For discussion FCR(96-97)15
on 24 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”

Members are invited to approve -

1. 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. reduction in the approved commitment under Subhead 101 Purchase of equity in Tradelink Electronic Document Services Limited by $130,875,000; and
3. reduction in the approved level of guarantees by Government of Tradelink’s loans by $165,424,987.

---

PROBLEM
PROPOSAL
JUSTIFICATION
FINANCIAL IMPLICATIONS
INVESTMENT CRITERIA AND CONTROL MECHANISM
BACKGROUND INFORMATION
URGENCY
Tradelink Cashflow Statement (HK$'000)
A SYNOPSIS OF THE TRADELINK CONSULTANCY REPORT

CONSULTANCY STUDY OBJECTIVE
CONSULTANCY STUDY METHODOLOGY
CONSULTANCY STUDY OBSERVATIONS

---

PROBLEM

Tradelink Electronic Document Services Limited (Tradelink) will need new working capital by June 1996 to continue operating.

PROPOSAL

2. We propose to provide a loan of up to $425 million to Tradelink for working capital.

3. We would make the proposed loan available to Tradelink in the form of a revolving credit line on the following terms and conditions -

1. Amount : a maximum of $425 million;
2. Term : the maximum period that is demonstrably required by Tradelink for cash flow purposes and ending no later than the term of Government’s Operating Agreement with Tradelink ;
3. Drawdowns and Repayments : on a revolving basis as required;
4. Payments of interest : interest on the outstanding balance (including accrued interest not paid) to be calculated and paid monthly; and
5. Interest rate : the average of the best lending rates quoted by the note-issuing banks (namely, the Bank of China, Standard Chartered Bank and The Hongkong and Shanghai Banking Corporation).

JUSTIFICATION

4. Government entered into an agreement with Tradelink in December 1992, requiring Tradelink to provide a Community Electronic Trading Service (CETS) in Hong Kong. CETS is to lay the foundation for the widespread use of information technology-based techniques like electronic data interchange (EDI) within Hong Kong’s business community to improve efficiency and competitiveness. The use of EDI is gathering momentum internationally. To remain competitive, Hong Kong can no longer afford to rely on old-fashioned ways of doing business.

5. Government (through the Financial Secretary Incorporated) is the largest shareholder in Tradelink. As approved by Members in 1992, the Government has a 48% shareholding. The Government’s current financial involvement in Tradelink is summarised as follows -

6. Tradelink has spent all its paid-up equity ($117 million) and is currently being funded by a bank loan ($45 million) guaranteed by all the shareholders of Tradelink (including the Government). Tradelink will exhaust the loan by the end of May/early June. The company needs immediate new funding if it is to continue operating. The company’s private sector shareholders have indicated that until Tradelink is in full commercial operation, they will reserve their position on additional investments or loans.

7. As the CETS is a vital piece of the economic infrastructure required by Hong Kong in pursuing continued economic growth, we believe that its implementation should not be delayed. To remain competitive, Hong Kong cannot afford to fall further behind its competitors in the region in the provision of such systems. We agree with the consultant appointed to conduct a financial consultancy on Tradelink (paragraph 14 below), that the only realistic option for Hong Kong is to continue with Tradelink and to make Tradelink work. To start the CETS afresh in any other way would only result in further delays and higher overall cost.

8. In order to keep Tradelink as a going concern beyond May 1996 and to ensure that we do not hold back the implementation of the CETS due to a lack of funds, we recommend the provision of additional working capital for Tradelink through a loan from the Government. We consider this to be the most cost-effective and viable option to take forward the CETS and to avoid delays in implementing this important project for Hong Kong. Compared with the original funding approval of a mixture of Government equity and loan guarantee, we consider that the proposed loan would incur little or no additional risk for Government. We estimate the amount of additional working capital required by Tradelink between now and the end of its Operating Agreement with the Government at $425 million. With this amount of additional working capital, Tradelink is projected to start operating at a profit during the year 1999-2000 and to repay in full the amount of Government’s loan by the year 2002-03. The projected drawdowns and repayments of Government’s loan are shown below -

A cash flow statement is at Enclosure 1.

