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6.4 International Financial Institutions and Multilateral Banks
6.4.2 Regional Development Banks
Regional development banks are also multilateral financial agencies, but they operate in a more restricted geographical area than the World Bank. They focus on one geographical area only (usually a continent), and their share capital is held by governments of countries in the area concerned.
6.4.2.1 European Investment Bank (EIB)
The European Investment Bank, the European Union’s (EU’s) financial agency, was set up in 1958 by the Treaty of Rome. Members of the EIB are EU member countries that subscribed to the bank’s equity capital. The agency is both legally and financially independent from the European Union, but its mission is to promote the EU’s objectives by offering long-term financing for specific projects meeting strict criteria in terms of evaluation and selection of the ventures concerned. In this way, it contrib- utes to economic integration within Europe and greater economic and social cohesion.
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EIB participation in financing investment projects is based on a preliminary evaluation and ongoing monitoring of the venture concerned; therefore, EIB operates according to best practices in the private banking sector. To receive EIB support, projects must be viable from the economic, technical, environmental, and financial standpoints. EIB loans are essentially financed by funding on capital markets. Given its special ownership structure, it has a maximum (AAA) international bond market rating, and so the bank can propose advantageous pricing to project companies.
Furthermore, as in the case of IFC, EIB continually seeks to involve private capital in projects it finances, acting as a catalyst for private lenders in order to expand available funds.
The scope of EIB’s activities can best be explained by dividing them into two categories:
. Ventures within the European Union
. Ventures outside the European Union
Ventures Within the European Union: As regards EU countries, EIB finances projects that contribute to economic growth and benefit cohesion within the EU.
Guidelines for financing are very precise: Participation can cover up to 50% of the total project cost for a duration of up to 12 years for industrial projects or 20 years for infrastructure projects. In the case of PPP projects (public–private partnerships;
see later), the duration can exceed 20 years (a common situation in the social infrastructure sector, such as hospitals) and even extend to 30 years for urban development and local transport projects. At the end of 2003, PPP projects with a duration exceeding 25 years accounted for about one-quarter of the Bank’s PPP portfolio.
Conditions proposed to SPVs are more favorable than those offered by the private banking sector, thanks to EIB’s ability to obtain funds in the bond market at a lower cost. A further feature of these loans is that there is no arranging fee, as is normally the case with syndicated loans, but only an agency fee to cover the bank’s operating costs. As in the case of private banking-sector loans, the bank can lend at a variable or fixed interest rate.
While there are clearly financial advantages, borrowers obtaining funds from EIB have to accept some very stringent conditions.
. Projects undergo an in-depth preliminary analysis to determine whether they are technically sustainable and what benefits can be obtained from the venture, even when there are guarantees from the private banking sector.
. Projects must meet EU environmental standards and follow the EU’s procure- ment rules and procedures.
. As opposed to private banks, EIB doesn’t take on project completion risk, in other words, risks associated with extra costs, delays, or performance before completion of the project and its start-up phase (see Chapter 3). The bank may, however, accept risks in the project’s postcompletion stage, although not im- mediately after operations begin and after an evaluation of initial performance.
The only exception from these guidelines is the Structured Finance Facility (SFF), created in 2000 for the purpose of providing senior debt, mezzanine debt, and derivative instruments to hedge risks. Under the terms of this facility and depending on funds set aside, the EIB can take on precompletion risk and also operating risk during initial project start-up phases.
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. To cover this very restrictive policy as regards risk-taking, EIB requests com- mercial bank guarantees to cover its own commitments at risk. These guarantees must cover outstanding debt at a certain date, interest payments for 6 months, and a figure to cover breach-of-contract risk. Banks must be able to meet eligible criteria based on a minimum rating level or provide cash guarantees.
Ventures Outside the European Union: Outside the EU, EIB finances projects based on mandates received from the EU defining the maximum amount that can be financed in every area. These mandates concern:
. Future member-states of the EU
. Certain countries in the Mediterranean area, developing countries, and the Balkans
For loans outside the EU, EIB takes on the political risk in its most restricted sense, namely, the risk of currency convertibility and transferability, political violence, and expropriation risk. Instead it doesn’t cover breach-of-contract or creeping-expropri- ation risk (see Chapter 3). So the bank requires complete bank guarantees to cover business risks. Furthermore, EIB doesn’t cover subsovereign risks and so requests a guarantee from the host government or lends directly to that government (in which case it can have a direct interest in the project), which in turn loans the funds to the SPV.
