Late on Friday (10) Government released the PricewaterhouseCoopers Independent Review on the agreement it has with Dart Realty and the National Roads Authority.

The government also released details of the third amendment, which was never agreed to after Dart pulled out of the talks.

A list of the documents released by government is below:

13-05-10 NRA Agreement – Appendix D – NRA Agreement.pdf

13-05-10 NRA Agreement – Appendix D – 1st Amendment to the Agreement.pdf

13-05-10 NRA Agreement – VfM Report October 2012.pdf

13-05-10 NRA Agreement – DRAFT VfM Report May 2013.pdf

13-05-10 NRA Agreement – Appendix E – JEC Report.pdf

13-05-10 NRA Agreement – Appendix A – Terms of Reference.pdf

13-05-10 NRA Agreement – Appendix D – 2nd Amendment to the Agreement.pdf

13-05-10 NRA Agreement – Appendix D – NRA Agreement- 3rd Amendment and Schedules.pdf

Because of the size of the documents we have only been able to show you part of Section 8 and the summaries and recommendations contained in Section 9 of the reports. These, however contain the salient points and we have also used BOLD type to show you what I consider are very important.

After, I have time to digest every document I might find others so this is a continuing story.

Please note also that the 2013 VfM (Value for Money) is a DRAFT only and details the potential value-for-money impact if that third amendment had been agreed.

Please also read DART’s response to the release by government of these documents.

The first part –  8.6 Public-Private Partnerships is applicable to both the 2012 VfM and the 2013 VfM. It provides PricewaterhouseCoopers (PwC) opinion as to the DART/NRA relates to the FFR (The Framework for Fiscal Responsibility agreed between the CIG and FCO on 23 November, 2011).

Abbreviations used throughout include: CIG (The Cayman Islands Government), CTC (CIG’s Central Tenders Committee), (DRCL (Dart Realty (Cayman) Limited, including its affiliates and successors), ETH (Esterley Tibbets Highway), FCO (The UK Government’s Foreign and Commonwealth Office), NRA (The National Roads Authority of the Cayman Islands), PwC (PwC Corporate Finance & Recovery (Cayman) Limited. PwC Corporate Finance & Recovery (Cayman) Limited is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity), ROW (Right of Way), PPP (Public-Private Partnerships) and SMB Hotel (The land and buildings on Parcels 82, 83 and 84 of Block 11B of Grand Cayman [parcel 83 of which being the former Courtyard Marriott]).

8.6. Public-Private Partnerships

The NRA Agreement, while not a PPP in the strictest sense, does constitute alternative financing of infrastructure, and as such there are specific provisions within the FFR with respect to the appropriate appraisal process, namely:

“PPPs or any other form of alternative financing will only be considered:

1. where there is a sound appraisal underpinning the proposed project before the financing means has been determined;

2. where a financial appraisal demonstrates improved value for money against a conventionally financed alternative;

3. where the long term affordability case has been assessed and agreed by the appropriate technical experts retained by the Cayman Islands Government; and

4. where an independent opinion has been received from a qualified accountant of good standing on the correct accounting treatment in the Cayman Islands Government’s accounts.”

CIG’s commissioning of this VfM review, and if appropriate acting on the review’s findings, meets a core requirement of the FFR. In non-standard transactions such as the NRA Agreement, where there is only one possible counterparty, the VfM review is a critical tool for protecting CIG’s interests. This is particularly the case given that a competitive tender process, and associated price discovery is not feasible in this scenario.

As set out under the FFR, this VfM review should have been conducted as part of the initial project appraisal at an early stage in the overall process, rather than at this late stage. Further, under the FFR, the CIG’s own project appraisal should have been published for public consultation prior to the procurement stage.

PwC understands that in practice the NRA Agreement business case development and negotiation was principally driven by policy makers, as opposed to civil service ministries and departments.

However, it is recognized that the FFR itself was only agreed in November 2011, by which point the NRA Agreement was largely completed, following up to a year of protracted negotiations. The NRA Agreement also includes a provision for the completion of the VfM Review and a process for addressing any associated amendments, which to an extent protects CIG’s position.

In addition, while the FFR provides general guidance on approach, it seems that the PMFL’s 2004 Regulations do not provide adequate detailed regulations for implementing the FFR’s guidance around business appraisal, VfM review and negotiation for non-standard capital transactions with only one potential counterparty. As the NRA Agreement could not feasibly be put out to competitive tender and is therefore not likely to be subject to CTC review, there does not appear to be a clear route for appraisal and project acceptance within CIG regulations. This is particularly the case given that the Public Sector Investment Committee (“PSIC”) envisaged under the PMFL has not been established.

2012 VfM

8.7. Conclusion

As discussed in detail at Section 5, the terms of the NRA Agreement are expected to generate substantial positive economic impact for the Cayman Islands, and CIG had the opportunity to secure greater certainty over this benefit by further tailoring the taxation incentives and other terms, as a result of the amendment clauses included in the NRA Agreement.

As such, and based on the likely impacts on public debt and revenues discussed above, the result of the NRA Agreement is expected to be broadly in line with the guidelines under the FFR and CIG’s five components of fiscal strategy.

In an assessment of compliance with the FFR, one must have regard to the appraisal and negotiation process undertaken by CIG, as well as the actual terms and expected outcomes of the NRA Agreement.

As set out under the FFR, this VfM review should have been conducted as part of the initial project appraisal at an early stage in the overall process, rather than at this late stage, and the CIG’s own project appraisal should have been published for public consultation prior to the procurement stage.

