PART I

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     Not applicable.

3

     Not applicable.

Because we are owned by the Government and substantially all our revenues are derived from operations in Hong Kong, changes in Hong Kong’s political situation may affect the manner in which our business is conducted as well as business confidence and economic conditions in Hong Kong, which could affect our business.

     From July 1, 1997, Hong Kong ceased to be a Crown Colony of the United Kingdom and became a Special Administrative Region of the People’s Republic of China. The basic policies of China regarding Hong Kong are embodied in the Basic Law of the Hong Kong Special Administrative Region, which was adopted by the National People’s Congress of the People’s Republic of China on April 4, 1990 and came into effect on July 1, 1997. Although the Basic Law provides that Hong Kong will have a high degree of legislative, legal and economic autonomy, there can be no assurance that China will not exercise, directly or indirectly, increased sovereignty over Hong Kong. In 2004, China issued a conclusive interpretation of the procedural requirements under the Basic Law on the electoral reform process. There can be no assurance that China will not issue further binding interpretations on the Basic Law that may or may not impact Hong Kong’s autonomy of political and economic control. In that event, the political and economic climate in Hong Kong may be adversely affected or our operations may be changed, which could adversely affect our financial condition and results of operations.

We generate revenues primarily from fares paid by Hong Kong residents and commercial activities within Hong Kong, including property-related revenues; adverse developments in Hong Kong’s social, public health and economic conditions could reduce these revenues and hurt our business and operating results.

     Most of our revenues are derived from our business activities in Hong Kong, which are directly affected by the performance of Hong Kong’s economy. Hong Kong’s economy is in turn affected, directly and indirectly, by the performance of the economies of mainland China and neighboring Asian countries. As a result, adverse economic developments in Hong Kong or elsewhere in the Asian region could result in fewer passengers on our railway or reduced rentals and other ancillary revenues which could have a material adverse effect on our financial condition and results of operations.

     Since the second half of 1997, Hong Kong has suffered adverse economic developments and experienced a deflationary phase of the economic cycle. We have not raised fares for six years in a row due to poor economic conditions. The Government’s announcement of a moratorium on land sales in 2002 led to a delay of our property development projects, and while the Government has since announced that land sales will resume in 2004, the Government has requested that the completion of our joint venture residential projects along the Ma On Shan Rail should not take place earlier than 2008, which would lead to a delay in revenue generation from such residential unit sales. Further, delay in completion of other residential projects along the new railway lines will, in addition, have an adverse impact on the recurrent revenue from the commercial activities arising from the new railways, namely West Rail Phase I and the Ma On Shan Rail. Also, any adverse social, public health and economic developments in Hong Kong or elsewhere in the Asian region could have a material adverse effect on our revenues.

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Our future financial performance, as well as our ability to meet our debt obligations, will depend on the level of revenues generated and costs of operating West Rail Phase I, the East Rail Extensions, the Kowloon Southern Link and the Sha Tin to Central Link, which are capital-intensive infrastructure projects, the successful development of which involves many uncertainties.

     The construction of large infrastructure projects such as West Rail Phase I, the East Rail Extensions projects, the Kowloon Southern Link and the Sha Tin to Central Link involve many potential risks, including land acquisition problems, shortages of equipment, material and labor, work stoppages, interruptions resulting from inclement weather, unforeseen engineering, environmental and geological problems and unanticipated cost increases and claims, any of which could give rise to delays or cost overruns.

     Although we have significant experience in the design and construction of railway projects, there can be no assurance that the new railway projects will be completed within budget and the planned completion schedule or particularly in the case of the East Rail Extensions, Sha Tin to Central Link and Kowloon Southern Link, that they will have the scope initially awarded. For more details on the project plans for the East Rail Extensions, Kowloon Southern Link and Sha Tin to Central Link, see “Item 4. Information on the Corporation—Rail Operations—East Rail Extensions,” “—Kowloon Southern Link” and “—Sha Tin to Central Link.” Furthermore, economic viability of these capital intensive transportation projects will depend on the achievement of projections for ridership levels and fares, which in turn may be affected by macro-economic factors such as population growth, changes in demographic and economic conditions.

Fares have been and will remain our primary source of revenue. We face competition from other transport providers. The increase in their market shares might adversely affect our revenue growth. Hence, this might inhibit our ability to raise fares or set fare levels that will adequately cover our costs if we do not want to lose market share.

     Although we are the only rail operator providing passenger and freight rail services from Hong Kong to mainland China, our passenger and freight services face competition from other transport providers, primarily operators of road and sea transport. The lower capital costs of our competitors might allow them to offer transportation services at lower prices and higher frequencies. We might be unable to raise our fares if our competitors do not increase their fares. The Government’s policy decision to open up the previously restricted areas near the boundary with mainland China to road transport and the extension of the boundary opening hours of the Lok Ma Chau-Huangguang boundary crossing to 24 hours has intensified the competition from cross-boundary bus services. As our profits depend heavily on cross-boundary passenger services, the increase in the market share of our competitors has adversely affected our revenue growth and profitability. Competition from such cross-boundary bus services may increase and may adversely affect our revenues in the future. The effect on the level of competition from the bus operators due to the Government’s recent decision to legalize and regulate the cross-boundary bus services, which were previously operating without authorization from the Government, is uncertain.

