5/29/2013 3:25 PM

ADF-13 Innovative Financing Instruments

Discussion Paper

ADF-13 Second Replenishment Meeting June 2013

Tunis, Tunisia

AFRICAN DEVELOPMENT FUND

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Executive Summary

In an effort to make the Fund more resourceful, during the first consultation meetings for the thirteenth replenishment of the African Development Fund (ADF) held in Tunis, Management presented six innovative financing instruments in the paper “Long term financial capacity of ADF”. Management deepened its analysis of the potential demand for the products, their costs, ability to catalyze additional financing and their impact on debt sustainability, if any. Consequently, two proposals are submitted for the Deputies’ consideration- a Partial Credit Guarantee (PCG) and a Private Sector Facility (PSF). These instruments were prioritized as they are designed to leverage the Fund’s scarce resources to crowd in commercial sources of financing for transformational development projects in low income countries (LICs).

With the Twelfth General Replenishment of the African Development Fund, Deputies approved the inclusion of the Partial Risk Guarantee (PRG) to the suite of ADF instruments. ADF PRG operations in Kenya and Nigeria are at an advanced stage of preparation, and a strong pipeline of new PRG projects has been constituted. Together, the two proposed instruments alongside with the ADF PRG will equip the ADF with a suite of catalytic risk mitigation instruments.

Facing the risk of losing the hard-won gains from a decade of sustained growth, Africa’s LICs urgently need to make massive investments in economic infrastructure. Although traditional sources of financing are no longer able to keep pace, the good news is that the private sector is increasingly ready to design, build, operate and finance the needed investments; and the financial markets are showing a growing appetite for sovereign exposure in the continent. The African Development Bank Group (AfDB Group) has responded to these important trends to become a trusted development partner for African governments looking to attract private investment and financing. The operational focus of the ADF is evolving and over the last two cycles it has increasingly supported enabling environment reforms and co-financed alongside the AfDB Group’s private sector operations.

Covering a portion of scheduled repayments of private loans or bonds against obligors’ risks, the ADF PCG is designed to support countries’ access to financial markets on more effective terms than they are currently able to. PCGs are intended to help well performing ADF countries in their quest to mobilize both domestic and external commercial financing needs of these countries for developmental purposes; but it is critical that such borrowings are adequately assessed and prudently managed. This paper proposes to introduce PCGs to ADF countries and related State Owned Enterprises that meet certain minimum eligibility criteria to help ensure that the resulting debt is prudently managed and sustainable. The instrument would be introduced on a pilot basis. During this pilot phase corresponding to the Thirteenth General Replenishment of the African Development Fund cycle or until total exposure under the ADF guarantee program for both PCGs and PRGs reaches UA 500 million, the AfDB Group will accumulate experience and make necessary adjustments. Subsequently, an evaluation of the operational, institutional and financial arrangements will be conducted to fine-tune the ADF guarantee program, and propose an operational budget for mainstreaming the product.

The proposed PSF is intended to provide a vehicle for the ADF to participate in the financing of transformational infrastructure, agribusiness and industrial development projects in LICs. The PSF is geared to catalyze additional private investment, by leveraging the transactional capability of the private sector window of the AfDB. The PSF will be established as a special purpose vehicle offering credit enhancement to a portfolio of transactions in LICs. As a separate and autonomous entity, its credit enhancement capacity will be backed by the liquidity of a reserve pool that will require an adequate seed contribution to cover potential losses. Furthermore and in order to maximize its leverage, the Facility will be structured as a guarantee on a portion of the Loss Given Default incurred by AfDB in a specific transaction. It is highly catalytic, the proposed seed capital of UA 165 million as an ADF grant to the Facility could catalyze an additional UA 3.3 billion of private sector investment: UA 660 million for AfDB and UA 2.6 billion for other financiers, over and above the financing that the AfDB can feasibly achieve without the PSF. A number of risks to achieving the desired results have been identified along with the appropriate mitigation measures. The robust Private Sector Operation pipeline in ADF eligible countries, presents excellent prospects for swift and significant development impacts with limited additional administrative cost.

In addition to the PCG and PSF, Management also proposes an innovative approach in the application of resources in the Regional Operations (RO) envelope, to help attract larger volumes of investments for the purpose of bridging Africa's massive infrastructure gap. More specifically, Management proposes that significant portion of the RO envelope be invested in the proposed Africa50Fund

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alongside other investments in the Fund that will be made individually by African countries. The Africa50Fund, described in the concept note attached at Annex VI, is designed to be an investment vehicle whose vision is to unlock private financing sources (especially from non-traditional sources of infrastructure financing such as sovereign wealth funds, pension’s funds, insurance companies etc.) and to accelerate the speed of infrastructure delivery in Africa. Working in collaboration with African Governments, the AfDB has already identified infrastructure projects worth USD 150 billion, including the Programme for Infrastructure Development in Africa (PIDA) pipeline. The Africa50Fund aims at attracting at least USD 100 billion worth of local and global capital to deliver this pipeline and needs an equity investment of USD 10 billion.

Deputies are therefore invited to approve the two innovative financing instruments (PCG and PSF) being proposed by Management, as well as to provide views and guidance on the proposal to invest a significant portion of the ADF-13 RO envelope in the Africa50Fund.

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Table of Contents

Abbreviations ........................................................................................................................................ iv

1. Introduction ................................................................................................................................. 1

2. PART A – The Partial Credit Guarantee Instrument ................................................................ 2

Introduction .................................................................................................................................... 2

Bank Group Experience with Partial Credit Guarantee Products ................................................. 2

Demand and benefits of the ADF PCG ......................................................................................... 4

Operational framework of the ADF PCG ....................................................................................... 5

Financial Considerations ............................................................................................................... 7

Risk Management Considerations ................................................................................................ 9

Conclusions and Recommendation for the PCG ........................................................................ 10

3. PART B- The Private Sector Facility ........................................................................................ 11

Introduction .................................................................................................................................. 11

Country Examples and Expected Demand ................................................................................. 12

Features of the Private Sector Facility ........................................................................................ 14

Financial Considerations ............................................................................................................. 16

Advantages of the PSF ............................................................................................................... 17

Managing the Risks of the PSF ................................................................................................... 18

Conclusions and recommendations for the PSF ......................................................................... 19

4. Africa50Fund ............................................................................................................................. 19

Annex I: Update on the Implementation of the ADF Partial Risk Guarantees (PRG) .............. 20

Annex II: Criteria for selecting innovative financing products................................................... 24

Annex III: Indicative pipeline for the Private Sector Facility (PSF) ............................................. 26

Annex IV: Leverage and multiplier of the PSF ............................................................................... 28

Annex V: Sample of Multilateral Development Bank experiences with leveraged credit enhancement through concessional financing ........................................................... 30

Annex VI: The Africa50Fund- Concept Note .................................................................................. 32

Boxes

Box 1: Select AfDB PCG transactions ..................................................................................................... 3

Box 2: Examples of Projects to be Supported by the PSF Facility........................................................ 14

Figures

Figure 1 : Catalytic effect of the ADF PCG .............................................................................................. 8

Figure 2 : Sources of Reserve for the Facility ....................................................................................... 16

Figure 3 : Catalytic effect of the PSF ..................................................................................................... 17

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Abbreviations

ADF African Development Fund ADF-12 Twelfth General Replenishment of the African Development Fund ADF-13 Thirteenth General Replenishment of the African Development Fund AfDB African Development Bank LGD Loss Given Default LIC Low Income Country LTWP Lake Turkana Wind Power MDB Multilateral Development Bank MIC Middle Income Country MSMEs Micro-Small and Medium Enterprises NCDA Non-Concessional Debt Accumulation PBA Performance Based Allocation PCG Partial Credit Guarantee PIDA Programme for Infrastructure Development in Africa PPP Public Private Partnership PRG Partial Risk Guarantees PSD Private Sector Development PSF Private Sector Facility PSO Private Sector Operation RMC Regional Member Country SOE State Owned Enterprise UA Unit of Account

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ADF-13 INNOVATIVE FINANCING INSTRUMENTS

1. Introduction

1.1. Among its top priorities, the African Development Bank Group’s (AfDB Group or Bank Group) new Strategy 2013-2022 emphasizes scaling up support for Africa’s infrastructure and private sector development (PSD). The strategy 2013-2022 also aims to channel a larger share of AfDB support to the part of the continent most in need, namely Africa’s low income countries (LICs) and particularly the fragile states. The African Development Fund (ADF) is a core instrument to implement the new Strategy. Recognizing the growing constraints on traditional source of financing, Deputies have called for new and innovative instruments that will catalyze additional financing in LICs from the private sector.

1.2. With the Twelfth General Replenishment of the African Development Fund (ADF-12), Deputies approved the inclusion of the Partial Risk Guarantee (PRG) to the suite of ADF instruments (see Annex I for an update on implementation and transactions under preparation). The PRG was introduced on a pilot basis to catalyze private investments in ADF countries by covering risks related to the failure of a government or a state-owned entity to honor its contractual undertakings to private sector lenders. Such risks include political force majeure, currency inconvertibility, and various forms of breach of contract. ADF PRG operations in Kenya and Nigeria are at an advanced stage of preparation.

1.3. During the first replenishment meeting of the Thirteenth General Replenishment of the African Development Fund (ADF-13), six innovative financing products were presented for Deputies’ consideration. Based on their guidance

1, these were narrowed down to two: a Partial Credit

Guarantee (PCG) and a Private Sector Facility (PSF). The PCG is designed to support countries’ access to financial markets on more effective terms than they are currently able to. The PSF is geared to catalyze additional private investment in partnership with the private sector window of the AfDB to promote transformational infrastructure and industrial development in LICs. Together, these two new instruments alongside with the existing ADF PRG will equip the ADF with a suite of risk mitigation instruments that are intended to catalyze additional financing, notably from the private sector.

1.4. The paper is organized in two main parts, each covering one of the two instruments proposed: Part A- covering the PCG, and Part B- presenting the PSF, as per the following structure:

The rationale for the proposed instruments;

A demand analysis;

A description of their respective features including the principal terms and implementation arrangements;

Financing considerations;

Specific advantages and expected results;

Key risks and mitigating factors;

Recommendations for Deputies consideration.

1.5. In addition Management puts forward for Deputies guidance a concept note on Africa50Fund included in Annex VI. The aim of that innovative Fund is to unlock private financing sources and to accelerate the speed of infrastructure delivery in Africa, thereby creating a new platform for Africa’s growth and prosperity. Specifically, Management proposes that a significant portion of the Regional Operation envelope be invested in the proposed Africa50Fund alongside the other investments in the Fund that will be made individually by African countries.

1 The criteria for prioritization included: i) ease of implementation and additional administrative costs required, ii) set-aside requirements, iii) existing and foreseen demand for the instrument iv) leverage and financial impact. Priority was also given to the financing instruments that cannot be implemented within the current PBA framework (see Annex II for additional information on the other financing instruments not selected).

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2. PART A – The Partial Credit Guarantee Instrument

Introduction

2.1. Private capital flows to developing countries have increased significantly over the past decade, but Sub-Saharan Africa has been less successful than other developing regions in attracting private investments. Investors continue to perceive doing business in African low-income countries (LICs) as excessively risky and require an additional 10-15% risk premium compared to other regions of the world. This perception of disproportionately high risk directly impacts the cost and volume of commercial financing and capital.

2.2. Guarantees are effective tools to insure investors against specific risks, enabling optimal allocation of risks to participants that are better equipped to bear them. The AfDB Group has offered two guarantee products since 2000: (i) Partial Credit Guarantees (PCGs), which cover a portion of scheduled repayments of private loans or bonds against all obligor’s risks and (ii) Partial Risk Guarantees (PRGs), which protect private investors against political risks.

2.3. Various studies have demonstrated that these two instruments facilitate the flow of private investments into countries and sectors that were considered as very risky. Under the Bank Group, the AfDB offers both the PCG and PRG while the African Development Fund (ADF or the Fund) has been offering the PRG since ADF-12. The objective of this note is to introduce a PCG instrument under the ADF window.

