LLCR ¼ Xsþn
6.4 International Financial Institutions and Multilateral Banks
6.4.1 Multilateral Organizations
Multilateral financial organizations play a very important role in project financing for developing countries, for three reasons.
. Their institutional mandate allows taking on financial commitments even in countries with a high political risk.
. They have played a leading role in privatization policies.
. They continue to promote financing in the private sector and private investment in the infrastructure sector.
In principle, multilateral financial organizations should counterbalance the trend for private financial flows by increasing loans in periods of reduced interest from the financial market. Among the multilateral financial organizations, the most important in terms of political weight and financing volume is the World Bank Group.
It comprises four major agencies through which the World Bank contributes to development in member countries in a wide variety of ways, working together with both private and public parties: the IBRD (International Bank for Reconstruction and Development), IDA (International Development Association), IFC (Inter- national Finance Corporation), and MIGA (Multilateral Investment Guarantee Agency). In addition to the World Bank, which operates at global level, there are other international multilateral financial organizations (major regional development banks) that focus their activities on a specific geographical area. Some have a continental scope and mission (European Investment Bank in Luxembourg, Asian Development Bank in Manila, African Development Bank in Abidjan, Inter-Ameri- can Development Bank in Washington). Then after the fall of the Berlin Wall, the European Bank for Reconstruction and Development (EBRD), based in London, was added. The regional bias of these banks is also seen in their governing bodies, given that stakeholders reflect the continental focus of their activities.
Table 6-9 shows the financial contribution of multilateral financial organizations at the end of 2004. The differences between the various agencies are quite evident.
From the standpoint of amounts, the most exposed are the World Bank and EIB, whereas in terms of investment in the private sector IFC (100%) and EBRD (75.6%) play a leading role.
TABLE 6-9 Financial Contribution of Multilateral Banks, 2004 (in US$billions)
Bank Portfolio Amount Invested in Private Sector % Invested in Private Sector
IBRD and IDA 104.40 n.a. 17.00%
IFC* 8.90 8.90 100.00%
Asian Development Bank 5.30 0.53 10.00%
African Development Bank** 1.26 n.a. 6.00%
EBRD 6.19 4.68 75.62%
EIB 98.32 n.a. 12.50%
Inter-American Development Bank 5.46 0.19 3.48%
* Refers to FY ending Dec. 31, 2005.
** Loan approvals.
Source: Multilaterals’ Annual Reports, various years. Where data are missing, estimates have been made by the author.
164 C H A P T E R u 6 Financing the Deal
In contrast, Table 6-10 shows multilateral bank commitments for loans to devel- oping countries concerning investments in infrastructures.
The table reveals that funds committed for infrastructure works saw a slowdown in 1999 but then grew progressively in terms of both amount and percentage inci- dence. A further aspect the table highlights is that as opposed to the early 1990s, when the World Bank was the major source of multilateral financing to emerging countries, in recent years the major regional development banks taken together have provided about the same level of resources as the World Bank.
6.4.1.1 World Bank Group
The World Bank was founded in 1944 at Bretton Woods during a conference that saw the participation of the governments of 45 countries. Originally called the International Bank for Reconstruction and Development (IBRD), it was set up primarily to finance postwar reconstruction in Europe. However, compared to the early days, the aim to reduce poverty in the world has taken on greater importance.4 The World Bank Group includes five interlinked agencies in which the stakeholders are governments of member countries that have power to make final decisions. Every agency has a distinct role in the common mission to fight poverty and promote sustainable growth in less developed economies, even though from the standpoint of project finance the two most significant are IFC and MIGA, because they focus
4. The World Bank’s most recent strategic goals were agreed on in 2002 by 189 countries during the Millennium Summit of the United Nations, at which the Millennium Development Goals were defined. More precisely these were: (1) to eliminate the roots of poverty and hunger; (2) to ensure universal primary education;
(3) to promote equality between men and women and give more power to women; (4) to reduce infant mortality;
(5) to combat AIDS, malaria, and other diseases; (6) to ensure a sustainable environment; (7) to develop global cooperation for growth.