FINANCIAL IMPLICATIONS

9. The proposed loan of $425 million to Tradelink is a one-off commitment and will operate as a revolving credit line to Tradelink. Tradelink will draw down the loan as and when necessary and repay it in full at the latest by the expiry of Government’s Operating Agreement with Tradelink² . Subject to Members’ approval of the proposed loan, we will no longer require the approved equity balance of $130,875,000 and loan guarantee balance $165,424,987 (paragraph 5 above). We will delete these amounts from the approved commitment under Subhead 101 Purchase of equity in Tradelink Electronic Document Services Limited and the approved level of guarantees by Government of Tradelink’s loans respectively. Approval of the loan will not lead to any additional recurrent expenditure implications for the General Revenue.

10. Having regard to the loan drawdown schedule stated in paragraph 8 above, we recommend supplementary provision of $225 million in 1996-97 for a new Subhead under Head 971 Tradelink Electronic Document Services Limited. We will offset part of the supplementary provision sought by the deletion of $78,428,000 under Subhead 101 Purchase of equity in Tradelink Electronic Document Services Limited of the same Head, and the balance of $146,572,000 by the deletion of the same amount under Additional Commitments of the Capital Investment Fund.

INVESTMENT CRITERIA AND CONTROL MECHANISM

11. Government’s interest is being looked after by representation on the Tradelink Board with the Secretary for Trade and Industry in the chair. The Director-General of Trade and the Principal Assistant Secretary for the Treasury (Investments) are also Board members.

BACKGROUND INFORMATION

12. On 24 July 1992, Members approved a commitment of $187 million for Government to take up a maximum of 48% shareholding in Tradelink and another commitment of up to $187 million for Government to guarantee Tradelink’s loans in proportion to Government’s level of shareholding in the company. We also informed Members of the salient features of Government’s agreement with Tradelink, including the provision for Tradelink to earn an 18% internal rate of return on equity.

13. In early 1996, both Government and Tradelink recognised the need for closer Government involvement in Tradelink as the CETS would soon approach its commercial phase. As a result, the Secretary for Trade and Industry and the Director-General of Trade accepted Tradelink’s invitation to become Tradelink Directors. The Tradelink Board also elected the Secretary for Trade and Industry as Chairman.

14. In February 1996, Government appointed a consultant to conduct a financial consultancy on Tradelink in order to obtain independent advice on Tradelink’s financial position and its likely funding requirement over the duration of its Operating Agreement with the Government. A synopsis of the consultancy report is at Enclosure 2. The consultant confirmed that Tradelink can remain commercially viable although its anticipated 18% internal rate of return on equity is no longer realistic due to the extended development period. We determine the amount of the proposed loan to Tradelink based on the funding requirement recommended in the consultancy report.

15. Both Government and the Tradelink Board have accepted the consultant’s report, and the various recommendations for strengthening Tradelink have been or are being implemented.

16. In respect of the technology audit (paragraph 5.3 of Enclosure 2), it is now being undertaken by a team of qualified experts pulled from within the shareholder organisations. The review so far has revealed that there should be no problem with the technical and physical capability of the system. However, the system design work requires the injection of more attention and resources to achieve the necessary quality standard. Tradelink has taken this up with its technology contractor and will continue to keep the matter under tight control.

17. In respect of the organisational re-structuring, Tradelink has already established the recommended Executive Committee (paragraph 5.5 of Enclosure 2). It comprises the chairman of Tradelink (i.e. the Secretary for Trade and Industry), three Board directors (of whom one is the Director-General of Trade), the Chief Executive Officer (CEO), the Chief Operating Officer (COO) and the Chief Finance Officer (CFO) of Tradelink. The Executive Committee will enhance the governance of Tradelink and will enable representatives from the Board to supervise and direct closely the operation of Tradelink. Recruitment is underway for the CEO, COO and CFO and we expect the new CEO to report for duty in July 1996.