2.4. Extending PCGs to LICs to raise non-concessional debt may be construed as condoning reckless accumulation of debt. The provision of concessional debts by ADF is primarily intended to help beneficiary countries sustain their development while avoiding the risk of debt trap. By allowing these countries to accumulate new debts on non-concessional terms, PCGs can be seen as undermining these objectives and introducing the risk of free-riding and moral hazard

2. At the same time, it is widely recognized that developing countries need significantly

more resources to achieve their development goals. The volume of resources expected from donors in the current international context would be far from matching these needs. Therefore, it is imperative to find ways to better leverage the resources that would be committed under ADF-13. The design of the PCG should address these potentially conflicting goals while accommodating financial market requirements to be effective.

2.5. This note is organized as follows: Section 2 reviews the Bank Group experience with the PCG instrument. Section 3 elaborates on the demand and the benefits of PCGs. Section 4 details the operational framework, with specific reference to guiding principles, eligibility criteria and the key features of the new instrument. Sections 5 and 6 outline the financial considerations and implementation modalities of the instrument, respectively. Section 7 discusses risk management considerations, while Section 8 presents the conclusion and recommendations.

Bank Group Experience with Partial Credit Guarantee Products

2.6. Since the establishment of the AfDB PCG program, the Board has approved a total of thirteen financial sector operations (including a policy based operation) and one in the infrastructure sector. The AfDB PCG has enabled tenor extension in a loan syndication; financing to small and medium sized enterprises (SMEs); and the restructuring of a commercial debt through a policy based operation to promote macroeconomic stability and improve financial governance. The following presents some highlights of some PCG transactions approved by the Board since the establishment of the guarantee program in 2000.

2 A situation in which grants and debt relief provided by one or more parties cross-subsidize new borrowing from third party lenders on non-concessional terms

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Box 1: Select AfDB PCG transactions

PCGs have enabled borrowers to access the commercial loans markets on better lending terms than they would have received without the guarantee. PCGs have also stimulated local currency financing: In 2000, the AfDB and FMO, the Dutch Development Bank, shared pari-passu a guarantee

extended to MTN Cameroon (a mobile phone network operator). The guarantee supported the company to mobilize a local currency loan of up to CFA 9 billion (equivalent to EUR 13 million) from local banks for a Euro 209 million mobile telephone development project. The project introduced the limited recourse project finance field to local banks; the AfDB’s guarantee allowed these local banks to provide long term funding (5 years) in an environment where the longest maturity was limited to 2 years. The Bank’s participation gave comfort to the private lenders through the risk sharing mechanism inherent to PCGs with a leverage effect of 1.25 times.

PCGs have been used to catalyze private financing in support of small and medium enterprises:

Through a series of portfolio guarantees with leverage effects of 2 times, AfDB PCGs shared with United States Agency for International Development (USAID), have facilitated access to finance for women entrepreneurs and SMEs through guarantees extended to K-Rep-Kenya: USD 2.5 million; CBA-Kenya: USD 5 million; CFC-Kenya: USD 2.5 million; BICEC-Cameroon: USD 5 million; SGBC-Cameroon: USD 5 million; Zanaco-Zambia: USD 2 million; and CRDB-Tanzania: USD 8 million.

PCGs have helped countries regain access to capital markets following crises and default: In the

case of Seychelles for example, the AfDB extended a USD 10 million PCG, which facilitated the restructuring of USD 320 million worth of debt. The facility, which took the form of a rolling non-reinstatable guarantee

3, was instrumental in getting Seychelles debt burden on a sustainable path. The

PCG was extended in line with a policy based program aimed to support the Government of Seychelles to implement economic reforms, in order to promote macroeconomic stability, improve financial governance and sustainable growth by reducing public debt to more sustainable levels. This was the second time that a PCG had been used in the context of a sovereign debt restructuring, after the experience of the Caribbean Development Bank with St Kitts and Nevis in 2006. The implied leverage effect of the Seychelles transaction was over 16 times.

PCGs are instrumental for the development of the Bank’s trade finance program: The Bank has set

up a comprehensive Trade Finance Program with an aggregate exposure of USD 1 billion which would be rolled out through Risk Participation Agreements, Lines of Credit and Commodity Finance. The Risk Participation Agreements are aligned with the guarantee program in which the Bank guarantees up to 50% of eligible trade transactions for a Maximum Participation Amount. To-date, two key transactions with Standard Chartered Bank and Ecobank Transnational Incorporated for a Maximum Participation Amount of USD 200 million and USD 100 million, respectively have been approved by the Board of Directors of the AfDB as of 20 February 2013.

2.7. Although the Bank Group experience with the guarantee product has proved successful its use has been limited. The main reasons could be (i) insufficient marketing to prospective clients; and (ii) corporate performance management indicators, which tend to favor the volume of lending and act as a strong incentive for staff to focus on loans. Guarantees are also legally, financially, and operationally more complex than direct lending, owing to the greater number of parties involved and the negotiations necessary to lower commercial lenders’ margins or lengthen their maturities. Addressing these factors to incentivize guarantee product utilization is fully within the purview of Management.

2.8. Before the financial crisis, African Middle Income Countries (MICs) had easy access to financial and capital markets and consequently did not require guarantees

4. Additionally, the lack of

leverage of AfDB PCGs in terms of capital consumption made them very uncompetitive compared to direct AfDB loans. This somewhat explains the limited uptake of PCGs by MICs. Had the ADF PCG existed at that time, there would have been greater demand from LICs since they required credit enhancement to access commercial debt markets.

3 A rolling non-reinstatable guarantee: where the guarantee cannot be “rolled over” if the guarantee has previously been called.

4 The situation has changed significantly since the financial crisis and the Arab Spring. For example Tunisia needed a United States Government guarantee to access capital markets in 2012.

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2.9. The design of the proposed ADF PCG will take into consideration the lessons learnt from AfDB’s experience with PCGs; namely on the need to have a leveraging factor. The ongoing sensitization process for the ADF Partial Risk Guarantee is also facilitating a general appreciation for the Bank Group’s guarantee products, and providing insight into improving the marketing for such products. These efforts will have to be aligned with revised corporate performance management indicators focused on leveraging the Bank Group’s risk capital and ADF resources.

Demand and benefits of the ADF PCG

Demand for ADF PCG

2.10. PCG for bond issues: Over the past couple of years, the Bank Group has received credit guarantee inquiries from investment banks arranging first time international bond issues for a number of RMCs. In particular, there is an increasing number of ADF countries that will have improved access to international capital markets, through either greater volume of private financing or lengthened maturity, and also improved financial leverage or terms, should the option of a PCG instrument be expanded to them. A further market exists for PCGs among ADF countries with relatively developed domestic capital markets as the instrument has the potential to help mobilize local capital markets for public investment needs. However, since the European sovereign debt crisis, there has been a significant appetite for emerging market debts, and several African countries have been able to benefit from this unexpected interest without the need for a guarantee: In April 2013, Rwanda issued a 10-year $400 million bond with a coupon of 6.625%; Zambia issued a 10-year $750 million bond with a 5.372% coupon in September 2012; while Namibia issued a 10-year $500 million bond with a coupon of 5.5% in October 2011. The Rwandan bond was 8.5 times oversubscribed; the Zambian bond was almost 20 times oversubscribed, with $12 billion offered at the time of issue, while the Namibian bond was 5 times oversubscribed. This is in stark contrast with the situation prior to the financial crisis when coupons on African countries’ bond issues varied from 8.5% - 9.0%, irrespective of the then existing low interest rate environment and subscriptions fell short of countries’ targets. Such enthusiasm is likely to continue over the coming years, supported by the search for portfolio diversification, the growth story on the continent and the drive for higher returns given the likely persistence of low yields in major developed markets. Yet, the recent experience of Tanzania with an expensive private placement of a 7-year bond at Libor + 600bps in February 2013 leaves room for pricing improvement with an ADF PCG.

2.11. This notwithstanding, there is also demand for guarantees from parastatals that are also looking to tap international and domestic capital markets and where the enhancement provided by an ADF PCG would impact the volume of financing raised and their pricing terms. A very recent example would include an infrastructure related state owned enterprise in Zambia which is considering securitizing its revenue stream for a domestic bond issuance. They have approached the Bank Group to provide a guarantee to lend credibility to the issuance.

2.12. In the syndicated loan market for parastatals and countries: the Bank Group is also regularly contacted by investment banks arranging financing for parastatals in ADF countries. Typically, investment banks are not familiar with LIC’s credit risk and they need a guarantee to strengthen their lending proposals. Recent examples include enquiries for a loan to the Ministry of Planning in Mozambique to refurbish the Massingir Dam to help facilitate the supply of water to a new sugar plantation; and a loan for the development of a gas turbine power generation project in Tanzania through a state owned utility.

2.13. The Bank Group has prior experience of providing commercial loans to public sector owned entities in LICs. These entities would be natural beneficiaries of the ADF PCG which could help them raise financing from commercial financiers at improved terms. In 2010 and 2011, the private sector window of the Bank Group lent to commercially-run public enterprises in Rwanda and Uganda. In both cases, the proposed transactions were assessed to fall within the flexibility provided by the Bank Group Policy on Non-Concessional Debt Accumulation (NCDA). The Bank’s enclave policy also offers another avenue to lend non-concessional resources, from the AfDB window to public projects in ADF countries. Prior beneficiaries have been SNIM in Mauritania and Chantier Naval Industriel du Cameroon.

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2.14. Overall, the demand for ADF PCG has been identified in the following areas:

Project Finance: where PCGs can be used for public sector investment projects, especially in infrastructure, to encourage the extension of maturity and to improve access to capital markets. The guarantee could cover the principal for bullet maturity of corporate bonds, or later maturity principal payments of amortizing syndicated loans;

Financial Intermediation: where PCGs can be used to support the mobilization of long-term resources from both international and domestic capital markets, and

Policy Based Finance: where PCGs can be used to support Sovereign mobilization of commercial financing to be used for policy or sectorial reforms.

The Benefits of an ADF PCG

2.15. Both the ADF and its borrowers will benefit from the use of the ADF guarantees. A PCG for LICs would help access markets, extend debt maturities, and lower borrowing costs for their projects. Specific types of PCG, for instance the tenor extension guarantee, aim mainly at extending the terms of financing by guaranteeing payments at the longer end of the debt facility, thus incentivizing private lenders to bridge the gap. The debt issuance guarantee, in contrast, seeks to reduce the interest spread on the overall amount guaranteed. These two variations of credit guarantees can be combined for greater impact.

2.16. Commercial lenders would also stand to gain from the instrument as certain risks of lending will be mitigated including perceived default risk. The Fund’s strong relationship with governments can give comfort to lenders and also mitigate the risks of default on the nonguaranteed portion of the financing. Additionally, depending on the banking regulations that govern the commercial lenders, the portion of the commercial loans covered by PCGs may be exempt from country-risk provisioning requirements, thus reducing the impact of the loan on their risk capital allocations, freeing up their lending capacity.

2.17. The benefits for the Fund are also numerous: the shorter maturity of the underlying loan guaranteed by an ADF PCG as against the longer maturity of a regular ADF loan would tie up ADF resources for a shorter period of time and be beneficial to the Fund’s advanced commitment capacity. The leverage of the ADF PCG will impact positively the Fund in different ways: (i) it will generate more income for the Fund since the guarantee fee will be charged on the entire amount guaranteed and not just the fraction of the Performance Based Allocation (PBA) earmarked to back the guarantee; and (ii) it will spare the Fund’s scarce resources that will continue to be directed to the Fund’s priority areas. Finally, the PCG would be instrumental in achieving the overarching goal of attracting private investors to the financing of African LICs, while ensuring prudent and appropriate debt management.

Operational framework of the ADF PCG

Alignment with the Bank Group Policy on NCDA

2.18. The Bank Group Policy on NCDA 5

governs the Bank Group’s use and allocation of concessional resources in a manner that supports RMC’s development agenda and their long-term debt sustainability. To discourage non-concessional borrowing it sets a number of compliance measures ranging from hardening the concessional loan terms to volume discounts on ADF loans for countries in breach of the policy.

2.19. However, in the revision of the NCDA policy in May 2011, the Board acknowledged that “Non-concessional borrowing that is transparently contracted by RMCs with low-risk of debt distress and strong policies and institutions may supplement limited concessional resources.” As a result and in line with changes on debt limit policy introduced by the International Monetary Fund (IMF) in 2009, the Board decided to provide (i) more flexibility in determining the Bank Group’s concessionality limits, by replacing the single benchmark grant element of 35 percent approach with a more nuanced concessionality framework, to better take into account the diversity of country circumstances and (ii) give some ADF-only regional member countries the flexibility to

5 ADF/BD/WP/2011/23/Rev.1

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contract prudent non-concessional borrowing in line with their debt vulnerability and their debt management capacity.

