For discussion FCR(96-97)17
on 31 May 1996

ITEM FOR FINANCE COMMITTEE

CAPITAL INVESTMENT FUND
HEAD 971 - TRADELINK ELECTRONIC DOCUMENT SERVICES LIMITED
Subhead 101 Purchase of equity in Tradelink Electronic Document Services Limited
New Subhead “Loan for Tradelink Electronic Document Services Limited”

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The Community Electronic Trading Service (CETS)

Introduction
Why Hong Kong needs the CETS now
Risks to Tradelink’s business prospects
Why private sector shareholders are holding back
Other options available
Option 1 - abandon the CETS
Option 2 - start the CETS again by Government on its own
Option 3 - replace loan by equity

Estimates of Major Items of Expenditure by Tradelink
Tradelink Cashflow Statement (HK$'000)

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Members discussed Item FCR(96-97)15 at the Finance Committee meeting on 24 May 1996. In the light of Members’ queries and comments, we withdrew the item and indicated that we would provide supplementary information in response to the points raised and resubmit the funding request for consideration by Members on 31 May 1996.

2. Subsequently, we issued an information note to the Legislative Council Panel on Trade and Industry on 27 May 1996. A copy of the note is at Enclosure 1.

3. The Panel held a meeting on 29 May 1996 to consider the supplementary information. As requested at the Panel meeting, we now provide a summary of Tradelink’s expenditure estimates at Enclosure 2.

4. One additional query raised during the Panel meeting concerns the transfer of assets from Tradelink to the Government. The Government’s agreement with Tradelink of 1 December 1992 stipulates that upon the expiry date of the Operating Agreement (paragraph 21 of Enclosure 1), “the assets to be transferred shall include all computer hardware, software, operational manuals, technical documentation and intellectual property and such other assets as are necessary for the provision of the Exclusive Services¹ by an entity² other than the Company”. The agreement further stipulates that the transfer to Government or its nominee shall be at zero value.

5. There were two typing errors in the cash flow statement included as Enclosure 1 of item FCR(96-97)15. The first two rows under the year 2000 should have been “113,084” and “49,815” instead of “13,084” and “149,815”. A revised cash flow statement is at Enclosure 3. We apologise for any inconvenience caused.

6. Members are invited to approve -

1. the creation of a new Subhead with a commitment of $425 million and supplementary provision of $225 million in 1996-97 for providing a loan to Tradelink Electronic Document Services Limited (Tradelink) for working capital;
2. the reduction in the approved commitment under Subhead 101 Purchase of equity in Tradelink Electronic Document Services Limited by $130,875,000; and
3. the reduction in the approved level of guarantees by Government of Tradelink’s loans by $165,424,987.

The approvals now sought are identical to those set out in item FCR(96-97)15 discussed at the Finance Committee meeting on 24 May 1996.

Trade and Industry Branch
May 1996

1 -- "Exclusive Services" refer to the services covered by Tradelink's franchise.
2 -- "Entity" means the Government or Government's nominee.

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Enclosure 1 to FCR(96-97)17

Information Note for the Legislative Council Panel on Trade and Industry

The Community Electronic Trading Service (CETS)

Introduction

At the Finance Committee meeting held on 24 May 1996, the Administration withdrew FCR(96-97)15, which set out its proposal for a loan of $425 million to Tradelink as working capital, for resubmission on 31 May 1996. This note has been prepared in response to the questions raised by Members.

Why Hong Kong needs the CETS now

2. The use of electronic data interchange (EDI) is gathering momentum internationally. An obvious trend is emerging. To become more efficient and competitive, leading international trading centres are abandoning the use of paper in favour of EDI. Hong Kong’s competitors in the region have already installed such systems. These include Korea, Singapore and Taiwan.

3. In March this year, we have been approached by the United States (US), one of our major export markets, to explore stopping the use of paper forms for clearance by US Customs of Restrained Textiles Export Licences (RTEL) issued by Hong Kong and using EDI instead. Singapore is already doing so with the US and we understand that a number of other Asian countries are about to start doing so as well. Although it is not explicitly stated so far, the signs clearly point to EDI clearance being the method preferred by US Customs. It is only a matter of time before EDI clearance becomes mandatory.