However, the FFR was only signed in November 2011, toward the end of the NRA Agreement negotiation process. Further, while the FFR provides general guidance on approach, it seems that the PMFL’s 2004 Regulations do not provide adequate detailed regulations for implementing the FFR’s guidance around business appraisal, VfM review and negotiation for non-standard capital transactions with only one potential counterpa1ty. As the NRA Agreement could not feasibly be put out to competitive tender, and is therefore not likely to be subject to CTC review, there does not appear to be a clear route for appraisal and project acceptance within CIG regulations. This is particularly the case given that the Public Sector Investment Committee envisaged under the PMFL has not been established.

Accordingly, it is recommended that CIG consider amendments to the PMFL and associated Regulations in order to provide for a clear and transparent appraisal and approval process for non-standard transactions, where competitive tender is not feasible. Such amendments could ensure that the process draws on a cross section of civil service expertise thereby enabling policy makers to focus on strategic policy, rather than detailed appraisal and negotiation.

It should also be noted that, by transferring the responsibility for the Road Infrastructure construction to DRCL, CIG is effectively putting the Road Infrastructure expenditure outside the scope of CTC’s, and therefore the public’s, review. This approach is standard practice for PPP arrangements internationally, in which Governments contract for the delivery of an ‘outcome’ and the means of delive1y is essentially left to the private contractor.

However, given CIG’s close cooperation with DRCL under the FCIA, there is inherent reputational risk for CIG should DRCL’s procurement process fail to meet prescribed CIG standards around potential or perceived conflicts of interest. As such, it is recommended that CIG provide DRCL with guidelines around management and disclosure of any actual or perceived conflicts of interest in their procurement process.

9.2.      VfM Assessment: Infrastructure and SMB Hotel development

The NRA Agreement provides for significant financial benefits for the CIG in the sh01t term, pa1ticularly in the form of road construction to be carried out by DRCL, land to be transferred to CIG by DRCL, improvements to existing and new public beaches and creation of new public pedestrian and bike paths as well as a cash grant which DRCL has already paid to the CIG. The NRA Agreement also allocates risks relating to the construction of the ETH Extension to DRCL which would traditionally be supp01ted by the NRA. Finally, the NRA Agreement should generate substantial economic benefits for the Cayman Islands from the reopening of the SMB Hotel as well as from the rest of the DRCL Development Plan should it be executed.

Gaining these benefits requires the CIG to incur certain costs and divest assets to DRCL. The most important of these is the CIG agreeing to the closure of a portion of the WBR and the vesting of this land to DRCL following the process set out in the Roads Law as well as the extinguishing of DRCL’s obligation to provide the public rights of way stipulated under the Cayman Islands Development and Planning Regulations .The proceeds of this divestment/land sale are effectively the benefits which accrue to CIG under the NRA Agreement. The NRA will also be required to support monitoring costs relating to the construction of the ETH Extension and New Barkers Road as well as incremental costs and risks relating to the operation of these new roads.

A summary of these benefits, costs and risks is shown in Figure 32/2012.

Overall, PwC believes that the infrastructure and SMB Hotel development component of the NRA Agreement provide VfM to the CIG. Although the sum of

tangible benefits to the CIG (including transferred risks) is less than the sum of CIG costs, divestments and retained risks, this comparison is somewhat misleading since:

•          The most important contribution by the CIG to the NRA Agreement is the divestment of the closed WBR and Barkers lands, valued at $75.0m representing a share of WBR and Barkers land value uplift for which CIG is foregoing a direct cash compensation. This value uplift, while real, is difficult to estimate and does not constitute an immediate source of cash for DRCL. Further, for DRCL to recoup the value of this uplift requires substantial additional investment in the construction and operation of a major hotel. This represents a relatively high-risk venture in the current economic climate. While PwC believes it is appropriate to include this amount among the CIG costs and divestments under the NRA Agreement, it does not require any disbursement of funds by CIG.

•          The quantified benefits do not include intangible benefits such as the anticipated improvements to the existing public beach following the closure of the WBR and the creation of the Public Beach Park.

•          Most of the benefits CIG is to receive will materialize in the short term. DRCL has started work on the ETH Extension and has already paid CIG the entire $5m grant.

VfM is also provided to the Cayman Islands from the economic impact and other advantages generated by the NRA Agreement:

•          PwC estimates that the net economic impact to the Cayman Islands over the 20 year operational period covered by the economic impact study to be up to approximately $755m if only the SMB Hotel is reopened and up to $2-4bn if the entire DRCL Development Plan is implemented;

•          The closure of a portion of the WBR and the construction of the ETH Extension will provide benefits to the Cayman Islands not fully captured in the estimated economic impacts. Most notably, these road projects will be a major step in the NRA’s plan to make the WBR better adapted for pedestrians and will help to alleviate congestion. The diversion of traffic from the WBR to the ETH Extension is also expected to contribute to the safety and well being of Caymanians, albeit concerns have been raised regarding the social impact of potentially reduced beach access to the public;

•          The addition of the new hotel brands comprised in the DRCL Development Plan to the Cayman Islands will generate new location specific marketing spend which can be expected to raise the profile of Cayman as a destination and have consequent benefits for the wider Cayman Islands tourism sector.

