BABCOCK & BROWN

terrorist attack, major plant breakdown, pipeline or electricity
line rupture or other disaster. Operational disruption, as well
as supply disruption, could adversely impact the cash flows
available from these assets.
Moreover, the provision or acquisition of infrastructure assets
often involves an ongoing commitment to a governmental
agency. The nature of these commitments exposes the owners
of infrastructure assets to a higher level of regulatory control
and risk than typically imposed on other businesses. Cashflows
from these assets may also be disrupted by an adverse change
in regulatory conditions or decisions. Public infrastructure
activity can also be exposed to political risks associated with public
perception of projects and resistance to certain elements of them.
Certain of the Babcock & Brown Group’s investments are in
operating companies with significant development components.
While the value of the assets may exceed the liabilities in these
businesses, under normal operating conditions these businesses
rely on cash flow to fund the development components.
Therefore should cash flow be constrained this could have
an adverse impact on the business and significantly impair
the value of the investment.
6.2.14 Performance fees
The Babcock & Brown Group earns performance fees
on a number of its managed funds. The future receipt of these
performance fees will depend on a number of factors, including,
but not limited to, the underlying performance of the funds’
assets in both an absolute and relative sense, and the market
value of the securities of the managed funds. There can be no
guarantee that the Group will earn these performance fees in
the future.
6.2.15 Regulatory environment
The Babcock & Brown Group is subject to extensive regulation
in multiple jurisdictions. The Group may be fined, prohibited
from engaging in some business activities or subject to limitations
or conditions on business activities.
New laws or regulations or changes in the enforcement of
existing laws or regulations applicable to clients may also
adversely affect business performance.
6.2.16 US Promoter Penalty Examination (PPE)
Like many companies in the financial services industry, the
Babcock & Brown Group is routinely subject to tax audits.
At present, there is an ongoing examination being conducted
by the United States Internal Revenue Service (IRS). The IRS
is looking into the Group’s US affairs in relation to the years
ended 31 December 1993 to 1999, with a view to determining
whether the Group should have made certain filings and
registrations required under US tax law in relation to corporate
tax shelters that may have been used by the Group’s clients in
that period.
At present, the IRS is still gathering information and reviewing
documents. The IRS has not commenced proceedings against
the Group, nor has it issued an assessment to any member of
the Babcock & Brown Group for liability under the relevant
provisions.
However, there is no time limit requiring the IRS to conclude
the audit by a specific date. It is uncertain whether or not the
IRS will ultimately make a claim against the Group as a result
of its examination. If the IRS does make a claim, the amount is
also highly uncertain, and could be within a wide range. Based
on advice from its legal and financial advisors, the Group has
made such provision as it considers appropriate in its financial
statements in respect of this matter.
6.2.17 Provision of warranties on sale of businesses
When the Babcock & Brown Group disposes of assets it is
sometimes required to provide warranties regarding the assets
(and associated liabilities). These vary significantly in content
and length required.
6.2.18 Interest rates
The Babcock & Brown Group, as a borrower of money, is
potentially exposed to adverse interest rate movements that
may increase the financial risk inherent in its business. While
this risk may be reduced through interest rate hedging, such
as interest rate swaps or other mechanisms, there is sometimes
residual risk.
An increase in interest rates could have both a positive and/or
negative impact on the revenues of the Babcock & Brown
Group. Interest rates do not operate in isolation from the
broader economic environment.
BABCOCK & BROWN SUBORDINATED NOTES 55