2.20. This authorization to raise non-concessional borrowing will be applied to ADF-only countries with low risk of debt distress (green light countries), while less flexibility is offered for ADF-only countries assessed to have a moderate and high risk of debt distress (yellow light and red light countries). It is worth noting that between 2008 and 2013, several countries have been granted exemption by the IMF to raise non-concessional debts, this includes Democratic Republic of Congo, Senegal, Congo Republic, Cameroon, Rwanda, Tanzania, Zambia, etc. The proposed ADF PCG will be aligned with the revised NCDA.

2.21. It should be emphasized that the entire amount of non-concessional debt raised with the assistance of the PCG would impact a country’s Debt Sustainability Analysis (DSA) and not just the portion of the debt covered by the PCG.

Alignment with the Bank’s enclave policy

2.22. The Bank’s enclave policy provides for circumstances under which a commercially viable, self-sustaining, export-oriented enterprise located in a LIC may borrow from the Bank on non-concessional terms from the private sector window. The borrowing entity in such a case should be fully or partially owned by a LIC government which would normally have been precluded from raising non-concessional resources. The stringent enclave criteria in terms of independence of the management, ability to sue and be sued, and establishment of an off-shore escrow account to service the debt have permitted the provision of loans on commercial terms to such enterprises. Consequently these enterprises would be natural candidates for ADF PCGs, which would enable them to raise even more financing from commercial financiers at better terms.

2.23. It is important to note that the Bank’s enclave policy does not contain any restriction linked to the country’s DSA

6. Additionally, the requirement of having foreign income generating projects

has already been waived by a sister institution7 subject to having strong financial flows in local

currency through an off-take agreement with a strongly creditworthy party and the dedication of alternative defined source of foreign exchange to the service of the debt. A similar waiver is being considered for the revision of the Bank’s enclave policy. The ADF PCGs will comply with these requirements by designing the appropriate eligibility criteria for State Owned Enterprises (SOEs) and availing the instrument to local currency generating projects.

Eligibility criteria

2.24. Guarantees are contingent liabilities and in the event that they are called, they create similar repayment obligations to the Fund as a disbursed loan. Therefore, it is intended that in using this instrument, similar eligibility criteria that applies to ADF loans would be followed. It should be highlighted that the proposed ADF PCG will promote non-concessional borrowing using the Bank Group resources and reputation, which could result in rapid accumulation of sovereign debt in the absence of appropriate debt vulnerability and debt management capacity safeguards and other stringent criteria.

2.25. Accordingly, the following additional eligibility criteria will prevail:

Consistent with the NCDA, ADF countries would only be eligible for PCGs if there are classified as countries with low risk DSA (green light countries – low risks of debt distress) and have adequate debt management capacity. This will provide well-performing ADF countries the prospect of greater flexibility to take on prudent levels of new non-concessional borrowing. Any change to the NCDA will affect ratably this criterion. The operational guidelines (Guidelines) to be developed will detail measures for the appropriate use of the funds raised with the assistance of the ADF PCG.

SOEs will be exempted from the country level requirements and will be eligible for the ADF PCG subject to receiving government guarantee and meeting certain requirements to be outlined in the Guidelines. The requirements will include but not limited to commercial

6 The enclave policy is prior to the DSA. 7 The International Development Association of the World Bank Group.

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viability, financial autonomy, distinct legal personality and capacity to sue and be sued. These requirements will allow the provision of the PCG to the SOEs irrespective of the Country’s DSA classification.

2.26. Altogether:

Eligible projects will fall within the Bank Group’s priority sectors funded by the government or an SOE.

Eligible Debt: will be any commercial debt including bonds and local currency loans. Equity investments will be excluded but risk management products such as swaps can be covered by the guarantee.

Risk Coverage: Only a portion of the debt will be covered to enable the leverage and risk sharing between the Fund and investors. Financial leverage will be an important consideration in the assessment of the guarantee.

Hierarchy of instruments

2.27. In situations where more than one instrument of the Bank Group is available to finance a transaction, for instance an ADF PCG and an Enclave loan, the Bank Group will adopt a flexible approach to decide in consultation with the beneficiary country which instruments to select or the appropriate combination of instruments.

Counter Indemnity

2.28. The ADF PCG would require a counter-guarantee8 (counter indemnity) from the beneficiary

member country. This is in line with the features of the AfDB PCG9 as well as the AfDB and

ADF PRGs. In case of a call under the ADF PCG, any payment made by the Fund would be immediately due and payable to the Fund by the country providing the counter indemnity. This is to mitigate the moral hazard should a country expect to get a long term ADF loan after a default under the guarantee. Failure to reimburse the Fund would create arrears the same as the failure to make timely payments of debt service on an ADF loan, and would trigger the sanction policy and cross default provisions. However, the Fund, in its own and at its sole discretion, would be able to amortize the amount to be paid in the form of a loan over a period of time.

No Acceleration of obligations under the Guarantee

2.29. The ADF PCG would not be accelerable i.e. under no circumstance can the Fund be liable for or obliged to pay to the beneficiary of an ADF PCG amounts not yet in default or amounts due and payable as a result of acceleration of the underlying debt. The obligation of the Fund under a PCG will be limited to the scheduled debt service. However, the Fund reserves the right, at its own and sole discretion, to accelerate payment of amounts due, but not yet payable, under a called guarantee.

Cooperation with other risk mitigation providers

2.30. The ADF will be encouraged to cooperate with other private and public risk mitigation providers through the sharing of risks, knowledge, and due diligence.

Financial Considerations

Commitment capacity

2.31. ADF government performance guarantees are closely linked to country performance. ADF guarantees will be available to regional member countries through their allocations including PBA and additional resources available to the country under the Regional Operations Envelope and the Fragile States Facility. In light of the lessons learned from other guarantees issued by the Bank Group and specifically the ADF PRG, it is suggested that only 25 percent of the

8 An agreement whereupon the beneficiary member country agrees to indemnify the Fund for payments it has made under the guarantee. Any payments by the Fund would be repaid by the respective country.

9 For sovereign and sovereign guaranteed entities.

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nominal value of the guarantee be deducted from the country’s PBA10

. However the country will be liable for the entire amount of the guarantee extended. Each country may opt to leverage its PBA with more than one PCG, but the total guarantee amount per country would be limited to 100% of a country’s original PBA. The amounts deducted from country PBAs would be channeled into an accounting pool dedicated to insure against calls on guarantees.

Leverage

2.32. As indicated above, the ADF PCG will boost the volume and catalytic impact of the financed transactions. Given the indication of the section on commitment capacity, the Fund would be leveraged 4 times. Thus, for a guarantee amount of UA 100, only UA 25 of a country’s PBA resources will be used. Given that on average guarantees cover at most 50% of the total investment amount; it is estimated that the ADF PCG will have a combined leverage and multiplier effect of at least 8 times

11 the PBA resources used.

Figure 1 : Catalytic effect of the ADF PCG

Fees and pricing

2.33. The Bank Group will apply the same pricing for PCG as for ADF loans. The financial impact of making a disbursement against a called guarantee is equivalent to granting a loan to the country providing the counter-indemnity. The only difference is the timing of disbursements. An additional strong reason for aligning guarantee charges to charges on loans is that the cooperative nature of the Fund will make it difficult to justify charging different prices on guarantees and loans where they create the same exposure to risk. The following fees will apply:

Standby fee: The level of the fee is equal to the contractual commitment fee on similar ADF loans and will be charged on the unused portion of the guarantee. Accordingly, the standby fee will be set at 0.5%. The standby fee is payable by the beneficiary of the guarantee on the standard payment dates set by the Fund. The standby fee ceases to be applied once the guaranteed facility is fully disbursed.

10 For the avoidance of any doubt, PBA going forward refers to the actual PBA topped up by any allocation from the Fragile States Facility or the Regional Envelope.

11 Should the guarantee cover 20% of the transaction, the multiplier/catalytic effect would be 20 times.

9

Guarantee fee: This fee is similar to the interest rate level on a standard ADF loan. The level of the guarantee fee will be set at the service charge applicable to standard ADF loans, currently 75 bps. The guarantee fee will accrue on a daily basis and is payable either according to an approved schedule, standard payment dates or as a one-time up-front payment.

2.34. All the fees will be borne by the borrowers i.e. the sovereign or the SOE.

Implementation Modalities

2.35. The new instrument would be embedded, managed, and operated within the existing institutional structure. Guarantee products have been available at the Bank Group for 13 years, in that time experience has been gained in conducting the due diligence and risk assessment of the projects which use the instrument.

Risk Management Considerations

Credit Risk

2.36. Credit risk is the potential for loss if a country fails to honor its obligation to the Fund. It is by far the largest source of risk for the Fund. The credit exposure resulting from PCG is generally smaller than for direct lending because of the reduced set of default events. In order to mitigate that risk, the following will apply:

2.37. Stringent eligibility criteria as outlined in section 2.24, shall apply:

PCG will be limited to debt or debt derivative instruments. This would exclude guarantees of equity investments but permit guarantees of risk management products such as swaps and the guarantee of local currency loans.

Maturity limits will apply: The shortest maturity possible that would make the project viable shall be considered. In any case, the maturity of a PCG will be capped at the maturity limit of ADF loans extended to the host country.

A counter indemnity agreement will be signed with the beneficiary country. This is expected to have a deterrent effect due to the negative impact a default on the counter indemnity could have on the disbursement of the country’s current and future ADF allocations.

Liquidity Risk

2.38. The Fund does not enjoy an independent funding capacity. The Fund commitment capacity under a given replenishment includes donor contributions and internally generated resources. Under the proposed framework, a PCG may not be backed by an equivalent level of resources held in ADF liquidity. As a result, a call on an ADF guarantee could potentially put a strain on its liquidity.

2.39. The Fund’s liquidity policy requires that the Fund holds between 50% and 75% of the moving average of three years of expected disbursements in the form of liquid assets. In order to mitigate the liquidity risk, the Bank Group will ensure that the ADF Operational Portfolio

12

captures any amount callable in a given year, when this amount is greater than the 25% PBA earmarked initially for guarantees.

Operational Risks

2.40. In the 13 years that guarantee products have been available at the Bank Group, implementation has been smooth therefore no operational difficulties are expected for the ADF PCG.

12 The Operational Portfolio provides a readily available source of liquidity to cover both expected and unexpected disbursements as well as any other probable cash outflows for the Fund.

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Conclusions and Recommendation for the PCG

2.41. This paper seeks to address the challenges faced by well performing ADF only countries in their quest to mobilize both domestic and external commercial financing for developmental purposes, by introducing PCGs for ADF countries and related SOEs provided they meet the minimum eligibility criteria. Private financing would help to meet large developmental financing needs of these countries, but it is critical that such borrowings are adequately assessed, prudently managed and sustainable.

2.42. With ADF-12, Deputies approved the inclusion of the PRG to the suite of ADF instruments. ADF PRG operations in Kenya and Nigeria are at an advanced stage of preparation, and a strong pipeline of new PRG related projects has been constituted. The similarity of operational modalities between the two ADF guarantee instruments (PCG and PRG) such as the common deduction of 25% of the country’s PBA and the requirement of a counterindemnity from the Government, advocate for a single headroom for the Fund guarantee instruments. Therefore it is proposed that the two instruments share a combined ceiling of UA 500 million. This will allow for more PRG related projects to be pursued outside of the current UA 200 million ceiling exposure, while the ADF PCG instrument is fully operationalized.

2.43. The ADF PCG will be introduced on a pilot basis, allowing the Bank Group to accumulate experience and make necessary adjustments during the pilot period corresponding to the ADF 13 cycle. Subsequently, an evaluation of the operational, institutional and financial arrangements will be conducted to fine-tune the ADF guarantee program, and propose a budget for mainstreaming the product.