     West Rail Phase I commenced revenue service in December 2003. For the first five months of 2004, West Rail daily patronage, at around 103,200, was 47.7% below the budgeted figure of 197,200. Due to severe competition from road transport, consumer pressure to reduce fares and a sluggish economy, revenues generated from West Rail Phase I may not reach a level which would make West Rail Phase I profitable for the foreseeable future. If we are unable to achieve our ridership or fare revenue forecasts, it is likely that construction of our other railway projects may need to be funded by increased borrowings.

     In August 2003, the Government issued a paper on a new fare-setting mechanism based on a price-cap model, which would allow transport fares to increase or decrease in light of certain factors and by reference to a specified formula. While we are empowered by the KCRC Ordinance (as defined below) to establish our own fares for passenger, freight and other services, and therefore are not bound by the recommendations proposed by the Government, the proposals in the paper could potentially lead to lower

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bus fares from the bus operators, which could place further downward pressure on our fares, a result of which would be increased consumer pressure to offer additional discounts and promotions on our fare system, leading to lower revenues.

Our fare revenues depend in part on fare levels, and the Government has the ultimate authority to change our fares; a reduction in our ability or our inability to raise fares to cover future operating costs could adversely affect our financial performance.

     Although we are empowered by the KCRC Ordinance to establish our own fares for passenger, freight and other services, the Chief Executive of Hong Kong may, if he considers it to be in the public interest, give us a direction in writing to adjust our fares. While the Chief Executive of Hong Kong has not exercised this power since the establishment of KCRC, the Chief Executive of Hong Kong may require us to set fares that do not adequately cover our operating and other costs. Although the KCRC Ordinance provides that we are entitled to receive reasonable compensation from the Government if such direction requires us to act in a manner contrary to prudent commercial principles, we cannot assure you that restrictions imposed on our fare policies may not adversely affect our results of operations and financial condition or restrict our ability to make payments on our debt obligations in a timely manner. Furthermore, members of the Legislative Council of Hong Kong may introduce bills to take away our power to determine our fares. Although one such attempt was defeated by a wide margin in 1997, we cannot assure you that similar bills will not be introduced or adopted in the future.

Accidents, natural disasters and other technological problems could affect the performance of our railway and prevent us from generating rental and other ancillary revenues or reduce our operating flexibility.

     Our operations may be affected from time to time by equipment failures, collisions, derailments and natural disasters, such as typhoons or floods. Natural disasters could interrupt our rail services leading to decreased revenues, increased maintenance and higher engineering costs. Accidents could interrupt our rail services, subject us to increased liabilities or bring about pressure for greater regulation of our services. As West Rail Phase I is a new railway, notwithstanding the extensive technical trials that were conducted on the railway system, technological problems and other problems are still in the process of being discovered and rectified. We also experienced some initial problems with the signaling system during the testing phase of West Rail Phase I, which resulted in some train delays. Although we have acquired insurance that is consistent with industry practice against such risks, our insurance may not be sufficient to cover our losses or the losses of others, and the insurance may not continue to be available to us on a commercially reasonable basis.

We are regulated by the Government, which could modify the scope of our activities or impose obligations on us or our customers which could reduce revenues, increase costs or otherwise change our business from its current scope.

     We are a statutory body established by the KCRC Ordinance, with the Government as our sole shareholder. The KCRC Ordinance, like other statutes and ordinances of Hong Kong, may be amended, modified or repealed by the Government in accordance with the Hong Kong legislative process. Any amendment, modification or repeal could modify our scope of authorized activities or adversely affect our financial condition and results of operations by reducing our ability to generate fares or ancillary service revenues or imposing obligations that increase operating costs. Although we are not aware of any proposed material amendments or modifications to, or efforts to repeal, the KCRC Ordinance, we cannot assure you that these kinds of changes will not occur in the future. Furthermore, because our operations are restricted to authorized activities set forth in the KCRC Ordinance, our ability to enter into new businesses is limited and, to the extent amendments to the KCRC Ordinance are needed, subject to the legislative process.

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Since we are developing additional large-scale infrastructure projects, such as the Kowloon Southern Link and Sha Tin to Central Link, in parallel with the East Rail Extensions, although not anticipated, we may encounter a shortage of technical staff which could affect our ability to complete the projects in a timely manner or increase the costs of the projects.

