautical • Aeronautical revenues include fees charged to passengers or to airlines for the use of the runway, apron parking, loading bridges, terminal facilities, security etc. • Non-aeronautical revenues are paid by commercial tenants such as duty free, retail, food and beverage, car parking etc. • As airports are natural monopoly, aeronautical revenues are typically regulated • Non-aeronautical revenues are typically freely priced based on market

4. Single till - all revenues are considered in setting aeronautical charges • Double till - only aeronautical revenues are taken into account • Ideal regulatory schemes: * transparency * simplicity * calculation based on pre-agreed parameters * regulator not to have arbitrary discretionary power * no room for political interference

5. CASE STUDY 1 Terminal Three Toronto International Airport • Date: 1991 • Concession • Private investment US$600 million • Private sector investor to build a new third passenger terminal • New terminal to compete with two existing Government owned terminals • Government did not allocate airline tenants • No passenger usage fees • No regulatory regime on charges • Sponsors negotiated 20 years leases with 8 airlines • Signatory airlines pay a common set of aeronautical charges • Charges are adjusted annually such that total annual revenues from the airlines always equal to a fixed sum (in this case a pre-agreed sum equal about 90% of the annual debt service)

6. CASE STUDY 1 Toronto International Airport • If traffic/usage increase, the unit rate of charges will drop. Airlines love it! • If traffic/usage decreases, the unit rates will increase. Lenders love it! • Private investors realise ROE from commercial (non airlines) revenues, which are completely free and market based • Advantages (a) no government involvement in fee setting; (b) airlines entering into lease commitments entirely on a voluntary basis; hence no complaints (c) lenders have a de-facto “joint and several” guarantee on the debt service by 8 flag carriers; (d) for investors, no restraint on the upside returns from commercial revenues • Disadvantages (a) only feasible when the facility is not perceived as a monopoly; (b) bidders have no certainty that the airlines will accept the leases when tendering (c) requires long term leases from airlines, which is not common practice in Latin America

7. CASE STUDY 2 Budapest International Airport, Hungary • Date: 1998 • Public Private Partnership • Private investment US$120 million • Government and private investors jointly owned Project Company; management resided with private sector • Project Company constructed new passenger terminal and took over operation of all existing terminals • Aeronautical charges are regulated by Government • Non-aeronautical charges are not regulated • Single Till • Regulated charges are set annually based on the business plan of the Project Company • If projected IRR on equity is 15.5% or more, no change in regulated fees • If projected IRR is less than 15.5%, then the regulated fees will be adjusted to attain the target rate of 15.5%

8. CASE STUDY 2 Budapest International Airport • There is a cap on ROE. If equity investors achieves an IRR of 17.5%, no more distributions to investors . • Advantages • (a) minimal financial risks to lenders and investors; • (b) Government and investors’ incentives are aligned • Disadvantages • (a) strong Government influence in fee setting; • (b) potential political interference; • (c) ROE capped; • (d) due to single till, less incentive to maximize commercial revenues

9. CASE STUDY 3San Jose International Airport, Costa Rica • Date: 2001 • Management Contract • Private Investment US$300 million in two phases • Regulatory regime extremely complicated • Two separate and independent regulatory bodies-one for aeronautical revenues and one for commercial revenues • Single till but with multiple cost centres • Tariff set annually by regulators based on (a) amortization costs for CAPEX; (b) inflation; (c) Efficiency Factor • CAPEX (including hard and soft costs) are limited by price caps • Tariff setting regime alone is about 30 pages • Complexity of tariff regime led to dispute between private investors and Government • Main issue was interpretation of CAPEX price cap leading to disputes on tariff

10. CASE STUDY 3 San Jose International Airport, Costa Rica • Disputes on tariff led to slow down/suspension of capital work in 2003-2007 • Senior debt accelerated in Nov. 2007 • Management Contract assigned to a joint venture between ADC & HAS Airports and Andrade Gutierrez in July 2009 • Capital work resumed by new JV • Advantages – tariff regime is transparent • Disadvantages – * complexity led to disputes * discretionary power to regulators * susceptible to political interference

11. CASE STUDY 4Quito International Airport, Ecuador • Date: 2006 • Concession • Private Investment US$650 million • Concessionaire to develop new green field airport and to operate existing airport during construction • Maximum level of aeronautical charges are set in concession contract for 35 years subject only to inflation adjustment • Non-aeronautical charges are not regulated • No Government regulator on tariff setting • Advantages (a) transparent (b) simple (c) not subject to political interference, at least contractually • Disadvantages: Investors take all traffic and CAPEX risks

12. CONCLUSION • What is the recommended model for airport section PPP? • Government sets aeronautical tariff in RFP preferably as in Quito model • Private sector should take traffic risks (except force majeure) and CAPEX risks, thus eliminating need for tariff regulatory framework • Bids should be judged on percentage of gross revenues offered as concession fee • Bids should not be based on tariff offered to avoid low balling and potential disputes • Government uses concession fees from PPP airports to subsidize other publicly managed airports