2.44. Deputies are invited to:

Approve the proposal to introduce PCGs to ADF countries subject the eligibility criteria which would help ensure that the resulting debt is prudently managed and sustainable;

Approve the ADF PCG program on a pilot basis for 3 years (ADF- 13 cycle);

Approve a ceiling of UA 500m for the total ADF guarantee program (PCG and PRG combined); and

Authorize Management to take all steps necessary for the proper implementation of the new instrument.

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3. PART B- The Private Sector Facility

Introduction

3.1. The Financing Gap: Weak infrastructure and embryonic industrial capacity hinder LIC’s inclusive growth potential, their abilities to create jobs, improve livelihoods and decrease poverty. Africa needs to invest at least USD 50 billion per annum to close the gap. But this will not be easy. Concessional funding from traditional sources is increasingly scarce. Local capital markets are still nascent and unable to meet the surging demand for government financing of infrastructure both in terms of the sheer volume as well as the required tenors. Recent efforts by a number of African countries to access the international capital markets have been remarkably successful. Yet, investors continue to perceive doing business in African LICs as excessively risky. This perception of disproportionately high risk directly impacts the cost and volume of commercial financing and capital. As a result, the financing terms are often unfavorable (with short tenors and premium pricing) leading to concerns about the future debt sustainability of the countries tapping the capital markets. That raises questions regarding the possible strategies that could be implemented by African governments.

3.2. Private Sector Potential: Promoting private investment and financing is a possible solution. Domestic and foreign investors are increasingly interested to design, build, operate and finance infrastructure and industrial development projects in Africa. Private investors, who almost exclusively focused on projects in the natural resources and telecommunications sectors at the beginning of the decade, are steadily branching out into industrial development projects as well as basic infrastructure services. In the past few years there has been an unprecedented number of large scale industrial investments in sectors such as fertilizers, cement, refineries, smelters and other manufacturing and processing plants. Private investors are also investing in a range of power plants, including in renewable energy. They have even shown an appetite for capital intensive investments in ports, airports, railways and roads. Fiscally constrained African governments increasingly rely on the private sector to provide these services either on a purely private basis or on a Public Private Partnership (PPP) basis. Given the shallowness of the domestic and regional financial markets, and against the backdrop of the global financial and European debt crisis, foreign and regional investors have had to rely heavily on Development Finance Institutions (DFIs), for financing at the scale and tenors needed for large infrastructure and industrial investments.

3.3. AfDB Responds: The progressive shift from public to private sector financing has evolved the operational focus of the AfDB Group. In 2000, the AfDB approved about UA 65 million of new Private Sector Operations (PSO), representing less than 1% of total AfDB Group operations. A decade later, PSO grew to around UA 1 billion per annum in new approvals or almost 1/3 of new operations. The geographic orientation of the Bank’s private sector window has also shifted dramatically. Historically, the Bank’s PSO focused on projects in MICs. By 2010 almost two-thirds of the Bank’s PSO was directed towards LICs. The Bank’s PSO also has a built-in catalytic impact to attract resources from other partners. A recent review of the Bank’s portfolio highlighted that on average each UA of private sector financing from the AfDB generates between five and six UA of total investment.

3.4. ADF Responds: The operational focus of the ADF is evolving too, and over the last two cycles it has increasingly been mobilized as a PSD-enabling and PSO co-financing instrument for the AfDB Group. Recognizing the opportunity which the private sector presents for development results on the ground, RMCs are channeling ADF resources to PSD and PPP projects. Examples of PSD projects financed through ADF operations include the establishment of centers providing administrative services to private enterprises in Mozambique and Rwanda, or support to the agricultural value chain in Malawi and Nigeria. Since 2009, RMCs have been channeling ADF resources to infrastructure and real economy PPP projects, to seize the opportunity of risk and cost-sharing with the private sector. With ADF-12, Deputies approved the inclusion of the PRG to the suite of ADF instruments, to better seize the private sector’s potential for development results. ADF PRG operations in Kenya and Nigeria are at an advanced stage of preparation and are expected to be submitted for consideration to the ADF Board before the end of the ADF-12 cycle.

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3.5. Africa’s Leading Development Partner: The AfDB Group has built on its status as Africa’s leading financial institution for public sector clients to also become Africa’s leading development partner for development results through the private sector. By successfully structuring and financing integrated infrastructure operations such as the four projects in Senegal (the port, the airport, a toll road and a power plant), the AfDB Group has become a trusted partner for African governments seeking to catalyze large-scale private investment. In turn, this has enabled the Bank to build a robust pipeline of new PSO that can potentially catalyze more than UA 7.5 billion of new investment, of which about UA 5.6 billion is in LICs. This presents an opportunity for the ADF to build on its emerging track record as a co-financing partner of the AfDB for development results through the private sector. The current global and regional economic context, as well as changes in the methodology used by rating agencies’ call for the AfDB to become significantly more prudent, in order to preserve its AAA rating. The AfDB’s risk bearing capacity to finance this pipeline of capital-intensive transformational infrastructure and industrial projects in LICs is increasingly constrained.

3.6. Consolidating the ADF’s development results through the private sector: Prior co-financing experience between the ADF and AfDB has shown the challenge of synchronizing the deployment of financing from both windows given the different planning cycle of the public and private sectors, and particularly in countries with small ADF allocations. The use of funded instruments- in the case of loans and grants- does not optimize the catalytic potential of concessional resources. While existing ADF instruments continue to be relevant, this paper proposes to establish an additional instrument for the ADF to consolidate its development results through the private sector: the PSF, an instrument geared to catalyze additional private investment, by leveraging the capability of the private sector window of the AfDB to promote transformational infrastructure and industrial development projects in LICs.

Country Examples and Expected Demand

3.7. Potential demand for a Private Sector Facility can best be illustrated by two specific country examples: Cote D’Ivoire and Kenya.

3.8. Cote D’Ivoire: In 2012, the Bank approved two green-growth infrastructure projects in Cote D’Ivoire: the Henri Konan Bedie bridge and the Azito power clean energy expansion. The Government identified both projects as strategic priorities to be financed in partnership with the private sector. The combined cost of these two investments was just over UA 460 million and the AfDB’s contribution through its private sector window was UA 85 million, or 20% of the total investment. The Bank played the role of lead arranger for the bridge project by structuring the transaction with the Government and actively mobilizing co-financing. When completed, the bridge will alleviate costly downtown traffic congestion, save fuel by shortening the route for users, and reduce green-house gas emissions. With regards to the Azito power project, the Bank was a key co-financier under the mandate of the IFC. When completed, the expansion will increase the generation capacity of the power plant by 50% with no increase in fuel consumed. It will provide clean and reliable electricity for Cote D’Ivoire and its neighbors.

3.9. By financing these two projects, the AfDB almost reached its Performance Adjusted Capital Limit for Cote D’Ivoire and a special waiver from the Board was required. Although the AfDB has two new opportunities to finance transformational energy projects in Cote D’Ivoire, it will have to decline them unless it is able to reduce its exposure on the first two projects

13 or benefit from

additional capital allocation for the country. The proposed PSF could immediately participate in the project on a risk-sharing basis to enable the AfDB Group to finance four projects instead of two, for more investment into transformational projects with less public resources.

3.10. Case Study 2: Kenya On the other side of the continent, the AfDB Group is leading the structuring and financing of Lake Turkana Wind Power (LTWP) project in Kenya. Clean energy from the 300MW LTWP will address chronic power blackouts domestically and regionally through the regional grid by linking up to the NELSAP transmission project. The cost of LTWP is about UA 530 million. Although the Bank’s UA 95 million financing for this project is less than 20% of the total investment, it utilizes a significant amount of the Performance Adjusted Capital

13 The Bank is finalizing the sale of about 1/3 of its current exposure in the bridge project to another development partner. This should create sufficient headroom for a modest participation in one of the new power projects.

13

Limit of Kenya. The Bank is already planning to use external guarantees to reduce capital consumption and generate headroom for future lending activities

14. However, it will still have to

seek a waiver for the front loading of a significant portion of the risk limit for LTWP and for any future projects in Kenya. The PSF could be immediately deployed to enable the AfDB Group to support the LTWP project as well as other infrastructure and industrial development projects that are in the pipeline for Kenya.

3.11. The reduction of headroom for new PSO will undermine the ability of the AfDB Group to participate in further transformational investment in Kenya. It will also limit the capacity of the AfDB Group from partnering with Kenya’s private sector to invest in neighboring countries. The recent independent review of the Bank’s PSO encouraged the AfDB to pursue the practice of channeling its financing through institutions registered in lower-risk countries to reach higher risk countries such as fragile states. The Bank has been requested to provide financing to Kenyan financial intermediaries to accompany these institutions as they expand to serve more local enterprises across the East Africa region, including Southern Sudan. Yet, this opportunity to partner with a private intermediary to finance investments in fragile states will lapse unless the AfDB is able to share risks for Kenya investments.

3.12. Other Countries: The current global and regional economic context, as well as changes in the methodology used by rating agencies’ call for the AfDB to become significantly more prudent, in order to retain its AAA rating. The AfDB’s risk bearing capacity to finance its pipeline of capital-intensive transformational infrastructure and industrial projects in LICs is increasingly constrained. The cases of Cote D’Ivoire and Kenya illustrate a constraint that is even more acute in the fragile states. Currently there are 19 LICs where the lending headroom is less than UA 10 million per annum. For 7 countries, the Bank’s lending headroom is less than UA 5 million per annum. This is insufficient to finance even one infrastructure or industrial development project (even with the 3 year frontloading). The AfDB currently has a UA 3.1 billion pipeline of bankable and transformational infrastructure and industrial development PSO in LICs that it will decline for lack of risk bearing capacity (see Annex II on the pipeline).

3.13. Other financiers may theoretically be able to step in to fill a fragment of the financing gap, but none are better suited than the AfDB, by virtue of its African character, its Africa-focused mandate and its unique stakeholder benefit analysis methodology, to perform an honest broker role and to ensure an equitable spread of benefits between investors, communities and Governments. The AfDB Group has placed inclusivity and gradual transition to green growth at the core of its strategy 2013-2022 and this agenda permeates its approach to PSO. The PSF, if properly structured and resourced, could be deployed to enable the Bank to support these investments but more importantly to ensure that they are truly transformational for its RMCs. Examples of projects to be supported through the PSF

15 are presented in box 2 below.

14 In addition to the possibility of using a PSF guarantee for the Lake Turkana Wind Power project, the first ADF PRG is also being proposed to support the transmission line for the project.

15 These examples are indicative and submission for Board consideration would be subject to satisfactory due diligence and compliance with the Bank’s eligibility criteria and other policies for Private Sector Operation (PSO).

14

Box 2: Examples of Projects to be Supported by the PSF Facility

Infrastructure sector:

39MW run-of-river hydropower scheme in South Sudan: The project will initiate the development

of a domestic power generation sector that relies on an abundant and clean source that provides highly reliable power, necessary to fuel the green economic development of South Sudan.

89MW hydropower scheme in Sierra Leone: The green growth project will result in significantly

improved power generation capacity of this post-conflict country - thus resulting in a substantial drop in the cost of electricity and enhanced competitiveness.

369MW combined cycle natural gas-fired power plant in Côte d’Ivoire: The project will ensure a

reliable and affordable electricity supply for the country and the region to boost this post-crisis economy. It will promote more efficient energy production with the combined cycle feature of the plant thereby reducing CO2 emissions and promoting green growth.

Industrial and agriculture projects:

Greenfield cement plant in Democratic Republic of the Congo: This inclusive growth project is a

cost competitive import substitution project, which will support the economic efficiency of infrastructure investment by reducing input costs and shortening implementation times. The project will create up to 10,000 jobs during construction and operation and enable USD 150 million annual savings for the Government.

Rice import substitution project in Guinea: This inclusive growth project will create 50,800 new

jobs. The project includes an out-grower scheme, which will ultimately target 1,800 rice farmers. The project will allocate 5% of its gross profits to community health and education services.

4,000ha greenfield commercial farms in Senegal: The project will enhance food security by

expanding domestic production of basic cereals, and stimulate growth, employment and entrepreneurship in rural areas. The project promote inclusive growth by allocating a 3% ownership stake in each farm to local agricultural cooperatives and by establishing a vehicle to mobilize farm training and contribute seed capital to local SMEs in the agricultural value chain.