TABLE 6-10 Multilateral Bank–Committed Funds for Infrastructure Works, 1995–2002 (in US$billions)
1995 1996 1997 1998 1999 2000 2001 2002
Total funds committed 52.38 74.07 45.95 43.17 44.22 43.93 43.02 42.34
Total funds for Infrastructure works 17.8 18.3 16.6 17.7 13.8 15.0 14.7 16.5
% of total committed funds 33.98 24.71 36.13 41.00 31.21 34.15 34.17 38.97
Asian Development Bank 3.42 2.85 1.90 2.33 1.75 2.66 2.26 2.88
African Development Bank 0.17 0.08 0.21 0.37 0.28 0.16 0.37 0.46
EBRD 1.40 1.63 1.07 0.87 0.92 0.79 0.16 1.46
EIB 2.66 2.43 3.06 3.48 2.99 3.74 3.55 4.40
IBRD/IDA 7.38 7.95 6.61 6.67 5.28 4.29 4.98 4.60
Inter-American Development Bank 2.22 2.67 2.80 3.11 1.78 1.70 0.99 1.00
IFC 0.33 0.36 0.49 0.39 0.29 0.47 0.32 0.49
Islamic Development Bank 0.21 0.15 0.29 0.26 0.35 0.47 0.48 0.45
MIGA* 0.14 0.15 0.14 0.18 0.20 0.75 0.57 0.86
* Political risk insurance coverage.
Source: Global Development Finance, 2004.
International Financial Institutions and Multilateral Banks 165
mainly on private investment. Table 6-11 gives a summary of certain elements that help understand the mission of the different agencies.
IBRD (International Bank for Reconstruction and Development): IBRD is, effectively speaking, the World Bank because both share the same mission and intervention strategy.
Specifically with regard to project finance deals, the agency operates by means of:
. Direct loans
. Partial risk guarantees
. Partial credit guarantees
. Enclave guarantees
Direct loans encourage the private sector by means of cofinancing deals, known as B-loans. In direct loan schemes the private sector makes loans to developing country governments together with IBRD (which grants an A-loan) and benefits from the privileged status of the bank’s loans. To finance projects directly in the private sector the bank must use governments as intermediaries: IBRD and private banks (respec- tively with the A- and B-loans) finance governments that, in turn, finance private parties. An alternative is that IBRD and private banks lend directly to the SPV after TABLE 6-11 Target for Intervention of World Bank Group Agencies
Agency
Year Founded
Number of Member Countries
Main Activity Categories
Target for Intervention IBRD: International Bank
for Reconstruction and Development
1944 184 Loans, guarantees,
equity investments, consultancy
Developing countries with average income and high credibility IDA: International
Development Association
1960 164 Loans at heavily
subsidized conditions
Poorest developing countries IFC: International
Finance Corporation
1956 175 Loans, equity
investments, arranging of loan syndicates, indirect methods of support
Entirely private projects in developing countries MIGA: Multilateral
Investment Guarantee Agency
1988 163 Stimulates foreign
investment in developing countries by offering guarantees against political risks
Potential investors in developing countries
ICSID: International Center for Settlement of Investment Disputes
1966 139 Developing foreign
investments in emerging markets by means of legal advice and settling disputes on investment questions at
international level
Target investment countries for foreign operators
166 C H A P T E R u 6 Financing the Deal
obtaining guarantees from the host government. Operations of the SPV are partly conditioned by limits and rules imposed by IBRD, in conformity with international competitive bidding (ICB) procedures.
The partial risk guarantee covers political risks and is available for all countries entitled to receive World Bank loans, with the exception of very low-income countries that can be insured by guarantees proposed by MIGA (see later in this chapter). The guarantee is available for investors that enter into financing contracts directly with host governments (in other words, the borrower is a government body) or with SPVs guaranteed by the host government or with counterparties of the SPV backed by government guarantee.
These conditions explain why this facility is used in very few project finance deals.
Wherever possible the World Bank tries to use instruments made available by its other agencies (above all IFC and MIGA), thereby avoiding direct intervention, which only occurs in the form of a guarantee of last resort if:
. No private financing is available
. Financing from IFC or risk coverage from MIGA is insufficient
So the projects concerned are very large and complex and intervention of the World Bank is indispensable in order to structure the total financial package. The guarantee is granted to the SPV’s lenders and covers the following risks (see Chapter 3):
. Currency convertibility risk
. Transferability and expropriation risk
. Change in law
. Breach of contract risk
Instead the partial risk guarantee doesn’t cover the risk of political violence, war and expropriation, which must be handled directly with the host government by means of rules defined in the government support agreement.
The partial credit guarantee is a facility used to resolve a significant problem in the syndicated loan market for financing infrastructure projects. Some, especially very complex ones, require very long repayment plans that private banks find very difficult to finance. In this case, the World Bank can operate as the guarantor for capital repayments and interest due in periods beyond those that credit committees of private banks consider acceptable, given constraints imposed by their internal credit policies. The same guarantee can also cover bullet capital repayments (namely, a single repayment at the end of the loan period) that the SPV intends to refinance.