9·3· VJM Assessment: Stamp duty, development fees and import duty abatements

The $24m Abatements are presented by DRCL as an important component in DRCL’s decision to go forward with the DRCL Development Plan (excluding the SMB Hotel, which is eligible for separate abatements), the $24m Abatements appear to be reasonable:

•          The DRCL Development Plan, excluding the SMB Hotel, would, if fully implemented, generate $90.6m of incremental development fees and duties payable to the CIG after application of the $24m Abatements;

•          To benefit from the full $24m Abatements, DRCL must build the equivalent of the following projects, which represent a total investment of approximately $300m, which are included in the early stages of the DRCL Development Plan:

WB Lands Condo1 (100 units)

WB Lands Condos 2 (50 units)

WB Hotel 2 (300 rooms)

WB Hotel 3 (150 rooms)

Eco-Tourism Hotel (100 rooms)

Commercial Centre1 (50,000 square feet)

However, except for the SMB Hotel, the NRA Agreement does not oblige DRCL to undertake any specific type of development nor does it establish any guidelines as to the nature, timing or scope of future developments. Although the DRCL Development Plan does foresee a number of new hotels, actual development will depend on market conditions and DRCL’s commercial priorities. As a result of the limited specificity in the NRA Agreement, there are no restrictions which could prevent DRCL from concentrating its resources for the next few years on office and commercial space at Camana Bay and applying the entire $24m Abatements to such development, which arguably could have been viable even without the $24m Abatements.

Such an outcome would result in significantly lower economic benefits than those estimated from the hotel/tourism focused projects included in the DRCL Development Plan. Economic benefits to the Cayman Islands could therefore be significantly below those calculated in Section 5 of this report.

PwC believes these shortcomings in the potential application of the $24m Abatement need to be addressed to ensure that the GIG obtains VfM.

9·4· Vfm Assessment: Hotel Tax Rebate

PwC estimates the potential cost of the Hotel Tax Rebate to be up to $63.2m (as shown in Figure 7 on an NPV basis), when applied to the various hotel projects included in the DRCL Development Plan for a period up to 2052.

DRCL has presented the Hotel Tax Rebate as an important consideration in its decision to go forward with the hotel projects included in the DRCL Development Plan. However, PWC believes the following considerations must be taken into account when assessing the VfM provided to the GIG by the Hotel Tax Rebate:

•         DRCL can also claim the Hotel Tax Rebate for any hotel it opens or renovates, including hotels it could build on properties outside of its land parcels adjacent to the WBR (for example at Camana Bay) or if it acquires an existing hotel and undertakes “renovations”.

•          The purpose of the Hotel Tax Rebate is to spur the development of new hotels or the renovation or refurbishment of existing hotels by DRCL. DRCL represented to PwC that it would not likely undertake hotel investment in the Cayman Islands as currently planned without the Hotel tax Rebate. However, without a detailed analysis of projected ROI data on DRCL’s proposed hotel developments it is not possible to establish the need for the Hotel Tax Rebate to make hotel investment financially feasible. Given the DRCL Development plans are at an early stage, such analysis is not possible at present.

•          Given the wide geographical scope and very long period during which the Hotel Tax Rebate is applicable, it is not possible for PwC to judge whether the Hotel Tax Rebate would have a significant impact on a hotel investment decision in the Cayman Islands nor what the likely impact on competitors’ investment decisions would be.

•          To PWCs knowledge, a similar rebate on hotel taxes has never been made available by GIG to a developer. Although GIG has in the past negotiated other incentives with hotel developers on a case by case basis, there is clearly a risk that the Hotel Tax Rebate could set a new precedent in the Cayman Islands, which would weaken GIG’s negotiating position with alternative potential hotel investors.

•          The potential cost of the Hotel Tax Rebate is highly subjective and very difficult to estimate given the possibility of the hotel tax rate increasing over time, which directly increases the value of the rebate. The recent decision by GIG to increase the hotel tax from 10% to 13% effectively increased the cost of the Hotel Tax Rebate to GIG by 30%.

Overall, PwC believes the Hotel Tax Rebate may not, as set out in the NRA Agreement, provide the CIG with VfM because:

•          Except for the SMB Hotel, CIG does not know the size, type or location of any hotel developments, which would be eligible for the rebate;

•          The rebate could apply to existing hotels in which DRCL would acquire a 51% participation (or perhaps less); and

•          Once the details of the Hotel Tax Rebate are made public, owners of existing hotels or other potential investors could make demands for similar rebates, at a cost unknown to CIG.

9·5· Overall assessment of NRA Agreement Value for Money

In summary, PwC believes that:

•          The infrastructure and SMB Hotel development component of the NRA Agreements provides VfM to the CIG;

•          In conjunction with the full or substantial delivery of the DRCL Development Plan, the $24m Abatements would provide VfM to the CIG, but improved targeting of incentives is required in order to avoid the risk of DRCL applying incentives to existing or planned developments which may be viable without tax waivers and/or to developments which might not have the tourism-related economic benefits which the CIG is seeking; and

•          The Hotel Tax Rebate may not provide VfM to the CIG because CIG has little control over its application to either new hotels (of unknown category, size or location) or to existing hotels (without requiring substantial renovations) and because of the unknown impact it might have on other current or future hotel developers and owners.

9.6. CIG’s alternatives to the NRA Agreement

The ETH Extension has been part of the Cayman Islands’ infrastructure plans for over 20 years, with improved access and traffic flow to the West Bay population centre and the transfer of traffic volumes away from the WBR identified as being key infrastructure requirements. The NRA has confirmed that the WBR closure, while not part of their previous road planning, is consistent with the aim of ‘pedestrianisation’ of the WBR, leading to improvement in traffic safety and the general tourism offering in the Seven Mile Beach corridor.

PwC has examined the potential alternatives for delivery of the Road Infrastructure, by the 31 December 2013 deadline included in the Terms of Reference.

The Traditional Delivery method of NRA construction is dependent on the CIG financing the full cost of works. However, as discussed in Section 7,as a result of high existing debt levels and ongoing deficits, the CIG is required to carry out a significant fiscal retrenchment over the next three financial years. Given that there are a number of existing capital commitments on the Cayman Islands public purse, most notably the John Gray and Clifton Hunter High Schools, it is likely that any additional borrowing sanctioned by CIG and the FCO, would need to address these priorities. As such, in the circumstances, general prudent fiscal management as well as the provisions of the PMFL and the FFR would likely preclude raising new debt finance for Traditional Delivery of the road infrastructure by December 2013.