18. We have seconded a Trade Department officer, who is well experienced in Restrained Textiles Export Licences (RTEL) procedures, to Tradelink since March 1996 to provide specific trade control system information (e.g. licensing) to ensure that we can successfully complete joint testing of Government’s and Tradelink’s computer systems without further delay and that we can carry out smoothly preparation for the commercial launching of the CETS. This is also in line with the consultancy recommendation of instituting a “staff interchange” programme (paragraph 5.6 of Enclosure 2).

19. Tradelink has finalised plans for launching the CETS in January 1997 as recommended by the consultant. We will complete the joint testing of Government’s and Tradelink’s computer systems in June 1996. From July to September 1996, up to ten companies will participate in the final testing of the CETS under simulated environments. During this period, the participants will submit RTEL applications through the paper and CETS systems. Dual processing will take place with the CETS results compared with those of the paper processing. From September to December 1996, up to 50 companies will stop using paper applications and submit their RTEL applications through the CETS. From January 1997, Tradelink will open up the CETS to the entire business community for RTEL processing. From April 1997, Tradelink will also open up the CETS for Trade Declarations processing. This carefully controlled phased-in approach is necessary in view of the complexity of the operation involved.

URGENCY

20. Tradelink will run out of funds by the end of May/early June (paragraph 6 above). Unless new funding is made available to Tradelink urgently, the company will have no choice but to cease operation shortly. We briefed the Legislative Council Panel on Trade and Industry on 9 May 1996. Members raised a number of queries which took time to address, hence the late issue of this paper. We apologise for any inconvenience caused.

Trade and Industry Branch
May 1996

1 -- The term of Government's Operating Agreement with Tradelink is seven years starting from the date when Tradelink launches a commercial service (which, at present, is targeted for January 1997).
2 -- That is December 2003 on the basis of the current target of Tradelink startiing iits commercial operation in January 1997.

---

Enclosure 1 to FCR(96-97)15

Tradelink Cashflow Statement (HK$'000)

---

Enclosure 2 to FCR(96-97)15

A SYNOPSIS OF THE TRADELINK CONSULTANCY REPORT

CONSULTANCY STUDY OBJECTIVE

The Trade and Industry Branch, with the agreement of the Tradelink Board, commissioned a 6-week consultancy study, undertaken from February to March 1996. The objectives of the study were to:

1. establish Tradelink's current position;
2. identify any significant impediments to Tradelink's success or financial viability; and
3. develop a forward plan including recommendations for revised business plan including scope of services and estimated timetable for implementation, funding needs and sources of funds, project structure, interface requirements between Government and Tradelink, and trading community obligations.

CONSULTANCY STUDY METHODOLOGY

2. The consultant conducted interviews with Tradelink management and shareholders; potential user organisations (Trade Advisory Board, Textiles Advisory Board); Tradelink's major technology contractor (Hewlett Packard); Government (including Trade Department, Information Technology Services Department, Customs and Excise Department, Census and Statistics Department, Finance Branch and Trade and Industry Branch); Tradelink's potential partners and other relevant parties. The consultant also presented an interim and the final reports to the Tradelink Board of Directors, and attended before a joint meeting of the Trade Advisory and Textiles Advisory Boards.

CONSULTANCY STUDY OBSERVATIONS

3. In respect of Tradelink's current position, the consultant noted the following:

3.1 Commercial problems

1. Tradelink lacked credibility in the wider community. When launching its service, Tradelink must ensure that it be adequate and reliable, and public relations are well-managed.
2. Relationship between Government and Tradelink was not well-managed. It was imperative for government departments and Tradelink to co-operate fully.

3.2 Financial situation

1. With funding running out at end May 1996, Tradelink's position was untenable.
2. The budget freeze imposed on Tradelink in recent months had exacerbated the existing problems and prohibited necessary changes.
3. Existing controls had not been defined tightly enough by the Tradelink Board in terms of cost/expenditure for a project-based company.