Financial intermediation projects:

Greenfield West African financial intermediary focused on agriculture: This new financial

intermediary will target an inclusive growth agriculture investment portfolio of USD 135 million. It will aim to support agriculture value chain integration and food security by improving access to finance and technical assistance for farmers and agribusinesses to diversify and process agriculture products, thus supporting local value addition in the agriculture sector.

Partnership with a Kenyan Bank seeking to expand its activities in South Sudan: This financial

intermediation project will contribute to strengthening the banking sector in this post-conflict country, where the financial system is severely underdeveloped. It will offer inclusive financial services for households and Micro-Small and Medium Enterprises.

Features of the Private Sector Facility

3.14. The main features of the proposed Facility are examined from four perspectives: 1) Structure of the Facility; 2) the principal terms; 3) the implementation arrangements; and 4) the financing plan. In developing these features, Management has considered the credit-enhancement instruments/facilities established by other Multilateral Development Banks (MDBs) to enable them to play a significant transformational role through the private sector, in riskier countries than their AAA rating would otherwise permit (Annex V presents a sample of MDB leveraged credit enhancement structures using concessional financing).

3.15. A separate and autonomous structure: The PSF will be established as a separate and autonomous legal entity from the Bank and the Fund, and will have its own governance rules and procedures. The creation of the PSF will build on the organizational structure of the Post-Conflict Country Facility implemented in 2004 by the AfDB Group for arrears clearance programs. In compliance with Article 31 of the ADF Agreement on the separation of resources between the AfDB and the ADF, it will maintain an explicit arms-length relationship between the ADF and the AfDB.

15

3.16. Instrument: The PSF will be a special purpose vehicle offering credit enhancement to a portfolio of transformational transactions in LICs. This portfolio of covered transactions would be built up over time. For the purpose of illustrating the Facility’s modalities, the following section assumes that the Facility is implemented as a credit enhancement mechanism. In order to maximize its leverage, the credit enhancement will be structured in form of guarantee on a portion of the Loss Given Default (LGD) incurred by AfDB in a specific transaction. As a separate and autonomous entity, its credit enhancement capacity will be backed by the liquidity of a reserve pool. The reserve pool therefore will require an adequate seed contribution to cover potential losses.

3.17. Eligibility: Eligible operations would need to demonstrate that they are 1) aligned with the beneficiary country’s development priorities as well as the policies and strategies of the AfDB Group, 2) commercially viable and have a high probability of being able to repay their debts and achieve expected returns, 3) expected to generate strong development outcomes, and 4) will have adequate additionality.

3.18. Amount of Risk Participation: The basic premise of the structure of the PSF is that it should be additional to the exposure which the Bank would take using its own risk capital. In other words, the leverage effect of the PSF reflects only the incremental amount of lending which the AfDB Group finances with the guarantee relative to the amount that it would be able to finance without the guarantee. The amount of risk shared by the Facility and the AfDB would generally vary from 1/3 of AfDB’s LGD on the guaranteed transactions to as much as 2/3 of LGD

16, up to

a cap of UA 60 million of exposure per transaction. The specific amount of risk shared between the AfDB and the Facility would be determined depending on the financing needed to successfully facilitate the operation, the willingness and capacity of the Government to support the transaction by contributing to an additional credit enhancement from its PBA and the AfDB’s country risk headroom.

3.19. Operationalization of the Facility: The PSF will be operationalized under a general framework agreement to be developed building on the precedent of the approach taken for the Post-Conflict Country Facility (PCCF) and to incorporate the lessons from the practice of other MDBs that have established similar facilities (notably the EBRD and the EIB). One of the main goals of this framework would also consist in maximizing the leverage achievable to ensure the most efficient use of the PSF resources. The Boards of Directors of the ADF and the AfDB will be invited to approve the general framework and operational processes and procedures of the PSF.

3.20. Project Origination, Management and Reporting: The AfDB would originate investments that are eligible for cover by the Facility following its approved selection criteria and standard credit approval process. Because it retains risk, the Bank would apply the same rigor appraising PSO with a credit enhancement from the Facility as it does for PSO where it assumes all of the risk, both in terms of credit risk (because it shares faces losses simultaneously unlike first loss structures) and in terms of development outcomes and additionality. The AfDB Group would manage the projects covered by the Facility following its standard project management process until full repayment of any outstanding facilities. The AfDB Group would provide to the ADF and other voluntary bilateral donors an annual report on all project covered under the Facility.

3.21. Workout and Claims Process: In the event of difficulty on the underlying AfDB PSO, the AfDB would be responsible for managing the rehabilitation and workout process. For operations that cannot be rehabilitated, the AfDB would also be responsible for managing the asset recovery process. In the event that rehabilitation is terminated and a recovery process is initiated, the AfDB would file a claim to the Facility for the pro-rata share of the transaction’s LGD. On demand, the Facility would pay to the AfDB any eligible claims covered. When the recovery process is completed, the AfDB would settle any surplus on the claim with the Facility.

16 Specifically in cases where the Bank’s headroom for the country is particularly limited.

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Financial Considerations

3.22. Financing Plan: The PSF would only disburse in the event of a valid claim against the guarantee. The expected level of claims on the Facility would be the level agreed upon ex ante, expressed as a percentage of the transaction’s LGD. Because most private sector transactions in LICs are rated as high or very high risk, it would therefore be prudent for the Facility to maintain adequate reserves to cover the outstanding guarantees. The adequacy of coverage would be estimated based on transactions’ LGD and the probability that the guarantee would be called during the overall life of the guaranteed transaction (See Annex IV: Leverage and Multiplier of the PSF). In order to comply with the target guarantee to reserves ratio, the Facility will maintain a dedicated pool of reserves to cover potential claims on all outstanding guarantee. For each new PCG issued by the Facility, an additional amount of reserves required for the guarantee will be added to the guarantee reserve pool. Reserves would remain in the pool even if they are not needed to meet claims. By “mutualizing” risk, the pooling of reserves provides additional protection for the Facility in the event of a claim. As the portfolio of transactions covered grows, so does the ability of the Facility to self-sustain any losses that may arise from default events.

3.23. Sources of Reserves for the Facility: The reserves needed for the private sector Facility will come from four types of sources: a seed contribution from the ADF, 2) Country PBA and other top-up facilities, 3) voluntary bilateral contributions, 4) Guarantee Fee.

Figure 2 : Sources of Reserve for the Facility

ADF seed contribution: In order to catalyze the use of Facility, a seed contribution amounting to UA 165 million is proposed, through a distinct earmarking under ADF-13. The net effect of this set aside, in terms of resources available for more mainstream ADF operations, would be off-set by the leverage effect expected to be achieved, in terms of the additional investment mobilized.

PBA and other ADF top-up facilities: The second source of reserves for the Facility would be the country’s ADF Performance Based Allocation (PBA). Reserves from a country’s PBA would be added to the PSF guarantee reserve pool on voluntary basis, and subject to standard ADF approval procedures. The host country would have to agree with the use of its PBA as reserves for the PSF. For some countries the PBA is insufficient to meet the reserve requirements for a PSF Guarantee. In such cases countries may be eligible for “topping up” from two possible top-up sources: 1) regional integration envelope; 2) the supplemental pillar of the FSF.

Bilateral donors: Bilateral donors will be invited to contribute to the PSF to support private sectors in LICs. Donor contributions would be in the form of grants. Some donors have signaled strong appetite for promoting private sector investment in LICs and would be

17

invited to complement their ADF-13 contributions through bilateral contributions. In addition, the Facility could also procure additional cover from commercial and public guarantee providers.

Guarantee Fees: The AfDB would pass through to the Facility its pro-rata share of the risk premium earned on the underlying AfDB PSO. As the Facility will be seeded with a grant contribution from the ADF, all fees earned would be retained by the Facility.

Advantages of the PSF

3.24. Catalytic Effect: One of the principal challenges facing most LICs is how to mobilize the massive resources needed to finance critical infrastructure and industrial development. The proposed PSF excels precisely because of its strong leverage and multiplier effect to catalyze additional financing. Annex IV elaborates the basic parameters of the model developed to estimate and calibrate the leverage effect for the Facility. Figure 3 schematically illustrates the catalytic effect of the proposed PSF guarantee as a simple two-steps calculation. First, for every UA 1 million of PSF guarantee, AfDB will be able to take on its own balance sheet an additional total of UA 4 million of PSO. Second, assuming the Bank will have either an arranger mandate or perform an anchor investor role, the transaction financing of UA 4 million would result in a total additional investment of UA 20 million

17 on the ground.

Figure 3 : Catalytic effect of the PSF

17 Assuming that the Bank will finance on average 15 to 20% of the transaction, resulting in a multiplier of 5.

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3.25. Development Results: By seeding a Facility that will participate in the risks of PSO with the AfDB, the ADF will catalyze tremendous development outcomes. The types of expected results from the PSO pipeline are in line with AfDB Group

18 indicators, and include among others jobs

created (notably for women), tax generated and foreign exchange savings, and Micro-Small and Medium Enterprises supported. Key project outputs will positively impact ADF countries through more competitive infrastructure, improved macro-economic performance, enhanced food security, domestic value addition and import substitution, and by providing economic opportunities for African entrepreneurs and job-seekers. The application of the ADOA framework as a filter for approving new PSO ensures that projects supported are transformational.

3.26. Speed of Implementation: The key constraint to rapid deployment of a new instrument is the robustness of its pipeline of operations. For the proposed PSF, the pipeline would be the AfDB’s pipeline of transformational PSO meeting agreed upon eligibility criteria. Approximately UA 3.1 billion of the current PSO pipeline is for operations in LICs, of which approximately 1/2 are PSO which stand to be eligible for the PSF cover. Given the robustness of the current pipeline, there are clear opportunities to quickly deploy ADF resources through the proposed PSF.

3.27. Cost of Administration: Deputies are also concerned by the potential additional cost of administering new instruments and programs. The proposed PSF would be implemented by the existing origination and portfolio management capacities of the AfDB Group and would not require additional operational resources. The additional cost of appraising and managing a portfolio of AfDB PSO eligible for coverage under the PSF would be negligible. The only significant incremental cost would be up-front expenses to create the new Facility and prepare the legal templates and enforceable agreements.

Managing the Risks of the PSF

3.28. Legal Compliance: A potential concern arising from the ADF potentially sharing part of the risk on underlying PSO financed by the AfDB is the issue of legal compliance within the various entities of the AfDB Group. Thus in order to maintain an arms-length relationship between the ADF and the AfDB, the PSF will be a ring-fenced facility to which the Fund would provide a seed contribution in the form of a grant. These ring-fenced resources will then be used to provide credit enhancements to private sector projects in LICs in compliance with Article 31 of the ADF Agreement which requires the separation of resources between the AfDB and the ADF. The Bank will not have any control over the PSF. The absence of direct transactions between the AfDB and the ADF would also address potential concerns of consolidation of financial statements.

3.29. Moral hazard: A potential concern arising from the PSF is that it might lead to weaker credit standards (moral hazard) on the part of the Bank. This risk will be adequately mitigated in several ways. First, the “pro-rata” risk sharing structure whereby the AfDB retains a pro-rata share of any losses arising from the underlying PSO ensures the Bank has a strong financial incentive to maintain its rigorous due diligence standards. Second, the AfDB is responsible for rehabilitation and recovery and has a strong incentive to optimize the outcomes that also fully align with the financial interests of both the AfDB and the Facility. Third, pass through of a share of the risk premium to the Facility on the covered portion of the underlying AfDB PSO ensures the Facility is compensated equally as the Bank for the risks it assumes.

3.30. Excess Losses: The proposed PSF is a leveraged financial instrument that technically creates a contingent liability for the Facility that is higher than its level of reserves. Therefore, in extreme circumstances, it is theoretically possible that claims on the underlying AfDB PSO could exceed the level of reserves in the Facility for an individual guarantee. Although unlikely based on the experience of sister institutions that have already experimented with similar structures, this risk can be mitigated in two main ways. First, the proposed seed contribution provides an initial buffer against PSF commitments. Second, as the Facility issues more guarantees the portfolio-level risks will be progressively diversified, assuming a low correlation between guaranteed

18 The Bank established the “ADOA” framework for ex-ante assessment of PSO development outcomes and additionality. The ADOA assessments are made by the chief economist’s complex and link to the Bank’s results reporting system.