The option of CIG selling the WBR closure land to DRCL in a separate transaction and CIG building the ETH Extension itself was considered, given the potential benefits of improved transparency over WBR closure sale proceeds, greater control over development incentives and retention of control over the ETH Extension by the NRA. However, there are a number of disadvantages to this approach, and PwC concludes that the potential advantages can be achieved more effectively through amendment to the NRA Agreement.

Sale of alternative properties by the CIG to raise funds for the ETH Extension was considered, but in light of the significant synergy value released by the NRA Agreement, it seems unlikely that CIG would be able to secure proceeds on such terms for alternative public assets.

In light of CIG’s fiscal constraints, PPP alternatives for provision of the ETH Extension are limited to those that would not require recognition of future obligations as public debt. Essentially, this limits PPP options to those that could operate as a stand-alone commercial enterprise, such as ‘Real Tolling’ or ‘Tied-in Concessions’. Real Tolling for the ETH Extension is not considered commercially viable, given the expected traffic flow, investment required and feasible pricing. Tied-in Concessions would ordinarily comprise substantial transport infrastructure, such as airports and ports, or possibly sports stadia or casino concessions. Accordingly, there does not appear to be a realistic alternative option for a substantial Tied-in Concession along the route of the Road Infrastructure, particularly in light of DRCL’s extensive adjacent land holdings.

9·7· Compliance with the FFR

The provisions of the NRA Agreement have the potential to generate substantial positive economic impact for the Cayman Islands and, as a result of the amendment and variance clauses in the NRA Agreement, the CIG has retained the ability to secure greater certainty over this economic benefit by further tailoring the tax waivers and abatements and other terms.

As such, and based on the likely impacts on public debt and revenues discussed in Section 8, the result of the NRA Agreement is expected to be compliant with the guidelines under the FFR and the CIG’s five components of fiscal strategy.

In an assessment of compliance with the FFR, one must have regard to the appraisal and negotiation process undertaken by CIG, as well as the actual terms and expected outcomes of the NRA Agreement.

Ideally, and as set out under the FFR, this VfM review should have been conducted as part of the initial project appraisal at an early stage in the overall process, rather than at this late stage, and the CIG’s own project appraisal should have been published for public consultation prior to the procurement stage.

However, the FFR was only signed in November 2011, toward the end of the NRA Agreement negotiation process. Further, while the FFR provides general guidance on approach, it seems that the PMFL’s 2004 Regulations do not provide adequate detailed regulations for implementing the FFR’s guidance around business appraisal, VfM review and negotiation for non-standard capital transactions with only one potential counterparty. As the NRA Agreement could not feasibly be put out to competitive tender, and is therefore not likely to be subject to CTC review, there does not appear to be a clear route for appraisal and project acceptance within CIG regulations. This is particularly the case given that the Public Sector Investment Committee envisaged under the PMFL has not been established.

It should also be noted that, by transferring the responsibility for the Road Infrastructure construction to DRCL, CIG is effectively putting the Road Infrastructure expenditure outside the scope of CTC’s, and therefore the public’s, review. This approach is standard practice for PPP arrangements internationally, in which Governments contract for the delivery of an ‘outcome’ and the means of delivery is essentially left to the private contractor, subject to provisions for proper identification, management and disclosure of potential or perceived conflicts of interest.

9.8. Recommendations

Based on its analysis and findings as documented in this report, PwC recommends the following modifications be made to the NRA Agreement to ensure it provides VfM to the CIG:

•          The $24m Abatements should only be available for projects which are predominantly hotel/ tourist resort­ oriented (allowing for the inclusion of some well-defined ancillary projects such as condominiums, a golf resort, and associated real estate) and built on DRCL property adjacent to the WBR closure, the ETH Extension or the New Barkers Road. In defining qualifying tourism projects, CIG may wish to consider how the fact that DRCL’s development plans can be subject to amendment in light of market conditions is factored into the granting of abatements.

•          If deemed appropriate from the perspective of developing the wider tourism industry, the Hotel Tax Rebate should be expanded to provide a CIG hotel tax rebate program available to all investors who undertake hotel construction or renovation projects on a scale comparable to the hotels envisaged in the DRCL Development Plan. Clear rules should be developed concerning eligibility of such projects for the hotel tax rebate, including a demonstration of the project’s economic benefits for the Cayman Islands, scope and timing of the development. Further, the definitions of renovate and acquire need to be refined to ensure the rebate incentivizes incremental investment and economic activity, rather than subsidizing existing activity.

•          The stamp duty rebate provided to Caymanian purchasers of DRCL properties could potentially distort the local real estate market to the disadvantage of competing developers. As such, it is recommended that CIG consider whether any stamp duty concessions to Caymanians should be offered m1der a wider program, rather than one targeted solely at DRCL properties.

•          CIG should ensure the NRA has sufficient funding to be able to undertake the monitoring of road construction being undertaken by DRCL in order to ensure high construction standards are met and therefore ensure whole life maintenance costs for CIG are minimized.

•          CIG should establish a mechanism across its various departments and agencies to allow it to track all claims made by DRCL, its affiliates and sub-contractors under the $24m Abatements and the hotel tax rebate program to ensure claims made do not surpass the limits set out in the NRA Agreement and/or Hotel Tax Rebate program, and that waivers are awarded only for qualifying parties and qualifying development.

•          CIG should consider amendments to the PMFL and associated Regulations in order to provide for a clear and transparent appraisal and approval process for non-standard transactions, such as the NRA Agreement, where competitive tender is not feasible. Such amendments should ensure that the process draws on a cross section of civil service expe1tise thereby enabling policy makers to focus on strategic policy.