EIB Participation in Public–Private-Partnership (PPP) Projects: As part of its policy to provide support for growth of EU member states, starting in the second half of the 1990s the bank increased its participation in public infrastructure projects financed with private capital, with the aim of enabling the public sector to benefit from advantages deriving from EIB’s participation in financing these types of projects. For PPPs the bank applies the same valuation and selection criteria used for other projects. Ventures must be financially sound, economically and technically viable, and compatible with the bank’s EU environmental guidelines, and procurement contracts must be awarded based on competitive procedures and rules established by the EU. In fact the bank participates right from the early stages by working with potential bidders during the competitive phase running up to award of contract so that bidders can pass on part of the benefits deriving from EIB’s participation as a lender to the public sector.
As far as lending policies are concerned, however, a PPP project has to comply with the same rules applying to a 100% private project. PPPs financed by EIB need to present guarantees from the banking or monoline insurance sectors (see Chapter 4), excluding precompletion and early operating stage risks (except projects financed by a Structured Finance Facility), which must pass stringent tests in terms of cover ratios. The involvement of the public sector as the final debtor is considered very important. In many PPPs, in fact, the public sector is the sole purchaser of the product or service (take, for instance, the case of hospital or school construction), and so there is no market risk. It should also be noted that the average amount of participation in PPPs is not very significant; this means the bank is able to limit concentration risk as regards its loan portfolio.
6.4.2.2 AfDB (African Development Bank)
AfDB is a multilateral regional development bank whose stakeholders are the 53 African nations and 24 non-African countries from the Americas, Europe, and Asia.
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It was set up in 1964 and began operations in 1967 to promote the economic growth and social progress of its regional members, both individually and collectively. The bank promotes projects in the infrastructure field and with a particular emphasis on PPPs, for which it provides financial support in the form of loans and equity investments. It also provides:
. Advisory services to private parties as regards structuring deals
. Advisory and support services to public bodies to help them create a favorable institutional environment from the legal and regulatory standpoints and to ensure that they are capable of managing their relations efficiently with private parties
As with other multilateral agencies, the bank’s role is to integrate rather than replace sources of private capital. It stimulates and provides support for industrial investors and private lenders by supplying financial assistance to financially sound projects. In this way the bank acts as a catalyst to obtain resources from the private sector (particularly from multilateral and bilateral partners).
Loans: In the project finance field AfDB mainly participates as a lender in its own right, as regards both infrastructure and PPP projects and those in which no public body is involved. The Private Sector Department (OPSD) handles direct loan deals without a sovereign guarantee and provides technical assistance services. Direct financing, which includes senior debt financing and providing guarantees, has been used to finance important private infrastructure projects in Africa in the power, telecom, and wind-farm sectors.
In the project finance field the bank can approve loans to create, expand, and modernize plant in various sectors (excluding the real estate and commerce sectors).
The total amount of assistance for each SPV, including loans, guarantees, and underwriting, doesn’t normally exceed one-third of the total project cost, whereas the bank’s equity investment will usually not exceed 25% of the SPV’s capital stock.
Furthermore, it will not act as the sole large lender for the project. Total project costs must not be less than US$9 million; the only exception is if smaller projects have high growth potential and produce significant spin-offs for the rest of the economy.
The bank can lend long-term in hard currency. Loans are available in U.S.
dollars, euro, pounds sterling, and yen. There is also a growing number of loans in local currency, especially the South African rand. Interest rates (established with reference to LIBOR or Euribor interbank rates) and other fees are established based on market conditions in accordance with the risk level of the project being financed.
Fees include those usually applied in the case of syndicated loans (see Sections 6.3.1 and 6.3.2). Loans granted by the bank are guaranteed to limit credit risk. The standard security package (see Chapter 7), represented by mortgages on plant, pledges, and floating charges on the SPV’s cash balances, inventories, and other current assets, is normally requested and evaluated case by case according to the risk level of the venture. Guarantees can also be requested from lenders or sponsors of the SPV. Maturities generally range between 5 and 15 years, with adequate grace periods consistent with trends for project cash flows. Longer maturities are an exception and mainly involve complex infrastructure projects.