Despite its importance as a catalyst for private capital investment, only limited use has been made of this instrument.
The enclave guarantee is a facility reserved for so-called enclave projects, that is, project finance deals set up to realize projects focusing on exports (frequently seen in the oil and gas sector for realization of pipelines to export natural gas or oil production in offshore sites). Revenue flows for these projects are in foreign currency from a source outside the host country (for instance, from an escrow account outside the country or from an SPV domiciled outside the host country boundaries) and so protect the project from two basic risks.
. Foreign currency is never transferred to the host country, and therefore there is no possibility to limit its transfer to countries where the sponsors and creditors International Financial Institutions and Multilateral Banks 167
are resident; furthermore foreign exchange available outside the country can be withheld directly to service the debt (transferability risk).
. Revenues are stated in foreign currency, and so sponsors and lenders have no currency risk. Because both currency risk and transfer risk are covered, the enclave guarantee can be requested to cover additional risks, such as expropri- ation, civil war, or changes in regulations.
IDA (International Development Association): IDA provides financial support for poorer countries that fail to meet criteria for access to World Bank-IBRD financing.
Development finance support is in the form of very long-term loans (35–40 years), with long grace periods (up to 10 years) and with no interest payment, which is replaced by an annual servicing fee of 0.75%. The scope of interventions is development of human capital, basic infrastructures, support for setting up stable political structures, and institutions in very poor countries in order to promote sustainable growth. The main aim is to reduce inequalities between countries and within countries themselves, particularly as regards primary education and availability of water and health services. IBRD and IDA are managed based on the same guidelines, share the same staff and facilities, and use the same criteria when evaluating projects. The only difference is that they are financed by different sources.
Whereas the World Bank obtains funding in international financial markets, most of IDA’s operating resources come from contributions made by the governments of developed countries.
Bearing in mind the target countries and sectors concerned, IDA’s role in the project finance field is limited to indirect loans, similar to those offered by IBRD, and a guarantee program for projects that fail to qualify for enclave guarantees. IDA also provides private investors with guarantees against currency convertibility risk in the event such guarantees for investments are unavailable.
IFC (International Finance Corporation): IFC is the multilateral agency that provides financing (loans and equity) for private projects in all sectors in developing countries. Of all World Bank agencies, this is the only one that doesn’t require the direct intervention (or a guarantee) of the host government to proceed with financing a venture. Even though IFC focuses mainly on private projects, it can also provide financing for a company that has a public-sector partner, provided there is a private investor involved and that the company is managed as a profit-making venture. It can finance 100% locally owned companies or joint ventures with local and foreign partners.
IFC promotes sustainable growth in the private sector mainly by doing the following:
. Financing private projects in developing countries
. Helping private companies in developing countries to obtain financing in inter- national financial markets
. Providing consultancy and technical assistance services to companies and gov- ernments.
As far as project finance deals are concerned, IFC offers a series of financial products and services to companies in member developing countries, it helps to structure financial packages, to coordinate financing from foreign banks, from local banks, from companies, and from export credit agencies (ECAs; see Section 6.5.2). To be eligible for IFC financing, projects must be profitable for investors, 168 C H A P T E R u 6 Financing the Deal
generate benefits for the host country’s economy, and observe environmental and social guidelines imposed by the agency.
Services offered to investors are:
. Loan programs
. Equity investments
. Derivatives to set up hedging policies
. Guarantees
Loan programs involve IFC cofinancing with private funding. To ensure partici- pation of private investors and creditors, IFC caps the share of financing it makes available for each project: On average, for every $1 financed by IFC the other investors put up over $5. The current limit is a cap of $100 million per individual project, and with a limit of 25% of total costs for new projects, 35% for smaller projects, and 50% for expansion of preexisting projects. IFC finances are based on market conditions. (There are no subsidies for borrowers.) Moreover, there is no requirement for direct guarantees from the host country government, as opposed to other World Bank agencies. The term of loans can be up to 20 years.
In addition to financing by means of direct loans, IFC also has a B-loan program.