•          In light of the inherent reputational risk of CIG outsourcing major construction to a private developer, it is recommended that CIG provide DRCL with guidelines around identification, management and disclosure of any actual or perceived conflicts of interest in their procurement process. However, DRCL, as party responsible for road construction, must retain full discretion in its choice of suppliers and subcontractors.

•          CIG could consider options to further incentivize and facilitate Caymanian employment in the new DRCL hotels. For example certain tax incentives, such as the Hotel Ta.” Rebate, could be linked to Caymanian employment metrics.

•          The NRA Agreement does not appear to specifically include a waiver from DRCL for any compensation from the CIG for land which DRCL will transfer to the CIG for the New Barkers Road. This waiver should be made explicit in the NRA Agreement.

•          DRCL will have complete control over the route and other aspects of the new pedestrian and bicycle path which will be the only means for public access to significant parts of West Bay Beach. This control is important for DRCL to be able to carry out its long-term development plans. However, CIG should seek to enhance its control over this public amenity, without encroaching m1duly on DRCL’s need for c01mnercial flexibility. A possible approach would be to oblige DRCL to consult with CIG before important changes could be made to the pedestrian and bicycle path.

•          There are areas of the NRA Agreement in which the obligations on DRCL remain vague and do not appear to fully reflect both pa1ties understanding of their agreement in principal; most notably:

o          New Barkers Road: DRCL has confirmed that it still intends to meet the cost of construction of a new public road in Barkers.  However, under the Second Amendment of the NRA Agreement there is no clear obligation to do so; and

o          Sunrise Adult Training Centre: while DRCL has advised that it will meet the cost of providing road access to this land, there is no clear provision in the NRA Agreement for it to do so.

END

2013 VfM

8.7· Conclusion

As discussed in detail at Section 5, the terms of the NRA Agreement are expected to generate substantial positive economic impact for the Cayman Islands, and CIG had the opportunity to secure greater certainty over this benefit by further tailoring the taxation incentives and other terms, as a result of the amendment clauses included in the NRA Agreement.

As such, and based on the likely impacts on public debt and revenues discussed above, the result of the NRA Agreement is expected to be broadly in line with the guidelines under the FFR and CIG’s five components of fiscal strategy.

In an assessment of compliance with the FFR, one must have regard to the appraisal and negotiation process undertaken by CIG, as well as the actual terms and expected outcomes of the NRA Agreement.

As set out under the FFR, this VfM review should have been conducted as part of the initial project appraisal at an early stage in the overall process, rather than at this late stage, and the CIG’s own project appraisal should have been carded out and published for public consultation prior to the procurement stage.

However, the FFR was only signed in November 2011, toward the end of the NRA Agreement negotiation process. Further, while the FFR provides general guidance on approach, it seems that the PMFL’s 2004 Regulations do not provide adequate detailed regulations for implementing the FFR’s guidance around business appraisal, VfM review and negotiation for non-standard capital transactions with only one potential counterparty. As the NRA Agreement could not feasibly be put out to competitive tender, and is therefore not likely to be subject to CTC review, there does not appear to be a clear route for appraisal and project acceptance within CIG regulations. This is particularly the case given that the Public Sector Investment Committee envisaged under the PMFL has not been established.

Accordingly, it is recommended that CIG consider amendments to the PMFL and associated Regulations in order to provide for a clear and transparent appraisal and approval process for non-standard transactions, where competitive tender is not feasible. Such amendments should ensure that the process puts responsibility and authority for appraisal and detailed negotiation on the civil service, drawing on a cross section of civil service expertise, and thereby enabling policy makers to focus on strategic policy.

It should also be noted that, by transferring the responsibility for the Road Infrastructure construction to DRCL, CIG is effectively putting the Road Infrastructure expenditure outside the scope of CTC’s, and therefore the public’s, review. This approach is standard practice for PPP arrangements internationally, in which Governments contract for the delivery of andoutcome’ and the means of delivery is essentially left to the private contractor.

However, given CIG’s close cooperation with DRCL under the FCIA, there is inherent reputational risk for CIG should DRCL’s procurement process fail to meet prescribed CIG standards around potential or perceived conflicts of interest. As such, it is recommended that CIG provide DRCL with guidelines around management and disclosure of any actual or perceived conflicts of interest in their procurement process.

9.2.      VfM Assessment: Infrastructure and SMB Hotel development

The NRA Agreement provides for significant financial benefits for the CIG in the short term, particularly in the form of road construction to be carried out by DRCL, land to be transferred to CIG by DRCL, improvements to existing and new public beaches and creation of new public pedestrian and bike paths as well as a cash grant which DRCL has already paid to the CIG. The NRA Agreement also allocates risks relating to the construction of the ETH Extension and, partially, the ETH Expansion to DRCL, which would traditionally be supported by the NRA. Finally, the NRA Agreement should generate substantial economic benefits for the Cayman Islands from the reopening of the S.MB Hotel as well as from the rest of the DRCL Development Plan should it be executed.

In return for these benefits, the NRA Agreement requires the CIG to incur certain costs and divest assets to DRCL. The most important of these is the CIG agreeing to the closure of a portion of the WBR and the vesting of this land to DRCL following the process set out in the Roads Law as well as the extinguishing of DRCL’s obligation to provide the public rights of way stipulated under the Cayman Islands Development and Planning Regulations. Ordinarily, where a private developer seeks the closure and vesting of public land to facilitate its development, CIG could require sales proceeds in return, based on a market valuation. Accordingly, the proceeds foregone by CIG in transferring this land represent costs, or forgone assets, for CIG under the NRA Agreement. The NRA will also be required to support monitoring costs relating to the construction of the ETH Extension and New Barkers Road as well as incremental costs and risks relating to the operation of these new roads and of the ETH Expansion.