     Construction of the Kowloon Southern Link and Sha Tin to Central Link is expected to begin before the completion of our current projects in the East Rail Extensions. Since the supply of qualified engineers with expertise in railways in Hong Kong is limited, although not anticipated, we may encounter difficulties in recruiting experienced engineering staff for the new projects. In addition, when the new projects are completed, we may encounter difficulties and delays in recruiting and training qualified maintenance and operations staff as the supply of qualified railway maintenance and operations personnel in Hong Kong is largely limited to our employees and those of the MTR Corporation Limited (“MTRCL”). Although we are actively addressing this potential shortage in engineering, maintenance and operations staff through early recruitment, intensive training and internal promotion, we cannot assure you that we will not encounter difficulties in the future in attracting and retaining qualified staff to successfully complete our infrastructure projects in a cost-effective and timely manner.

If we are unable to obtain financing on reasonable terms to fund the substantial capital expenditure we expect to incur, we may not be able to implement our planned projects.

     We are in the process of significantly expanding our rail network. We expect the total cost of such expansion to be approximately HK$78.9 billion. In 2005, we will begin incurring material capital expenditure in connection with two new projects, the Kowloon Southern Link and Sha Tin to Central Link, the total project cost of which is currently estimated to be HK$8.9 billion and HK$43.3 billion respectively. The details on the capital expenditure related to the Kowloon Southern Link and Sha Tin to Central Link, however, are not final and will be subject to change even after the execution of the relevant project agreements governing such projects. The size of these expansion projects, the level of capital expenditure required and the green field nature of some of the routes will increase the risk to our business and financial operations. We currently expect to finance the projects from internal resources and new debt. We anticipate that we will need to expand our borrowings substantially to meet the project costs for the construction of the Kowloon Southern Link and Sha Tin to Central Link. We have in the past incurred, and may in the future incur, operating losses. Our actual expenditure in connection with the projects may exceed our planned expenditure due to a number of factors, including the following:

     We cannot assure you that additional financing will be available on satisfactory terms, if at all. If adequate funds are not available on satisfactory terms, we may be forced to curtail our project expansion plans or delay project completion dates, which could result in our inability to achieve projected revenues

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and limit the growth of our operations. We expect our debt level to peak between 2009 and 2013, when HK$33.3 billion of our borrowings are projected to fall due and when new railway construction will still be in progress. For detailed discussion relating to our capital commitments and resources for capital expenditure, see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources.”

Because we are undertaking significant U.S. dollar denominated capital expenditure for our expansion and expect to finance a portion of the cost in U.S. dollars, a devaluation of the Hong Kong dollar may increase costs associated with the capital expansion or the Hong Kong dollar cost to repay indebtedness.

     While the Hong Kong dollar has been linked to the U.S. dollar at the rate of approximately HK$7.80 to US$1.00 since October 17, 1983, we cannot assure you that the Government will maintain the link between the Hong Kong dollar and the U.S. dollar at this exchange rate or at all. Any devaluation of the Hong Kong dollar would increase the Hong Kong dollar cost of our future capital expenditure, including purchases of equipment, denominated in U.S. dollars or other foreign currencies. In addition, the Hong Kong dollar cost of our current and future liabilities denominated in U.S. dollars or other foreign currencies would increase. Since substantially all our revenues are denominated in Hong Kong dollars, any devaluation of the Hong Kong dollar may increase capital costs and related depreciation costs and increase Hong Kong dollar interest expenses on indebtedness in U.S. dollars, thereby reducing our net income, and making it more difficult to repay principal on our U.S. dollar-denominated debt obligations in a timely manner. For more detail, see “Item 5. Operating and Financial Review and Prospects—Effects of Interest Rate and Foreign Exchange Movements on Our Borrowings” and “Item 11. Quantitative and Qualitative Disclosures About Market Risks.”

The Government has invited MTRCL and us to commence negotiations on a possible merger. Pending the outcome of our negotiations, we are unable to ascertain the effects of such merger on our business, operations, financial results and financing capabilities.

     On February 24, 2004, the Government invited MTRCL and us to commence negotiations for a possible merger, with a view to completing negotiations by August 31, 2004. KCRC and MTRCL are requested to submit to the Government the outcome of the negotiations, including preliminary transaction terms and the framework of key terms for an operating agreement.

     Pending the finalization of the merger proposal, it is difficult for us at this time to evaluate the possible impact on our business, operations, financial results and financing capabilities if the merger were to occur. For more detail, see “Item 4. Information on the Corporation—Government Regulations—Merger between KCRC and MTRCL.”

You may have difficulty in enforcing judgments regarding the Notes you hold against us or our management outside the United States.

     We are a statutory corporation established under the laws of a jurisdiction other than the United States. All of our Managing Board members and members of our management reside outside the United States. As a result, in connection with any claims you may have against us relating to the Notes or the indenture, it may be difficult or impossible to serve legal process on us, the members of our management or our respective experts, or to force any of them to appear in a U.S. court. It may also be difficult or impossible to enforce a judgment of a U.S. court against any of these parties, or to enforce a judgment of a foreign court regarding the Notes or the indenture against any of these parties in the United States.