4. In order to maintain Hong Kong’s position as one of the leading trading centres in the world, Hong Kong cannot afford not to adopt EDI and to promote its use widely within the business community without further delay. We cannot afford to fall further behind our competitors. The objective of implementing the CETS now is to make sure we do not.

Risks to Tradelink’s business prospects

5. Risks to Tradelink’s business prospects can be broadly classified into three groups: whether Tradelink is up to the task; whether Tradelink has a viable business; and risks of technology obsolescence.

6. As explained in FCR(96-97)15, measures have been taken to improve Tradelink’s performance as well as co-operation between Tradelink and the Government. These measures include the representation of more senior Government officials in Tradelink’s Board of Directors with the direct personal involvement of the Secretary for Trade and Industry and the Director-General of Trade, the establishment of an Executive Committee chaired by the Chairman of Tradelink (i.e. Secretary for Trade and Industry) to assist the Board to closely supervise Tradelink’s management, the restructuring of Tradelink’s management, the recruitment of a new Chief Executive Officer, and the secondment of an officer from Trade Department. We will continue to introduce further improvement measures as necessary and to exercise a high level of governance in the company. We are confident that Tradelink will be turned around.

7. Tradelink’s core business is linked to Government’s statutory requirements for trade-related documents. Government’s decisions on these documents, therefore, will have a direct bearing on the business viability of Tradelink. As explained in the Finance Committee meeting held on 24 May 1996, Government has decided to make the use of EDI compulsory by stages. To begin with, all Trade Department counters for receiving RTEL applications will be closed two years after the introduction of EDI and all Customs and Excise Department counters for receiving Trade Declarations will be closed within a further 15 months. These measures will greatly assist to secure the success of Tradelink. They will also accelerate the use of EDI within Hong Kong’s business community. This is because once EDI is generally available for Government’s statutory trade-related documents, the motivation of the business community to use EDI for other applications will be greatly enhanced.

8. Information technology is fast changing. Such risks, however, have to be faced by any service provider relying on the use of information technology and can be managed by Tradelink in much the same way. It is worth noting that Government would be in a similar position if Government were to implement the CETS entirely on its own. In addition, as mentioned in paragraph 16 of FCR(96-97)15, a technology audit on Tradelink is being conducted and the results so far revealed that there should be no problem with the technical and physical capability of Tradelink’s system.

Why private sector shareholders are holding back

9. Although Tradelink’s projected internal rate of return on equity was 18% to begin with, it is now realistically estimated at 8% to 10%. Such a level of return is not attractive to any private sector company bearing in mind especially the need to continue funding in the meantime and the projected period (some six to seven years from now) before dividends are payable. As far as private sector companies are concerned, there are other more attractive investment alternatives from a business perspective. Government, however, cannot simply consider the financial return alone. It must also take the necessary steps to ensure that the important policy objective of securing the widespread use of EDI within the business community is achieved.

10. Tradelink’s private sector shareholders had doubted Government’s resolve in making the necessary decisions to ensure the success of the CETS, e.g. closure of Trade Department and Customs and Excise Department counters as mentioned in paragraph 7 above. Government’s much closer involvement in Tradelink now and its decision to make the use of EDI compulsory for the statutory trade-related documents have reduced their apprehension somewhat but they are still looking to the Government to take some positive concrete steps. The approval of Government’s proposed loan to Tradelink, thereby securing Tradelink’s need for working capital, will send a strong and positive signal not just to the existing shareholders but also potential investors that we are resolved to press on with EDI with all due speed.

11. Taking together both points set out in paragraphs 9 and 10 above, the attitude of Tradelink’s private sector shareholders can be readily understood.

Other options available

12. In addition to the proposed loan to Tradelink, there are three broad options available to Government. The first one is to abandon the CETS and wind up Tradelink. The second one is to wind up Tradelink and to start again entirely by Government. The last one is to replace the proposed loan by equity injection into Tradelink. These options have been considered by Government and discarded. The reasons for doing so are summarised in the following paragraphs.