A summary of these benefits, costs and risks is shown in Figure 32/2013.

Overall, PwC believes that the infrastructure and SMB Hotel development component of the NRA Agreement provide VfM to the CIG. Not only is the sum of tangible benefits to the CIG (including transferred risks) slightly greater than the sum of CIG costs, divestments and retained risks, the following considerations must also be taken into account:

•          The most important contribution by the CIG to the NRA Agreement is the divestment of the closed WBR and Barkers lands, valued at $57.1m representing a share of WBR and Barkers land value uplift for which CIG is foregoing a direct cash compensation. This value uplift, while real, is difficult to estimate and does not constitute an immediate source of cash for DRCL. Further, for DRCL to recoup the value of this uplift requires substantial additional investment in the construction and operation of a major hotel. This represents a relatively high-risk venture in the current economic climate. While PwC believes it is appropriate to include this amount among the CIG costs and divestments under the NRA Agreement, it does not require any disbursement of funds by CIG.

•          The quantified benefits do not include intangible benefits such as the anticipated improvements to the existing public beach following the closure of the WBR and the creation of the Public Beach Park. However, the quantified costs do not include intangible costs either, such as the potential social impact of reduced beach access to the public along the length of the former West Bay Road.

•          Most of the benefits CIG is to receive will materialize in the short term.  DRCL has almost completed work on the ETH Extension and has already paid CIG the entire $5m grant.

VfM is also provided to the Cayman Islands from the economic impact and other advantages generated by the NRA Agreement:

•                      PwC estimates that the net economic impact to the Cayman Islands over the 20 year operational period covered by the economic impact study to be up to approximately $755m if only the SMB Hotel is reopened and up to $2-4bn if the entire DRCL Development Plan is implemented;

•          The closure of a portion of the WBR and the construction of the ETH Extension and the ETH Expansion will provide benefits to the Cayman Islands not fully captured in the estimated economic impacts. Most notably, these road projects will be a major step in the NRA’s plan to make the WBR better adapted for pedestrians and will help to alleviate congestion. The diversion of traffic from the WBR to the ETH Extension is also expected to contribute to the safety and well being of Caymanians, albeit concerns have been raised regarding the social impact of potentially reduced beach access to the public;

•          The addition of the new hotel brands comprised in the DRCL Development Plan to the Cayman Islands will generate new location specific marketing spend which can be expected to raise the profile of Cayman as a destination and have consequent benefits for the wider Cayman Islands tourism sector.

9·3· VJM Assessment: Stamp duty, development fees and import duty abatements and SMB Hotel Tax Rebate

The $53m Abatements are presented by DRCL as an important component in DRCL’s decision to go forward with the DRCL Development Plan. From the perspective of VfM, the rationale or providing these abatements depends largely on the likelihood that they will act as true incentives to spur development and associated positive economic impacts, rather than acting as subsidies for future development that would have been undertaken in any event.

The full scope of investment included in the DRCL Development Plan (excluding the SMB Hotel, which is eligible for separate abatements) totals investment of up to $1.1bn in NPV terms and associated economic impacts of up to $2,447m. In this context the $53m Abatements appear to support VfM. Assuming that DRCL utilizes the $53m Abatements as soon as possible in line with the DRCL Development Plan:

•          The DRCL Development Plan, excluding the SMB Hotel, would, if fully implemented, generate on an NPV basis $39m of incremental development fees and duties payable to the CIG after application of the $5sm Abatements, which is equal to $162m on a nominal, undiscounted basis;

•          To benefit from the full $53m Abatements, DRCL must build the equivalent of the following projects, which represent a total investment of approximately $415m, which are included in years 2012 to 2017 of the DRCL Development Plan:

WB Lands Condo1 (100 units)

WB Lands Condos 2 (50 units)

WB Hotel2 (300 rooms)

WB Hotels (150 rooms)

Eco-Tourism Hotel (100 rooms)

Commercial Centre1 (50,000 square feet)

WB Condos 3 (100 units)

Commercial Centre 2 (50,000 square feet)

Housing development at Crymble Landholdings (partial)

Housing development at CIYCAM Lands (partial)

However, except for the SMB Hotel, the NRA Agreement does not oblige DRCL to undertake any specific type of development nor does it establish any guidelines as to the nature, timing or scope of future developments. Although the DRCL Development Plan does foresee a number of new hotels, actual development will depend on market conditions and DRCL’s commercial priorities. As a result of the limited specificity in the NRA Agreement, there are no restrictions which could prevent DRCL from concentrating its resources for the next few years on office and commercial space at Camana Bay and applying the entire $53m Abatements to such development, which arguably could have been viable even without the $53m Abatements.

Such an outcome would result in significantly lower economic benefits than those estimated from the hotel/tourism focused projects included in the DRCL Development Plan.  Economic benefits to the Cayman Islands could therefore be significantly below those calculated in Section 5 of this report.

PwC believes these shortcomings in the potential application of the $53m Abatement need to be addressed to ensure that the CIG obtains VfM.

9·4· VJM Assessment: Hotel Tax Rebate for other hotels

PwC estimates the potential cost of the Hotel Tax Rebate to be up to $23.8m (as shown in Figure 7on an NPV basis), when applied to the various hotel projects included in the DRCL Development Plan.