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individual transactions and the accumulated reserves in the guarantee reserve pool will create a comfortable buffer against commitments across the guaranteed portfolio.

3.31. AfDB’s Credit Rating: Credit rating agencies may be concerned about the effectiveness of the risk transfer mechanism on the covered portion of the AfDB PSO. The rating agencies will also be concerned about the ability and willingness of the Facility to pay any valid claims on the guarantee. These concerns can be fully mitigated. Maintaining an adequate level of reserves in the PSF reserve pool will be the first line of defense. Equally important is the robustness of the AfDB’s workout and recovery mechanisms that are currently being strengthened. In the event that there are claims on the PSF, the pay-out procedures to the AfDB will be expediently handled.

3.32. Country Debt Sustainability: Ensuring the long-term sustainability of the sovereign debt in ADF countries is a shared objective. Any new instrument needs to be evaluated against the potential impact on the debt sustainability of ADF countries. The proposed PSF would have a positive overall impact on country-level debt sustainability as the underlying AfDB PSO is replacing a project that would otherwise be primarily financed by the public sector.

3.33. Idle Resources: ADF donor countries are facing fiscal constraints. Therefore it is important that new instruments can be implemented quickly and if deployment is too slow, resources ear-marked for the new instruments must be easily redeployed to other priorities. The risk of ending up with idle ADF resources will be mitigated by maintaining a robust pipeline of AfDB PSO in LICs.

Conclusions and recommendations for the PSF

3.34. Facing the risk of losing the hard-won gains from a decade of sustained growth, Africa’s LICs urgently need to make massive investments in economic infrastructure. Although traditional sources of financing are no longer able to keep pace, the good news is that the private sector is increasingly ready to design, build, operate and finance the needed investments; and the financial markets are showing a growing appetite for sovereign exposure in the continent. The AfDB Group has responded to these important trends to become a trusted development partner for African governments looking to attract private investment and financing. The operational focus of the ADF is evolving and over the last two cycles it has increasingly been mobilized as a PSD-enabling and PSO co-financing instrument for the AfDB Group.

3.35. The proposed PSF is intended to provide an efficient and direct vehicle for the ADF to partner with the AfDB in the financing of transformational private sector projects and enterprises, for development results. The Facility is an effective and efficient way for the ADF to scale up private sector investments in ADF countries. It is highly catalytic: the proposed seed capital of UA 165 million as an ADF grant to the Facility could catalyze a total of UA 3.3 billion of private sector investment (UA 660 million from AfDB and UA 2.64 billion from other financiers). A number of risks to achieving the desired results have been identified along with the appropriate mitigation measures. The robust PSO pipeline in LICs, presents excellent prospects for swift and significant development impacts with limited additional administrative cost.

3.36. Deputies are invited to:

Approve the proposal to introduce the PSF as an additional instrument for the ADF to catalyze transformational investment in LICs, working through the private sector for development results;

Approve the seeding of the PSF on a pilot basis with a contribution of UA 165 million (for the ADF 13 cycle); and

Authorize Management to take all steps necessary to prepare for the proper implementation of the new Facility, including the Agreement establishing the Facility and the Framework Agreement between the Facility and AfDB, for approval by the ADF and AfDB Boards.

4. Africa50Fund

4.1. On the basis of the brief description in the executive summary and the attached concept note in Annex –VI, Deputies are invited to provide guidance on the proposal to invest a significant portion of the Regional Operations envelope in the equity of the Africa50Fund.

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Annex I: Update on the Implementation of the ADF Partial Risk Guarantees (PRG)

Africa’s acute infrastructure deficit, especially in ADF countries, cannot be filled by public sector investment and requires significant private sector investment. As country risks often deter private investors there is a clear requirement for risk mitigation instruments that provide investors with comfort. As an instrument that requires a customized application, covering political risks, the PRG can potentially be deployed in all infrastructure and real economy sectors. In rolling out its PRG program, the AfDB Group has particularly targeted the energy sector, in response to country demand.

In the energy sector, RMCs recognize the need for private investors such as independent power producers (IPPs) to help bridge the energy deficit, and there is significant private sector interest in the sector. However, the public sector players, such as utilities and transmission companies are often financially or technically weak which impacts the bankability of project-related agreements, e.g. power purchase agreements (PPAs), gas supply agreements etc. Strengthening the credibility and bankability of these agreements require some form of credit enhancement, notably guarantees. The RMCs’ fiscal constraints make it both difficult and sub-optimal for the government to provide blanket guarantees (for instance for PPAs between utilities and IPPs), and this is where the PRG provides significant additionality.

The PRG instrument, introduced in ADF-12 on a pilot basis to catalyze private investments, covers risks related to the ability of a government or a state-owned entity to honor its contractual undertakings to private sector investors. Such risks include political force majeure, currency inconvertibility, expropriation and various forms of breach of contract.

Subsequent to the approval by the ADF’s Board of Directors of the ADF PRG Strategic Framework and Operational Guidelines, in 2011, roll-out of the instrument has led to:

The constitution of the Bank’s ADF PRG Energy Task Force to identify, prepare and support the implementation of projects. The Task Force includes focal points from the energy, legal, private sector operations, treasury and environment & social and teams.

Training sessions to familiarize staff with the new instrument.

Focused business development through missions, meeting and outreach with not only RMCs but also private sector investors and lenders.

Dialogue with development partners such as the Multilateral Investment Guarantee Agency, the US Overseas Private Investment Corporation and USAID for potential cooperation on guarantees. The US Government’s Power Africa Initiative has identified the need for guarantees and recently expressed interest in working with the Bank to set up a Partial Risk Guarantee Facility that will top up/co-guarantee with the existing ADF PRG instrument. Discussions are underway to further develop the idea.

The Bank’s efforts to introduce the product have borne fruit as evidenced by the robust pipeline of

opportunities, spanning Kenya, Nigeria, Ghana, Tanzania, Ethiopia and Mozambique, which amounts

to well over UA 500 million. Future activities involve fragile states19

both at the national level and at the

regional level, including large-scale projects such as the Inga III Hydro Power Project.

Considering the volume of the PRG requirements, the relatively low Performance Based Allocation

(PBA) allocations of fragile states, and Management’s desire to offer fragile states a more flexible use

of resources, it is envisaged that under the Thirteenth General Replenishment of the African

Development Fund (ADF-13), countries eligible for support from the Fragile States Facility (Pillar I)

would be able to increase their participation in PRGs by tapping into their Pillar I allocations – as for

traditional investment loan/grant operations.

19 As envisaged at the outset of ADF-12, paragraph 3.29 of the ADF-12 Deputies Report states “the Fund should introduce the partial risk guarantee (PRG) instrument in ADF-12 on a pilot basis to leverage additional resources from the private sector and other co-financiers for ADF countries, including fragile states”.

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In the case of multi-country20

ADF operations where a PRG could usefully be employed instead of or

in complement to a traditional investment loan/grant, PRGs could benefit from the additional leverage

effect of the Regional Operations envelope to provide more incentive for participating countries

(subject to the annual Regional Operations Selection and Prioritization process).

The significant volume of opportunities – including the EUR 20m PRG in Kenya that is being

processed and the USD 440 million request from the Nigerian Government – clearly demonstrates that

the pilot phase of the PRG is drawing to a close with the end of ADF-12 and the PRG is set to be a

mainstream offering during ADF-13. However, the current ceiling of UA 200 million (~USD 300 million)

for PRGs is expected to hinder the full-scale mainstreaming and scaling-up of the instrument. Hence,

there is a need to review the ceiling so that the PRG instrument and the proposed PCG instrument

share a combined ceiling of UA 500 million.

20 In the case of multi-country operations, say, an IPP serving two utilities, it is envisaged that there will be two country specific PPAs and corresponding PRGs and hence a default by one utility will be resolved with concerned country without impacting the other utility or country.

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Table I-1: PRG Pipeline Overview

Country Opportunities Project Size Status

Kenya

Transmission line required for the 300 MW Lake Turkana Wind Power Project – the largest wind power project in Africa.

€ 20m PRG Bank is currently processing the operation

Menengai Geothermal Power Project requires PRGs to cover steam supply and off-taker payment risks.

400 MW Discussion ongoing with Kenya’s Geothermal Development Company

Kipeto Wind Power Project, in Marsabit, where GE Capital is providing initial development capital, requires risk mitigation for off-taker payment risk.

100 MW

Preliminary contact

Aeolus Wind Power Project requires risk mitigation for off-taker payment risk. 60 MW

Preliminary contact

Nigeria

Greenfield Okija Power Project, where the Bank is acting as the lead arranger. 495 MW

$ 140 m PRG

Bank, in consultation with Nigeria’s Bulk Electricity Trading Company, is developing a programmatic arrangement (up to ~ USD 440 m) to cover the off-taker payment risk

Greenfield Ikot Abasi Gas-fired Power Project 250 MW

$ 140 m PRG

Recently-privatized Ughelli Gas-fired Power Plant 972 MW

$ 102 m PRG

Recently-privatized Shiroro Hydro Power Plant 600 MW

$ 62 m PRG

Privatization of 10 new gas-fired power plants under the aegis of Nigeria’s National Integrated Power Plan: Alaoji Generation Co. , near Aba, Abia State Benin Generation Co., near Benin, Edo State Calabar Generation Co. , near Calabar, Cross River State Egbema Generation Co., near Owerri, Imo State Gbarain Generation Co., near Yenagoa, in Bayelsa State Geregu Generation Co., in Ajaokuta, Kogi State Ogorode Generation Co., near Sapele, Delta State Olorunsogo Generation Co., in Olorunsogo, Ogun State Omoku Generation Co., near Port Harcourt, Rivers State Omotosho Generation Co., in Okitipupa, Ondo State

831 MW 508 MW 635 MW 381 MW 254 MW 506 MW 508 MW 754 MW 265 MW 513 MW

Preliminary discussion

Ghana Cenpower Kpone Gas-fired Power Project is looking into risk mitigation options for fuel supply and off-taker payment risks.

340 MW Preliminary discussion

Tanzania

Ruhudji Hydro Power Project – being developed by Aldwych/PAIDF and Sithe Global – requires risk mitigation for off-taker payment.

360 - 480 MW Bank is in the process of assisting the Government of Tanzania with restoring the financial condition of Tanesco, the power utility, which will require a combination of financial instruments, including PRGs for specific projects

Kinyerezi IPP, where US Export Import Bank is providing equipment finance support, has potential for a PRG in lieu of a sovereign guarantee for the PPA from the Government of Tanzania.

150 MW

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Country Opportunities Project Size Status

Ethiopia Corbetti Geothermal Project, in the main Ethiopian rift valley, close to the Awasa Lake and Shala Lake, which is being developed by Sithe Global and Reykjavik Geothermal.

300 MW Preliminary contact

Mozambique PRGs to crowd-in investments in the context of the development of the gas and power sector. Preliminary discussion

Regional Ruzizi III Hydro Power Project, on the Ruzizi River, between Rwanda and the DRC, which Sithe Global and IPS will develop as an IPP to supply Rwanda, DRC, and Burundi will require 3 PRGs to cover the PPAs with EWSA (Rwanda), Regideso (Burundi) and SNEL (DRC).

147 MW Preliminary discussion

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Annex II: Criteria for selecting innovative financing products

Innovative Financing Product

Ease of implementation

and limited admin cost

Limited Set

aside Demand

Leverage and

financial impact

Ranking Comments

Partial Credit Guarantee

Very Strong Strong Strong Strong 1

Very strong appetite from Deputies and strong demand. However concerns on moral hazard and on Debt Sustainability need to be addressed.

Default Loss Portfolio Guarantee (now Private Sector Facility)

Medium Strong Strong Very

Strong 2

Strong appetite from Deputies and high potential impact for low Income Countries (LICs). However concerns on legal issues need to be addressed when structuring the product.

Private Sector Matching Fund

Strong Low Very

Strong Very

Strong 3

Limited appetite from Deputies due to significant required set aside. Can be implemented through the current PBA framework with countries using their allocation

Modified Framework for Assistance to Creditworthy Countries

Medium Strong Low Strong 4

Strong appetite from Deputies but limited current demand given the low number of blend countries (limited financial impact) and strong concerns on legal issues.