Guarantees: The bank can issue guarantees to lender banks or business partners (domestic and international) to cover servicing the debt. Claims are settled by the bank in currencies available for direct lending activities.
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Equity: The bank can invest in an SPV with an equity contribution for common or preferred stock or other participating securities, mainly in local currency. As with other multilateral and bilateral agencies, the bank acts as a passive stockholder and doesn’t intervene in the management of the SPV’s business. Right at the outset, however, it does establish the way to exit from the investment, which is preferably by selling stock held on the local market and only after the project becomes operational and shows a good track record in terms of performance.
6.4.2.3 IDB (Islamic Development Bank)
The Islamic Development Bank was founded in 1973 to promote economic growth and social progress in member countries and Islamic communities, both individually and jointly. The bank must abide by principles of Islamic law, which prohibits the charging of interest on loans; for this reason it has a limited range of action compared with other development banks. The bank participates in its own capital and in subsidies for projects in addition to offering other forms of financial assistance to member countries to further their economic and social growth. It offers technical assistance by financing preinvestment studies and valuations and feasibility studies in less developed countries. Financing is provided in the form of a grant up to a maximum of 300,000 Islamic dinars5 or in the form of a zero-interest loan for a maximum period of 16 years, with a 4-year grace period.
Various forms of participation are available as regards project financing.
Loans: Long-term loans are offered for projects that will have a strong impact from the economic and social standpoints (even if they are not particularly profitable).
Loans are granted to private companies, governments, and public bodies, and though they are zero-interest loans they do carry a fee of up to 2.5% to cover the bank’s administrative costs. Loans cannot exceed 7 million Islamic dinars per project and have a maturity ranging from 15 to 25 years, with a grace period from 3 to 7 years.
Leasing (ijara): Leasing is used to finance capital investments in profitable projects.
The bank acquires the asset and then allows the beneficiary to use it based on a leasing agreement for a given period of time during which the latter pays 6 monthly installments. At the end of the period ownership is transferred to the beneficiary. The maximum amount financed in leasing is 35 million Islamic dinars.
Installment Sale (murabaha): This is used to finance fixed assets. The bank purchases an asset (up to 90% of the total project value) that the beneficiary repays by installments. The amount repaid is the asset cost plus a profit margin of 6%; there is no commitment fee or penalty in the event of late payment. Total duration of the installment sale (from purchase of the asset to the end of the repayment period) can be as long as 15 years. Similar to themurabahais theistisna’a,a structure whereby the lender pays for the availability of an asset (for instance, an industrial plant) before it is built. The maximum loan period is 15 years.
Equity: The bank can participate in a member-country company’s equity, provided the terms and conditions are compatible with Islamic law. Maximum participation is one-third of the company’s capital. In addition, the bank can set up joint ventures with the sponsors of an SPV (musharakah).
5. The Islamic dinar is a fictitious unit of account equivalent to an International Monetary Fund SDR (special drawing right) (approximately US$1.50).
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6.4.2.4 ADB (Asian Development Bank)
The Asian Development Bank was founded in 1966 as a regional development bank.
Starting in 1983 with the creation of a PSOD (Private Sector Operations Depart- ment), the bank began to provide direct assistance for investments in the private sector that have a strong social and economic impact in member countries.
As with other multilateral agencies, the role of the bank is to act as a catalyst for private capital for investments in areas where it is active. Furthermore, the bank plays a promotional role toward governments in countries that are stakeholders in the bank, to encourage them to introduce favorable political and institutional frame- works that can attract private capital. In addition, as in other cases, the action of a regional bank like ADB provides a guarantee for private lenders, which in turn means long-term loans are easier to set up and also increases the amount of funding available. In the project finance field the bank focuses on strategic sectors such as telecommunications, power and energy, water, and transport infrastructures (ports, airports, and toll roads), often in favor of SPVs that have BOOT or BOT concessions.
There are various forms of support for private investors, for instance, equity investment, loans, guarantees, and credit enhancement. A preferential condition for obtaining ADB support is that projects be compliant with procurement rules estab- lished by the bank; in particular, sponsors must be selected by a competitive bidding type of process. In any event the maximum financial support for a single project is limited to the lesser of 25% of total project cost and US$75 million.