DRCL has presented the Hotel Tax Rebate as an important consideration in its decision to go forward with the hotel projects included in the DRCL Development Plan. However, PwC believes the following considerations must be taken into account when assessing the VfM provided to the CIG by the Hotel Tax Rebate:

•                      DRCL can also claim the Hotel Tax Rebate or any hotel it opens or renovates, including hotels it could build on properties outside of its land parcels adjacent to the WBR (for example at Camana Bay) or if it acquires an existing hotel and undertakes “renovations”.

•          The purpose of the Hotel Tax Rebate is to spur the development of new hotels or the renovation or refurbishment of existing hotels by DRCI. DRCL represented to PwC that it would not likely undertake hotel investment in the Cayman Islands as currently planned without the Hotel Tax Rebate. However,

without a detailed analysis of projected ROI data on DRCL’s proposed hotel developments it is not possible to establish the need for the Hotel Tax Rebate to make hotel investment financially feasible. Given that we have been informed that the DRCL Development plans are at an early stage, we understand that such analysis is not possible at present.

•          Given the wide geographical scope and very long period during which the Hotel Tax Rebate is applicable, it is not possible for PwC to judge whether the Hotel Tax Rebate would have a significant impact on a hotel investment decision in the Cayman Islands nor what the likely impact on competitors’ investment decisions

would be.

•          To PwC’s knowledge, a similar rebate on hotel taxes has never been made available by CIG to a developer. Although CIG has in the past negotiated other incentives with hotel developers on a case by case basis, there is clearly a risk that the Hotel Tax Rebate could set a new precedent in the Cayman Islands, which

would weaken CIG’s negotiating position with alternative potential hotel investors.

•          The potential cost of the Hotel Tax Rebate is highly subjective and very difficult to estimate given the possibility of the hotel tax rate increasing over time, which directly increases the value of the rebate. The recent decision by CIG to increase the hotel tax from 10% to13% effectively increased the cost of the Hotel Tax Rebate to CIG by 30%.

Overall, PwC believes the Hotel Tax Rebate may not, as set out in the NRA Agreement, provide the CIG with VfM because:

•          Except for the SMB Hotel, CIG does not know the size, type or location of any hotel developments, which would be eligible for the rebate;

•          The rebate could apply to existing hotels in which DRCL would acquire a 51% participation (or perhaps less); and

•          Once the details of the Hotel Tax Rebate are made public, owners of existing hotels or other potential investors could make demands for similar rebates, at a cost unknown to CIG.

9·5· Overall assessment of NRA Agreement Value for Money

In summary, PwC believes that:

•          The infrastructure and SMB Hotel development component of the NRA Agreements provides VfM to the CIG;

•          In conjunction with the full or substantial delivery of the DRCL Development Plan, the $53m Abatements would provide VfM to the CIG, but improved targeting of incentives is required in order to avoid the risk of DRCL applying incentives to existing or planned developments which may be viable without tax waivers and/or to developments which might not have the tourism-related economic benefits which the CIG is seeking; and

•          The Hotel Tax Rebate may not provide VfM to the CIG because CIG has little control over its application to either new hotels (of unknown category, size or location) or to existing hotels (without requiring substantial renovations) and because of the unknown impact it might have on other current or future hotel developers and owners.

9.6. CIG’s alternatives to the NRA Agreement

The ETH Extension has been part of the Cayman Islands’ infrastructure plans for over 20 years, with improved access and traffic flow to the West Bay population centre and the transfer of traffic volumes away from the WBR identified as being key infrastructure requirements. The NRA has confirmed that the WBR closure, while not part of their previous road planning, is consistent with the aim of ‘pedestrianisation’ of the WBR, leading to improvement in traffic safety and the general tourism offering in the Seven Mile Beach corridor.

PwC has examined the potential alternatives for delivery of the Road Infrastructure, by the 31 December 2013 deadline included in the Terms of Reference.

The Traditional Delivery method of NRA construction is dependent on the CIG financing the full cost of works. However, as discussed in Section 7,as a result of high existing debt levels and ongoing deficits, the CIG is required to carry out a significant fiscal retrenchment over the next three financial years. Given that there are a number of existing capital commitments on the Cayman Islands public purse, most notably the John Gray and Clifton Hunter High Schools, it is likely that any additional borrowing sanctioned by CIG and the FCO, would need to address these priorities. As such, in the circumstances, general prudent fiscal management as well as the provisions of the PMFL and the FFR would likely preclude raising new debt finance for Traditional Delivery of the road infrastructure by December 2013.

The option of CIG selling the WBR closure land to DRCL in a separate transaction and CIG building the ETH Extension itself was considered, given the potential benefits of improved transparency over WBR closure sale proceeds, greater control over development incentives and retention of control over the ETH Extension by the NRA. However, as outlined in Section 7.3.1, there are a number of disadvantages to this approach, and PwC concludes that the potential advantages can be achieved more effectively through amendment to the NRA Agreement.

Sale of alternative properties by the CIG to raise funds for the ETH Extension was considered, but in light of the significant synergy value released by the NRA Agreement, it seems unlikely that CIG would be able to secure proceeds on such terms for alternative public assets.

In light of CIG’s fiscal constraints, PPP alternatives for provision of the ETH Extension are limited to those that would not require recognition of future obligations as public debt. Essentially, this limits PPP options to those that could operate as a stand-alone commercial enterprise, such as ‘Real Tolling’ or ‘Tied-in Concessions’. Real Tolling for the ETH Extension is not considered commercially viable, given the expected traffic flow, investment required and feasible pricing. Tied-in Concessions would ordinarily comprise substantial transport infrastructure, such as airports and ports, or possibly sports stadia or casino concessions. Accordingly, there does not appear to be a realistic alternative option for a substantial Tied-in Concession along the route of the Road Infrastructure, particularly in light of DRCL’s extensive adjacent land holdings.