Loan Buy Down

Medium Very

Strong Low Strong 5

Low identified demand and Admin cost could be high. High risk of earmarking. Request for this facility will be implemented on a case by case basis.

DFI facility Strong Low Strong Strong 6

Limited appetite from Deputies due to significant required set aside. Can be implemented in the current framework by extending PRG to DFI

Based on the criterion, two products were selected to be further developed and discussed during the ADF-13 replenishment meeting. These products are: i) Partial Credit Guarantee (PCG), and ii) Private Sector Facility. Out of six innovative financing products presented during the first ADF-13 replenishment meeting, four have not been selected for further development. However, it should be noted that some of these can be used within the current PBA framework.

Modified Framework for Assistance to Creditworthy Countries: The Fund’s allocation for blend and graduating countries is provided by the AfDB, while ADF compensates the interest differential to maintain the ADF blend concessionality. Deputies’ appetite for this product was strong as it involves more synergy between ADF and AfDB, and optimizes use of the scarce resources of the Fund. However, its financial impact is limited to the few blend countries and concerns were shared regarding its effects on ADF providing subsidies to AfDB loans. As several countries are projected to be graduated during the ADF cycle, the Modified Framework for Assistance to Creditworthy Countries would be a very useful tool for managing ADF resources starting ADF-14.

The Private Sector Matching Fund: The Private Sector Matching Fund will enhance the development of public-private partnerships projects in LICs. However, there was limited appetite from Deputies due to significant required set aside (UA 300 million). Some deputies wondered on the potential of certain Fragile States to benefit from it because they might need Technical Assistance. In addition the product can be implemented through the current PBA framework with countries using their allocation.

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ADF Loan Buy-Down: ADF Loan Buy-Down, which gives the possibility to Donors and other parties to prepay ADF loans, freeing up resources to be reinvested in new projects. There is a low identified demand for the product and Administrative cost could be high through coordination, promotion, deployment and reporting as it involved multiple parties. As nothing prevents the product to be implemented through the current framework, request for this facility will be implemented on a case by case basis.

DFI facility: DFI facility provides Partial Risk Guarantees to Development Financial Institutions, or loans to Low Income Countries for equity financing in Regional DFIs. There was a limited appetite from Deputies due to significant required set aside (UA 300 million). The deputies perceived the products as a way of bailing out the DFI without any kind of supervision of those Institutions. In addition the product can be implemented in the current framework by extending PRG to DFI and the countries using their PBA for equity participation in DFI.

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Annex III: Indicative pipeline for the Private Sector Facility (PSF)

Project name Country Region Instrument Risk

Rating

Total Investment UA million

AfDB Financing UA million

Power generation Benin West Senior Loan 5 65.0 17.3

ICT project Burkina

Faso West Senior Loan 6 69.3 13.2

Mid-size enterprise finance

Burkina Faso

West Senior Loan 5 39.6 10.6

SME finance Burkina

Faso West LOC 5 45.9 7.8

Waste to energy generation

Cameroon Central Senior Loan 6 322.4 69.3

Mid-size enterprise finance

Cameroon Central LOC 5 86.7 17.3

Power generation Cote

D'Ivoire West Senior Loan 6 244.4 43.3

Desalinization plant Djibouti East Senior Loan 5 42.2 13.9

Cement plant DRC Central Senior Loan 6 132.0 19.8

Potash mine and plant Ethiopia East Senior Loan 4 528.1 66.0

Steel plant Ethiopia East Senior Loan 4 522.8 33.0

Trade finance Ghana West TF LOC 4 99.0 16.5

Salt production Ghana West Senior Loan 5 28.7 6.9

Power generation Ghana West Senior Loan 4 396.1 33.0

Highway Ghana West Senior Loan 4 477.3 66.0

Waste to energy generation

Ghana West Mezz Loan 5 95.1 26.4

Rice farming Guinea West Senior Loan 6 39.6 13.2

Renewable energy Kenya East Senior Loan 5 520.0 78.0

Renewable energy Kenya East Mezzanine Loan 5 - 8.7

Renewable energy Kenya East EKF covered

Loan 1 - 8.7

Mid-size enterprise finance

Kenya East LOC 6 66.0 16.5

Agriculture project Liberia West Senior Loan 6 135.3 13.2

Trade finance Mauritania North TF LOC 4 39.6 9.9

Forestry project Mozambique South Senior Loan 6 87.1 19.8

SME finance Niger Central LOC 5 30.0 11.2

Fertilizer plant Nigeria West Senior Loan 4 780.8 65.1

Microfinance Nigeria West Equity 6 2.6 0.3

Regional port Nigeria West Senior Loan 5 792.2 66.0

Mid-size enterprise finance

Nigeria West LOC 4 99.0 49.5

Agriculture project Nigeria West Senior Loan 5 140.6 19.8

Fertilizer plant Nigeria West Senior Loan 5 1,815.4 66.0

Urban transport Nigeria West Senior Loan 5 165.0 29.7

Urban transport Nigeria West Sub Loan 6 - 9.9

Power generation Nigeria West Senior Loan 3 644.8 86.7

Power generation Nigeria West Senior Loan 3 476.7 65.0

Green financing Nigeria West LOC 3 244.3 49.5

Green financing Nigeria West LOC 3 231.0 49.5

Power generation RCI West Senior Loan 5 347.2 33.0

Cereal farming Senegal West Senior Loan 5 30.3 8.7

Urban transport Senegal West Senior Loan 5 102.3 5.2

Renewable energy Senegal West Senior Loan 4 151.8 33.0

Renewable energy Sierra Leone West Senior Loan 6 363.1 99.0

Renewable energy South Sudan

East Senior Loan 7 94.4 13.2

Sugar refinery Sudan East Senior Loan 6 84.5 23.1

Sugar refinery Tanzania East Senior Loan 5 291.8 33.0

Mid-size enterprise finance

Tanzania East LOC 4 165.0 39.6

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Project name Country Region Instrument Risk

Rating

Total Investment UA million

AfDB Financing UA million

Microfinance Tanzania East Equity 6 0.9 0.3

Power generation Togo West Senior Loan 6 40.7 10.4

Renewable energy Zambia South Senior Loan 4 637.9 86.7

Power generation Zambia South Senior Loan 4 429.1 52.8

Power generation Zambia South Mezz Loan 4 - 9.9

Renewable energy Regional Central Senior Loan 6 297.1 66.0

Mid-size enterprise finance

Regional Central LOC 3 1,333.4 86.7

Regional DFI Regional East Equity 6 239.4 15.6

Insurance Regional East Loan 5 7.9 6.6

Oil and gas Regional East Equity Fund 5 329.5 16.5

Agriculture project Regional East Senior Loan 4 178.2 49.5

Regional DFI Regional East Equity 4 118.8 13.2

Regional DFI Regional East LOC 4 594.1 33.0

Insurance Regional East Equity Fund 5 66.0 5.3

SME finance Regional East Sub-debt 5 39.6 6.6

Trade finance Regional North RPA 3 792.2 66.0

Mid-size enterprise finance

Regional North LOC 3 264.1 66.0

Trade finance Regional North RPA 3 792.2 66.0

Trade finance Regional South TF RPA 3 1,557.1 129.8

Trade finance Regional South RPA 4 792.2 66.0

Insurance Regional South Equity 5 198.0 16.5

Financial infrastructure Regional South Equity 4 66.0 7.6

Mid-size enterprise finance

Regional South LOC 4 132.0 19.8

MSME finance Regional South LOC 5 660.1 82.5

SME investments Regional South Equity Fund 5 99.0 9.9

Power transmission Regional South Senior Loan 5 660.1 198.0

SME investment Regional South Equity Fund 5 46.2 9.9

Mid-size enterprise finance

Regional South LOC 2 343.3 99.0

Trade finance Regional South RPA 2 - 33.0

SME finance Regional South LOC 4 33.0 13.2

Mid-size enterprise finance

Regional South Loan 5 346.7 34.7

Trade finance Regional West TF RPA 5 778.5 64.9

Trade finance Regional West TF LOC 5 389.3 64.9

Agriculture finance Regional West Senior Loan 5 198.0 52.8

Energy investments Regional West Equity Fund 5 99.0 17.5

Infrastructure investments

Regional West Equity Fund 5 165.0 13.2

ICT project Regional West Senior Loan 5 481.9 6.6

ICT project Regional West Mezzanine 6 - 6.6

Large enterprises Regional West Equity Fund 5 330.1 16.5

Agriculture finance Regional West LOC 5 99.0 6.6

Agriculture finance Regional West Equity 5 - 3.3

SME investments Regional West Equity Fund 5 66.0 6.6

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Annex IV: Leverage and multiplier of the PSF

To define the leverage effect of the Facility, a model was developed on the basis of the capital adequacy framework of the AfDB. The basic premise of the model is that the PSF should be additional to the exposure which the Bank would take using its own risk capital. In other words, the leverage effect reflects only the incremental amount of lending which the AfDB Group finances with the guarantee relative to the amount that it would be able to finance without the guarantee. The AfDB’s capital adequacy framework of the AfDB determines the amount of risk capital that set-aside to backstop each financing transaction, on the basis of:

the risk rating and collateral strength of the project (which affects the expected loss or Loss Given Default (LGD) - of the transaction)

the Bank’s Performance Adjusted Capital Limit for the country (lending limit).

The risk rating of a project is determined on the basis of the risks intrinsic to the project and the country risk rating (which acts as a ceiling for private sector projects transactions’ ratings). The risk rating defines its default probability. The collateral strength of the project defines the transaction’s LGD. The risk capital charge depends on these two parameters as per the Bank’s capital adequacy framework and Basel II – IRB advanced approach.

AfDB financing without the PSF The parameters of the model have been set and applied to estimate leverage effect for transactions of different risk profiles starting with a particularly high risk transaction from 6+ to 5 to test its effectiveness even in high risk countries. This first example applies the model to a notional UA100 million transaction with a risk rating of 6+ and adequate collateral coverage translating into a LGD of 45%. The amount of risk capital necessary to cover the UA 100 million of lending is equal to the exposure multiplied by the risk charge attached to the transaction (59% in this case). In other words, without the PSF, UA 59 million of risk capital would be set aside for the Bank to finance a transaction of UA 100 million.

Incremental financing feasible with the PSF The guarantee will be structured in form of a guarantee on a portion of the LGD incurred by AfDB in a specific transaction. With a PSF guarantee of 50% of the LGD, the amount of reserves necessary to cover the PSF’s commitment toward the AfDB is equivalent to the commitment of the PSF multiplied by the probability of a default of the underlying transaction over its life time, triggering a call on the guarantee. With 50% of the LGD covered under the PSF, its commitment is equivalent to 22.5% of the transaction amount, translating into reserve requirement of 19.2% (i.e. 85.2% * 22.5%) where 85.2% is the Probability of default. The capital relief obtained by the AfDB as a result of the guarantee is equivalent to 50% of the risk capital utilization of the transaction with no guarantee. As a result of the PSF participation in the transaction, the AfDB can lend an additional UA 50 million with the UA 29.6 million of capital relief. This brings the total amount of AfDB Group financing to UA 150 million.

Risk charge - AfDB Alone

Amount of the transaction 100

Rating of the transaction 6+

Collateral Strength Moderate

LGD of the transaction 45%

Probability of default 85%

Risk Charge 59%

AfDB Necessary Risk Capital without Guarantee

59.2

Risk charge AfDB and PSF

AfDB With the

PSF guarantee

Risk Charge 59% 29.5%

AfDB Necessary Risk Capital

59.2 29.6

Capital Relief 29.6

PSF Reserves (%) 19.2%*

PSF Reserves (UA million) 19.2

* Amount of reserves of the PSF = 50% of (AfDB LGD * PD)

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Leverage and multiplier of the PSF The leverage of the guarantee results from the incremental financing feasible with the guarantee. In the case of a transaction rated 6+ with moderate collateral the leverage effect of the PSF would be that for every UA 1 million of PSF guarantee, the Bank could finance an additional UA 2.6 million of project (i.e. UA 50 million of additional financing / UA 19.2 million of PSF reserves). In turn, assuming that the Bank will finance on average 20% of a transaction, resulting in a multiplier every UA 1 of PSF guarantee, would result in UA 13 million of additional project investment on the ground.