Loans: Loans to the private sector are granted at conditions that reflect the risk level of the project concerned. Pricing is based on a spread above LIBOR or Euribor, although fixed-rate loans can also be made at the fixed rate quoted at the time of financing for swaps against floating rate. In addition, standard fees for syndicated loans are applied (front-end fee 1%–1.5% and commitment fee 0.5%–0.75%). The bank can ask for guarantees for the loan based on a case-by-case analysis. There are no rigid guidelines as regards duration. Normally there is a grace period of 2–3 years, while final maturity is established based on the project’s cash flow profile. As in the case of IFC, ADB offers a B-loan program (syndicated loans) known as com- plementary financing schemes (CFS), in which the bank acts as lender, lender of record, and agent bank. In this way a private lender obtains the same privileges and immunity guaranteed for a loan disbursed directly by ADB (for instance, exemption from withholding taxes or extension of restrictions imposed by the host government on capital and interest payments) and also preferred creditor status in the event of sovereign risk.
Guarantees: ADB offers private investors credit enhancement schemes to improve the ability to attract private capital. The first type of guarantee is a partial credit guarantee (PCG), which provides coverage for both business and political risks. The guarantee covers that part of debt service maturing beyond the normal tenor of a private lender and all instances of failure to pay capital and interest. This is especially useful (1) for projects that require very long-term funding and (2) in countries with more severe capital rationing conditions.
The second type of guarantee is a political risk guarantee (PRG), which aims to facilitate investment of private capital in cases where there are sovereign or political risks. This provides coverage for risks of breach of contract, expropriation and nationalization, nonconvertibility or nontransferability of currency, and politi- cal violence. The PRG can be issued without counterguarantees from the host 176 C H A P T E R u 6 Financing the Deal
government for an amount not exceeding a minimum of US$150 million and 50% of the project cost.
Equity investments: ADB can make private equity investments up to a maximum of 25% of the SPV’s capital stock. Divestment of shares occurs once the project has entered the operating stage and can entail either a sale to the other sponsors or listing on the local stock exchange.
6.4.2.5 European Bank for Reconstruction and Development (EBRD)
The EBRD was set up in 1991 and operates in 26 countries in central and eastern Europe plus countries that were once part of the Soviet bloc. As with other international financial agencies, its role is to promote infrastructure systems in target countries. The bank also stimulates target countries to improve their regulatory, institutional, and political framework. In the large-scale project sector EBRD is involved in those with a value ranging from 5 million to 250 million euro, with an average in the area of 25 million. The bank finances up to 35% of the total project cost (in the case of Greenfield projects) or up to 35% of long-term investments in the case of already-existing com- panies. Projects must be localized in one of the bank’s target countries and be sufficiently profitable to be adequately capitalized with equity from sponsors (at least one-third of the cost must be equity financed). Furthermore, projects must have externality within the economy and conform to the bank’s environmental standards. Its forms of intervention are, again, loans, equity investments, and issuing guarantees.
Loans: Loans are granted based on a valuation of a project’s ability to generate cash flow. The amount can range from 5 million to 15 million euro and apply to either fixed- or variable-interest loans. Maturities vary between 5 and 15 years and can also include grace periods negotiated on a case-by-case basis. The bank can also establish subordination clauses or grant mezzanine or convertible debt. Loans are without recourse; however, the bank can ask sponsors to provide specific performance or completion guarantees, as is normally the case in limited-recourse project finance deals. Similarly, sponsors must stipulate insurance contracts and provide the usual security package, which may include mortgages, pledges, floating charges, and assignments in favor of creditors. The bank has also set up an A-/B-loan program similar to the IFC’s, in which EBRD acts as lender of record for private lenders involved in the pool, who also benefit from preferred creditor status granted to international financial agencies.
Guarantees: The bank provides both all-risk guarantees against default as a result of whatsoever cause and partial risk–specific contingent guarantees that cover default originating from specific events.
Equity Investments: EBRD can provide equity for projects—directly or through its own investment funds—acting as a minority stockholder and with a clear exit strategy.
It can invest in ordinary stock or special categories of instruments; however, the specific terms of the investment depend on the nature of the project financed.
6.4.2.6 Inter-American Development Bank (IADB)
The IADB was founded in 1959 and operates in South America and the Caribbean, participating in the private sector with loans and guarantees. However, equity par- ticipation is through funds (MIF—Multilateral Investment Fund—and IIC—Inter- American Investment Corporation).
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