3.3 Current business plan

1. Too much attention had been placed by Tradelink on the "goal seeking" Internal Rate of Return of 18% enshrined in its agreement with Government, leading to unreasonable assumptions in terms of migration, pricing, numbers of documents and delivery dates.
2. A lack of revenue stream early enough combined with the finite project life (governed by the term specified in its agreement with Government) had rendered the current business plan unviable.

3.4 Technical problems

1. There were difficulties with delivery of CETS as a project.
2. There was a lack of satisfactory resource in the technical area regarding both the technology selected and the basic concept of the service.
3. Project management disciplines and methods were introduced only since December 1995 and the ongoing delivery of contracted services were still suffering as a result.
4. Improvement was necessary in managing the relationship with Tradelink's technology contractor.

3.5 Change control process

1. There was a need to merge the two separate processes, one for working with government and another for working with Tradelink’s technology contractor, so as to ensure that both parties were aware of consequences that might arise from any change request, with appropriate approvals from each group.
2. Tradelink’s CETS project manager should meet the other participants at least weekly to "clear" outstanding change requests.

3.6 Communication, management, project structure

1. An "interchange" of personnel between the Government and Tradelink was required to improve relationship and shorten the time line in communications and subsequently speed up the decision making process.
2. The Joint Implementation Team mechanism should be strengthened and rendered more effective.

4. In respect of significant impediments and risks, the consultant noted the following:

4.1 Tradelink

1. Its ability to deliver the service on time and of appropriate quality in a technical sense.
2. The viability of its proposed services for non-computer users.
3. Its ability to physically resource the tasks of registration and connection during high-volume periods.
4. Its ability to manage the essential third party partners to ensure that indirect channels would be available at the appropriate time.
5. Its ability to switch from a project driven company to a service provider operation in a short space of time.
6. Its ability to construct a commercially viable business to attract further investment and generate confidence in the company's ability to deliver financially.
7. Its lack of effective management of external relationships.

4.2 Government

1. A lack of vision by user departments regarding EDI.
2. An inability to identify cost/benefit rationale in EDI.
3. A reluctance to mandate the compulsory electronic submission regime with an "assisted" migration plan.
4. An unclear definition of the role of Tradelink.

4.3 Trading community

1. A general lack of vision about the benefits of EDI.
2. A perception of cost increase for EDI.
3. No push to adopt EDI in the absence of coercion and the post shipment/freeport status of Hong Kong.

5. In respect of recommendations, the findings are detailed below.

5.1 General: The consultant concluded that although there were significant difficulties and risks with proceeding with Tradelink, it would be counter-productive to start again in any other way.

5.2 Business Plan: A new business plan, based on stated realistic assumptions and with the goal of seeking the 18% Internal Rate of Return removed, be adopted as the base model to continue developing the business of Tradelink.

5.3 Technology: A technology audit should be undertaken to ensure that Tradelink’s systems would be able to meet the forecast business requirements of the company. An analysis of the performance of Tradelink's major technology contractor in meeting its obligations should also be undertaken. A process for ISO certification should be started to ensure that the agreed project development path met a level of international acceptance and a process was gradually put in place within Tradelink. This could ensure that "world best practice" was targeted in the long term to facilitate the necessary international interconnects needed for the long term commercial health of the business.

5.4 Funding: Government, as the major driver in this initiative, should approach the existing private sector shareholders and possible new shareholders as soon as possible to discuss future funding plans to secure the continuation of Tradelink.

5.5 Organisation: A new organisational structure, including the formation of an Executive Committee between the Board of Directors and the CEO (Chief Executive Officer) assisted by a COO (Chief Operating Officer) and a CFO (Chief Finance Officer), be adopted to allow Tradelink to make the transition from a project based business to a service provider operation in an effective manner.

5.6 Relationships: In conjunction with the organisational re-structuring, Tradelink's senior managers should be empowered and given responsibility to manage the company’s external relationships. A public relations firm should be appointed to work with internal staff to create a plan for the launch of the service and to assist the senior managers to deal with external relationships with a goal of "turning around" the current negative perception of Tradelink in the market. A "staff interchange" program should be implemented across all participants to promote the free transfer of necessary knowledge and improve the time to delivery of documents and subsequent services.

---