Calibrating the leverage to reflect the risk profile of the current Private Sector Operation (PSO) pipeline The above model achieves different levels of leverage depending on the risk rating of each project (from 2.2 X for a project rated 7 to X 10.3 for a project rated 3). Not all projects in the LIC pipeline are high risk projects, but the Bank’s ability to support them may nonetheless be limited by country-specific headroom constraints. To determine the likely leverage of the Facility for the current pipeline of PSO projects, a two-step process was undertaken: The risk distribution of the pipeline was determined (share of the volume of the pipeline in each risk category);

The weighted leverage effect of the Facility was then calculated as the leverage factor relative to the share of the pipeline in each rating category.

Applied to the current pipeline of PSO projects, the leverage effect expected is equivalent to 5.06 X.

Calibrating the leverage to a riskier pipeline While all transactions in LICs would be potentially eligible to the PSF cover, not all transactions would necessarily need such cover. Therefore, the risk distribution of the pipeline can be calibrated to take in a higher risk appetite; with more projects particularly in categories 6 and 7 (more generally projects in fragile states). With this calibration, assuming a higher risk profile, the leverage effect expected is equivalent to 4 X. Building in the multiplier effect of PSO, the total additional amount of project financed on the ground for every UA 1 million of PSF would amount to UA 20 million.

Project Rating

Pipeline Distribution

Leverage* for each

rating

Weighted Leverage

3 22.32% 10.3 2.30

4 25.61% 4.9 1.26

5 36.87% 3.1 1.14

6 14.75% 2.4 0.35

7 0.44% 2.2 0.01

4.45 100%

5.06

* Leverage = UA 50 million / Amount of PSF Reserves from Model

Project Rating

Pipeline Distribution

Leverage for each rating

Weighted Leverage

3 10% 10.3 1.03

4 23% 4.9 1.1025

5 35% 3.1 1.085

6 28% 2.4 0.66

7 5% 2.2 0.11

4.95 100%

3.99

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Annex V: Sample of Multilateral Development Bank experiences with leveraged credit enhancement through concessional financing

EBRD/Italy Local Enterprise Facility: The EBRD- Italy Western Balkans Local Enterprise Facility (LEF) is a regional framework program with authority to provide equity, quasi- equity and debt financing to private sector businesses. The initial geographic coverage was limited to the post-conflict Western Balkan territories of Albania, Bosnia and Herzegovina, FYR Macedonia, Serbia and Montenegro, including Kosovo.

As a framework, project approvals are conducted under the delegated authority of the LEF Investment Committee (below EBRD board level). The facility was made feasible by donor contributions from the Government of Italy (GoI), which provided:

A risk participation facility through the Italian Investment Special Fund (IISF) to co-invest with the EBRD on a first loss basis (initially up to 30 per cent of the investment amounts- increased up to 50% to provide greater flexibility, but ratio of projects coverage for overall portfolio to decrease for greater leverage of the donor support).

Grant funds to support headcount and operating expenses for dedicated LEF staff (to defray the higher transactional costs associated with smaller enterprises), reporting to the EBRD Director for the Western Balkans.

Grant funds to defray some of the client’s incremental transaction costs under the EBRD business process, legal, financial, technical and environmental due diligence.

The first framework approval in February 2006 provided a facility of €30 million, comprising €20 million EBRD funds and €10 million co-investment finance, supported by €2 million of grant funding for operating expenses and project facilitation. Following several replenishments of the framework, by December 2010, the framework amounts had already reached €250 million EBRD commitment alongside €20 million IISF plus a cumulative TC commitment of €6 million. The facility achieves a ratio of almost 1:10 (Each EUR 1 of guarantee under the Italian Special Investment Fund’s first loss enable almost EUR 10 of EBRD financing). Credit performance has been sound. The portfolio so far has withstood market challenges.

EU Community Guarantee for EIB operations: The EIB external mandate provides for a Community guarantee for EIB operations carried out in eligible countries under the mandate. The amount covered by the Community Guarantee is equal to 65% of the net outstanding disbursements in the current mandate. The types of EIB operations eligible for the Community guarantee cover, as well as other provisions and procedures, are defined in the Guarantee Agreement entered into between the Commission and the EIB.

The Community Guarantee enables the Bank to intervene in higher risk countries and operations than it would otherwise be able to; whilst maintain its gearing ratio of 250% without a negative impact on its AAA rating. The Community Guarantee has provided a very high financial leverage compared to the budget resources allocated as provisions in the EC Guarantee Fund, which are equal to 9% of the net outstanding disbursed amounts. Given that the Guarantee has been very rarely called and funds have always been recovered in full, the net actual cost for the EU budget has so far been negligible.

The appropriateness of the provisioning rate of 9% has been evaluated as part of the evaluation of the EC Guarantee Fund. The Community Guarantee is a form of concessional support for EIB borrowers, although the leverage is significantly higher than direct grant support due to the low failure rate as well as a possible re-utilization of provisioned budget funds in case the guarantee is not called or funds are recovered, as it has been the case so far.

Investment Guarantee Trust Fund for Bosnia and Herzegovina: Cooperation between the European Union and MIGA: The Board of Directors of the Multilateral Investment Guarantee Agency (MIGA) approved in 1997 the establishment of a special Investment Guarantee Trust Fund, sponsored by the European Union and administered by MIGA, to facilitate the flow of foreign investments into Bosnia and Herzegovina. The Trust Fund, consisting of a European Union credit line of 10.5 million ECU, provided investment insurance against investors' major political risk concerns, including expropriation, currency transfer restriction, war and civil disturbance, and breach of contract (denial of justice).The Trust Fund followed the parameters of MIGA's guarantee program and provided long-term (up to 15 years) insurance for eligible small- and medium-sized investments. MIGA issued guarantees on behalf of, and compensation would have been paid from, the Trust Fund. New investments, including contributions associated with the expansion, modernization, or financial restructuring of

31

existing projects, and acquisitions that involve the privatization of state enterprises were eligible. Only investors from member countries of the European Union, and certain East European countries, were eligible for Trust Fund guarantees. In keeping with MIGA's mandate to promote economic growth and development, eligible investments covered by the Trust Fund were financially and economically viable, environmentally sound, and contributed to the country's developmental needs such as creation of jobs, transfer of technology and generation of exports. The Trust Fund utilized MIGA's underwriting, claims and recovery expertise, and supplemented the Agency's available insurance capacity for foreign investments in Bosnia-Herzegovina. By using a first loss structure, the Trust Fund achieved considerable leverage with a total value of guarantees provided amounting to EUR 275 of political risk insurance cover.

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Annex VI: The Africa50Fund- Concept Note

Background

Africa’s infrastructure financing gap, which now stands at USD 50 billion a year, is growing. Investors are too focused on ready-made projects, and existing financial products are not allowing Africa to meet its needs. Inadequate infrastructure holds back economic growth in the continent by 2% each year, and reduces the productivity of the private sector by as much as 40%. This equates to USD 40 billion in lost GDP every year, and the mounting weight of missed opportunity.

Business as usual is not working, and Africa cannot afford this. To sustain the solid economic growth which it has experienced over the past decade, Africa must find a way to address its infrastructure financing gap.

We could raise more taxes, but this will require strengthened institutions and legal frameworks. We could improve our natural resource management systems, but this will take time and, inevitably, success will vary from country to country. We could tap into international capital markets. In some countries this is already a way of funding national infrastructure, but regional projects will prove harder to realize. These approaches should be pursued, as appropriate, to help bridge the infrastructure financing gap. Still, it is unlikely that they will be enough. The challenge is too daunting, and the need is too pressing. The demographic dividend of a young, dynamic African population is at risk.

Africa needs an innovative solution, and African Heads of State formally requested one in the PIDA Declaration of January 2012. To respond to this request with the scale and ambition required – and given the constraints including the prudential limits of the existing windows of the AfDB Group – we propose the creation of The Africa 50 Fund (the “Africa50Fund” or the “Fund”) – a Fund for Africa, delivered by Africa. The vision is to narrow significantly Africa’s infrastructure financing gap by delivering high-impact national and regional infrastructure projects and building competitiveness across Africa’s 54 nations.

The Africa50Fund

New Vehicle

The aim of the Africa50Fund is to unlock private financing sources and to accelerate the speed of infrastructure delivery in Africa, thereby creating a new platform for Africa’s growth and prosperity. The Africa50Fund will focus on high-impact national and regional projects in the energy, transport, ICT and water sectors.

Increasing the rate of infrastructure delivery in Africa implies a greater focus on project preparation and project development. In addition, Africa’s project finance landscape lacks specialized financial tools to address specific market challenges. This demands financial innovation and deep-rooted knowledge of the local context.

The Africa50Fund will establish two business lines:

Project Development, increasing the number of bankable infrastructure projects in Africa.

Project Finance, delivering the financial instruments required to attract additional infrastructure financing to the continent, including credit enhancement and other risk mitigation measures.

In addition, the Africa50Fund will aim at reducing the timeline from project idea to financial close from a current average of 7 years to an intended 3 years, thus accelerating the pace of infrastructure delivery in the continent.

Funding the Africa50fund – Through Equity and Debt

Working in collaboration with African Governments, the AfDB has already identified infrastructure projects worth USD 150 billion, including the PIDA pipeline. The Africa50Fund aims at attracting at least USD 100 billion worth of local and global capital to deliver this pipeline. AfDB has shown that for every dollar in equity, it can deliver ten dollars in total infrastructure investment. As such, to deliver on its aim, the Africa50Fund will need an equity investment of USD 10 billion.

Through an immediate drawdown of USD 3 billion, the Africa50Fund will begin operations, bringing already-advanced projects to financial close, and building credibility within 3 years. The USD 3 billion

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equity drawdown, along with its early investment operations, will position the Africa50Fund to seek an investment-grade rating. This will enable the Africa50Fund to issue bonds in the capital markets to mobilize a significant portion of debt from institutional investors requiring comparatively more secure returns. It is expected that the debt amount will exceed that of the equity. The remaining equity of USD 7 billion will be drawn as the Fund’s operations grow, and will be used to raise a proportional volume of additional debt to respond to growing infrastructure needs.

The primary investors will be African Governments, drawing on their internal resources, as well as the AfDB. First, lower-income African countries could opt to pay for their investments by using their country or regional operations allocation from the African Development Fund (ADF). The target is to raise USD 1 billion from the ADF resources of African countries. Second, middle-income African countries will also have the opportunity to invest in this core equity base. Third, subject to the approval of its Board of Directors, the AfDB will participate in the equity of the Africa50Fund with up to US$100 million per annum. This would represent up to USD 1 billion over 10 years. These initial equity investors will play prominent roles in the governance of the Fund, commensurate with the risk assumed. Fourth, the initial equity investments will enable the Africa50Fund to raise additional equity-type funding from more risk-averse investors with large pools of capital, including pension funds, sovereign wealth funds and central banks. Figure VI-1 outlines the proposed funding structure of the Africa50Fund.

Legal Framework

The Africa50Fund will be structured as a legally and financially independent entity. It will have its own governance and capital structure. The Africa50Fund will offer ownership and representation to its providers of equity, and will have appropriate mechanisms to ensure agility and flexibility in fast-changing and complex environments.

The AfDB and the Africa50Fund

The Africa50Fund will draw on the AfDB’s deep operational experience and expertise, leveraging its convening power and knowledge to address policy and institutional constraints to infrastructure development. The Africa50Fund will work closely with AfDB, benefiting from its extensive presence, and sector expertise. Through service level agreements, it will also benefit from the AfDB’s back office functions, including treasury management. Together, the Africa50Fund and the AfDB will work together to deliver the infrastructure investment which Africa needs.

Conclusion and Way Forward

A new dawn is on the horizon for Africa. The proposed Africa50Fund aims to unleash the potential of a continent by filling a debilitating infrastructure gap. Heads of State called for new and innovative solutions, and the AfDB has responded. It is now asking for the commitment of all African nations to establish a fast-moving and flexible way of delivering infrastructure – not tomorrow, but today. The Africa50Fund will deliver USD 100 billion worth of infrastructure projects with just USD 10 billion of equity. A roadmap for the establishment of the Africa50Fund is shown in Figure VI-2. It includes internal consultations with the Board of Directors, as well as discussions with external stakeholders.

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Figure VI-1: Funding Structure

Figure VI-2: Roadmap