Option 1 - abandon the CETS

13. As explained in paragraphs 2 to 4 above, Hong Kong must adopt the use of EDI without further delay. It will not be in Hong Kong’s best interest to abandon the CETS and to live with the consequences, which include not just economic losses, but also damages to Hong Kong’s image as a leading trading centre in the world. Winding up Tradelink would also have financial consequences. Government will have to write off its investment and pay off its share of Tradelink’s liabilities. For all these reasons, the option of abandoning the CETS and winding up Tradelink is not acceptable.

14. There were suggestions that the private sector will provide such a service if market conditions are right and Government does not need to intervene. The answer to this is that without Government’s active participation, no private sector organisation will consider implementing a CETS as the business of the CETS involves Government’s statutory trade-related documents.

Option 2 - start the CETS again by Government on its own

15. Government winding up Tradelink and starting the CETS again on its own does not mean that everything would need to be rebuilt from scratch. Nonetheless, the momentum already built up will be dissipated and valuable time will be lost in the process. It is conservatively estimated that to assemble the necessary resources within the Government, to redevelop the necessary systems and to install these systems again will take a minimum of two years before we can get back to the same position reached now.

16. Government will have to write off its investment in Tradelink, pay off its share of Tradelink’s liabilities, and bear totally the cost of rebuilding the CETS. From a financial perspective, this option is most unattractive.

17. Another relevant consideration is the parties that need to be involved to ensure the successful implementation of the CETS. The participants of successfully implemented projects of similar nature overseas include the telecommunications provider, the cargo terminal operators and the major banks. While some such entities may be Government-owned elsewhere, they are all in the hands of the private sector in Hong Kong and most of them are already Tradelink shareholders. We should not sever this ready-made partnership.

18. Taking all the points considered above, the option of winding up Tradelink and starting CETS again entirely by Government is not supported.

Option 3 - replace loan by equity

19. Government already holds a 48% share in Tradelink. Replacing the proposed loan by equity injection will increase Government’s share to about 85%. It will also result in Government’s share of Tradelink’s liabilities being increased by the same extent. Bearing in mind the likely return from such an investment and the risks involved, a loan is the preferred option.

20. Tradelink’s private sector shareholders have indicated their reservations in investing further in the company now. A drastic reorganisation of the capital structure of the company to the degree set out in paragraph 19 above would result in the private sector shareholders losing interest in the company altogether. This would not bode well for the key success factor of a partnership approach explained in paragraph 17 above. The Government would like to develop the partnership approach further by inviting trade-related bodies in the public sector (such as the Trade Development Council) to invest and become new shareholders of Tradelink. We consider that these organisations, which share the common objective of improving Hong Kong’s trading competitiveness and which are not solely motivated by profit maximisation, may find an internal rate of return on equity of 8% to 10% more readily acceptable that private sector companies.

21. Under Government’s agreement with Tradelink, important decisions of the company must be supported by shareholders representing not less than 80% of the shares. With Government’s existing holding of 48%, Government is already in a sufficiently strong control position without having to own more than 50%. Moreover, on expiry of the franchise period, all the assets of Tradelink relating to the exclusive services will revert to the Government anyway. Therefore after seven years we will own 100% of the relevant assets without having to increase our equity stake meanwhile. Instead we can enjoy a commercial rate of interest on the loan.

22. Again, the option of replacing the proposed loan by equity injection is not desirable and is not supported.

23. In summary, therefore, the proposed loan to Tradelink is the best option in terms of speed of implementation, cost to Government and, most important of all, preserving the key success factor of involving the right partners.

Trade and Industry Branch
27 May 1996

1 -- "Exclusive Services" refer to the services covered by Tradelink's franchise
2 -- "Entity" means the Government or Government's nominee.

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Enclosure 2 to FCR(96-97)17

Estimates of Major Items of Expenditure by Tradelink

¹ Software 70%
Hardware 25%
Office Equipment 5%

² Including staff costs and other recurrent costs in operating the system, marketing and sales, and administration.

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Enclosure 3 to FCR(96-97)17

Tradelink Cashflow Statement (HK$'000)

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