9·7· Compliance with the FFR

The provisions of the NRA Agreement have the potential to generate substantial positive economic impact for the Cayman Islands and, as a result of the amendment and variance clauses in the NRA Agreement, the CIG has retained the ability to secure greater certainty over this economic benefit by further tailoring the tax waivers and abatements and other terms.

As such, and based on the likely impacts on public debt and revenues discussed in Section 8, the result of the NRA Agreement is expected to be compliant with the guidelines under the FFR and the CIG’s five components of fiscal strategy.

In an assessment of compliance with the FFR, one must have regard to the appraisal and negotiation process undertaken by CIG, as well as the actual terms and expected outcomes of the NRA Agreement.

Ideally, and as set out under the FFR, this VfM review should have been conducted as part of the initial project appraisal at an early stage in the overall process, rather than at this late stage, and the CIG’s own project appraisal should have been published for public consultation prior to the procurement stage. Further, PwC understands that in practice the NRA Agreement evaluation and negotiation was principally carried out by policy makers, as opposed to civil service ministries and departments.

However, the FFR was only signed in November 2011, toward the end of the NRA Agreement negotiation process. Further, while the FFR provides general guidance on approach, it seems that the PMFL’s 2004 Regulations do not provide adequate detailed regulations for implementing the FFR’s guidance around business appraisal, VfM review and negotiation for non-standard capital transactions with only one potential counterparty. As DRCL is the only counterparty which is able to generate the synergy value from the WBR closure, the NRA Agreement could not feasibly be put out to competitive tender, and is therefore not likely to be subject to CTC review, there does not appear to be a clear route for appraisal and project acceptance within CIG regulations. This is particularly the case given that the Public Sector Investment Committee envisaged under the PMFL has not been established.

It should also be noted that, by transferring the responsibility for the Road Infrastructure construction to DRCL, CIG is effectively putting the Road Infrastructure expenditure outside the scope of CTC’s, and therefore the public’s, review. This approach is standard practice for PPP arrangements internationally, in which Governments contract for the delivery of an ‘outcome’ and the means of delivery is essentially left to the private contractor, subject to provisions for proper identification, management and disclosure of potential or perceived conflicts of interest.

9.8. Recommendations

Based on its analysis and findings as documented in this report, PwC recommends the following modifications be made to the NRA Agreement to ensure it provides VfM to the CIG:

•          If deemed appropriate from the perspective of developing the wider tourism industry, the Hotel Tax Rebate should be expanded to provide a CIG hotel tax rebate program available to all investors who undertake hotel construction or renovation projects on a scale comparable to the hotels envisaged in the DRCL Development Plan. Clear rules should be developed concerning eligibility of such projects for the hotel tax rebate, including a demonstration of the project s economic benefits for the Cayman Islands, scope and timing of the development.

•          The stamp duty rebate provided to Caymanian purchasers of DRCL properties could potentially distort the local real estate market to the disadvantage of competing developers. As such, it is recommended that CIG consider whether any stamp duty concessions to Caymanians should be offered under a wider program, rather than one targeted solely at DRCL properties.

•          CIG should establish a mechanism across its various departments and agencies to allow it to track all claims made by DRCL, its affiliates and sub-contractors under the $53m Abatements and the hotel tax rebate program to ensure claims made do not surpass the limits set out in the NRA Agreement and/or Hotel Tax Rebate program, and that waivers are awarded only for qualifying parties and qualifying development.

•          CIG should consider amendments to the PMFL and associated Regulations in order to provide for a clear and transparent appraisal and approval process for non-standard transactions, such as the NRA Agreement, where competitive tender is not feasible. Such amendments should ensure that the process draws on a cross section of civil service expertise thereby enabling policy makers to focus solely on strategic policy.

 

•          In light of the inherent reputational risk of CIG outsourcing major construction to a private developer, it is recommended that CIG provide DRCL with

any actual or perceived conflicts of interest in their procurement process. However, DRCL, as party responsible for road construction, would be expected to retain full discretion in its choice of suppliers and subcontractors.

•          CIG could consider options to further incentivize and facilitate Caymanian employment in the new DRCL hotels. For example certain tax incentives, such as the Hotel Tax Rebate, could be linked to Caymanian employment metrics.

•          DRCL will have complete control over the route and other aspects of the new pedestrian and bicycle path which will be the only means for public access to significant parts of West Bay Beach. This control is important for DRCL to be able to carry out its long-term development plans. However, CIG should seek to enhance its control over this public amenity, without encroaching unduly on DRCL’s need for commercial flexibility. A possible approach would be to oblige DRCL to consult with CIG before important changes could be made to the pedestrian and bicycle path, if appropriate this could be dealt with under a separate agreement or amendment to the NRA Agreement.

•                      The NRA Agreement foresees that development adjacent to the WBR Legal Closure shall be predominantly hotel/tourist resort-oriented. CIG should put in place a mechanism to ensure DRCL’s WBR development respects these guidelines. Further, improved targeting of incentives is required in order to avoid the risk of DRCL applying incentives to existing or planned developments, which may be viable without tax waivers, and/or to developments, which might not have the tourism-related economic benefits, which the CIG is seeking. For example, a consultation process between CIG and DRCL should be required for major new developments to be subject to the incentives, in order that CIG can understand the wider impacts on the Cayman Islands economic and competitive environment and the expected level of inward investment generated. If necessary, this could be dealt with under a separate agreement or amendment to the NRA Agreement

•          The Third Amendment includes provisions for when DRCL is assessed compensatory mitigation for sensitive habitat loss under a Coastal Works Licence or Coastal Works Permit. The impact of these provisions and the extent to which they modify CIG’s standard approach in similar situations is not clear for PwC. CIG should have these provisions reviewed by legal counsel to fully assess their potential impac

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