(B-type loans are syndicated loans.) This is based on similar principles to the World Bank program discussed earlier in this section. In B-loan programs IFC sells shares of the loan to commercial banks but continues to act as if it were the lender of record, administering the loan and being the recipient of guarantees. In this way a borrower cannot pay IFC and declare default as regards other members of the pool, given that all payments are divided proportionately between A-loans (granted directly by IFC) and B-loans. Default on a B-loan equates to breach of contract with IFC. The fact that IFC is lender of records as far as B-loans are concerned has positive effects for members of the pool, inasmuch as privileged creditor status applies to loans granted as part of the B-loan program. In this way banks can avoid setting up risk provisions if the country in which the project is financed is insolvent, given the privileged status assigned to such lenders.
In addition to direct loans and cofinancing in A- and B-loan programs, IFC can hold a minority stake (usually between 5% and 15%, up to a maximum of 35%) in the equity of SPVs as a passive investor according to the private equity investor approach (equity investment program). In other words, IFC doesn’t intervene in the SPV’s strategic and operating decisions. The average duration of investments is longer than in the private equity market and can extend up to 8–15 years. Preferably sale of equity takes place on the stock exchange in the country where the SPV is set up. Equity investment is rather conservative and usually requires payment for shares at par value without any share premium reserve to repay sponsors for study, initial development, and start-up costs. There is always a potential conflict of interest in deals where IFC is both an equity investor and lender of record for a B-loan program for the same project. Sponsors and lenders clearly have opposite interests as regards the amount of equity in a project’s financial structure: The former want to minimize it, whereas the latter subordinate high financial leverage to perfect mitigation of project risks. If IFC were an equity investor, it could propose a more aggressive debt-to-equity ratio and lower cover ratios (see Chapter 5) to banks participating in the B-loan program.
The third type of assistance, which IFC began offering in the early 1990s, concerns derivatives. These involve swaps to hedge interest and exchange rate risks, options, forward contracts, and other derivative products to help clients manage International Financial Institutions and Multilateral Banks 169
financial risks in the best possible manner. Derivatives are offered because SPVs in developing countries find it difficult to access international capital markets. IFC acts as an intermediary. It mobilizes participation of commercial banks in these deals by sharing risks and promoting development of local capital markets.
The fourth type of aid provided by IFC is the guarantee program. In fact, partial credit guarantees are given similar to those issued by the World Bank, which cover all credit risks during a specific period of the loan and can therefore be used to extend the repayment period of private-sector loans.
As can be seen in Table 6-12, even today the majority of IFC’s financial activities concerns loans, which account for over 70% of total funds allocated in the years analyzed. Commitments in terms of equity contribution have instead decreased progressively as a percentage of the total committed portfolio. Furthermore, starting in 2003 there has been a constant increase in the number of projects.
MIGA (Multilateral Investment Guarantee Agency): MIGA contributes to the World Bank’s mission by providing political risk coverage to lenders and investors;
in this way it makes investment in developing countries more attractive for private foreign capital.
MIGA offers coverage for all 163 World Bank member countries. Its own capital is for the most part provided by members and a smaller proportion by the World Bank as a contribution to capitalize MIGA. Within the World Bank Group, and including regional development banks, it is the only agency that offers coverage for investments against political risks. In addition to this main activity, MIGA has a special section dedicated to consultancy (IMS, Investment Marketing Services), the aim of which is to help developing countries attract foreign investment. In this area MIGA offers both consultancy services on request and investment information and tries to help companies in member countries by developing necessary skills.
As a World Bank Group agency, MIGA only offers coverage based on an agreement with the host country. In line with its aims to promote economic growth and development, investment projects must be financially and economically viable.
Coverage for political risks includes both debt financing and equity investments, up to a maximum coverage of 95% of debt service (principal repayment plus interest) and equity investment, with a maximum limit of US$200 million per project and US$420 million per country. The insurance premium ranges from 0.5% to 1.75% of the insured sum, and the contract has a duration of 15 years, with a possibility of up
TABLE 6-12 IFC Intervention in the Private Sector by Type of Facility, 2001–2005 (in US$billions)
2001 2002 2003 2004 2005
New projects committed 205 204 204 217 236
Total financing committed 3.90 3.60 5.00 5.63 6.45
Financing committed for IFC’s own funds 2.70 3.10 3.90 4.75 5.37
Total committed portfolio* 5.4 5.8 5.4 17.9 19.3
Equity as % of portfolio 25% 23% 21% 20% 17%
Loans as % of portfolio 75% 71% 71% 74% 77%
Structured finance products (including guarantees) as % of portfolio n.d. 5% 6% 5% 5%
Risk management products as % of portfolio n.d. 1% 2% 1% 1%
* Includes off-balance-sheet products such as structured finance and risk management products.
Source: IFC,Annual report, various years.
170 C H A P T E R u 6 Financing the Deal