summary of key recommendations on enhancing official...

World Economic Forum Financing for Development ProgramStatus Report on Enhancing Official Sector Leverage:

Preliminary Recommended Action Areas & Next Steps for Further Research(first incomplete discussion draft 2/ 12/ 05 – further input needed from participating experts)

BACKGROUND: The World Economic Forum (WEF) program in support of the United Nations Financing for Development Initiative (FfD) is responsible for developing concrete recommendations on how to enhance official sector leverage in support of development finance for the review of the international policy community. Immediate improvements are critical to delivering on the Monterrey Consensus and the Millennium Development Goals, given the recognized imperative of supplementing limited official resources and the indisputable critical role of private sector in increasing growth and the standard of living in developing countries. The WEF FfD recommendations are to be finalized by July 2005 with presentations at the General Assembly and the annual World Economic Forum CEO meeting in Davos.

STATUS OF RESEARCH: In the six months of the initial research phase from May-December 2004, over 150 experts from across the public and private sectors have been consulted on a not-for-attribution basis. Consultations have included a workshop in Sao Paulo with extensive discussions on critical action steps that need to be taken by official sector entities. Experts from both the public and private sectors have submitted over 27 specific proposals [COUNT NUMBER OF PROPOSALS HERE]. The research methodology underlying this report is dedicated to including those expert assessments and suggestions as an invaluable resource in guiding senior decision makers in the official sector responsible for most effectively employing official sector resources. Please note this is only a preliminary first status report, so research is incomplete and recommendations are tentative, with changes certain before the final report is submitted in July 2005.

PRELIMINARY CONCLUSIONS: The overall consensus conclusion from the research to date is that official sector resources can be much more effectively leveraged in mobilizing private sector investment, increasing the available finance for developing countries by billions of dollars, and resulting in huge advances towards meeting the Millennium Development Goals. However, to realize this tremendous potential, radical change is needed throughout the official sector, encompassing financial engineering, the process of how official sector institutions interact with the private sector, and the very structure of the institutions themselves. The preliminary recommendations in this status report are therefore far-reaching, with implementation of the recommended action steps requiring committed focused leadership from the executives responsible for official institutions and support from their political constituencies.

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FEEDBACK NEEDED: This draft status report is intended to facilitate feedback from experts in the public and private sectors who are willing to contribute their detailed suggestions in two areas:

Toward this end of facilitating senior official sector review, the proposals received to date have been grouped in seven overall “action focus areas,” with broad overarching general recommendations. These seven preliminary action recommendations are listed in the below Executive Summary.

Each of the seven broad action recommendations is accompanied with a more detailed section spelling out specific “recommended action steps.” Providing as much detail as possible is critical to insuring these recommendations culminate in actual changes with concrete benefits for all stakeholders. The rationale for providing detailed action steps from both public and private sector experts is three-fold:

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RESEARCH : How can the preliminary recommendations and action steps in this first status report be refined and expanded with further research?

STRUCTURE OF RECOMMENDATIONS : What is the best way to organize recommendations so as to: (a) focus limited political will on the key areas critical to improved official sector leverage; and (b) enable the review and support of needed senior political leaders (without the time or technical knowledge to understand the detailed action steps)?

Without suggested action steps, no results : There is a long history of widely acclaimed papers with stellar recommendations that have resulted in absolutely no action. General recommendations by themselves are not sufficient guidance on the difficult task of trying to determine the practical means to correct the daunting problems. Experts have been asked on a not-for-attribution basis to define the specific action steps they see as most realistically correcting the problem.

The technical nature of the subject : The practical need for defining possible action steps is further complicated by the inherent complexity of financial instruments and needed support structures. Risk mitigation is a highly-specialized profession, requiring a deep knowledge of the private sector and financial markets, so action steps cannot be correctly determined by senior decision makers without this expert guidance.

The imperative for private sector involvement : The official sector cannot leverage its resources in partnership with the private sector without involving the private sector in virtually all aspects of the process. The details in each action area attempt to pull together private sector input and recommendations received to date.

Therefore, to facilitate the determination of the merits of the recommendations and the possible implementation strategies, each of the seven action focus areas in this status report is broken down into as much detail as possible, drawing on the specific recommendations and proposals provided by experts. Please note, however, that the recommended action steps suggested in this status report are only intended to be illustrative (rather than conclusive) and are incomplete and require more research and elaboration. All experts are strongly encouraged to engage in this research process, providing their detailed candid suggestions on how to best refine both recommendations and action steps. Without open partnership and extensive exchange among experts, neither countries nor companies will be able to define practical means for meaningfully advancing financing for development. (Please see below questions.)

STATUS REPORT STRUCTURE: As noted above, each of the seven action focus recommendations have sections that contain the proposals received to date. The sections necessarily vary in content and length, reflecting the different types of input received to date. In a few cases, proposals have been slightly altered to integrate similar suggestions from other experts, in addition to overall editing. (Authors of proposals are asked to communicate any concerns with changes to their original proposals, and further suggestions on improvements. Some proposals still need to be included; authors are asked if at all possible to draft text for inserts.)

QUESTIONS FOR EXPERT FEEDBACK: As noted above, the purpose of this status report is to refine the recommendations and proposals contained therein. Each expert reading this report is to provide his or her candid comments and suggestions. In particular, suggestions and research assistance would be very much appreciated in the following specific areas:

MAIN RECOMMENDATION : In your judgment, are the overall recommendations valid? If not, how would you change them and why (please be as concrete as possible with changes and rationale providing evidence)?

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Preliminary Action Focus Recommendations (7 total)

Reported Problems (summary of expert comments on problems hindering effectiveness of official sector entities to mobilize private sector resources)

Recommended Action Steps (specific suggestions made by experts in workshop and one-off consultations)

o Benefits (expected from implementing action steps)o Obstacles (prohibiting recommended action steps)

Detailed Specific Proposals (when available -- not all recommendations are detailed with specific proposals)

PROBLEMS : What concrete evidence could you provide of the problems to help bolster the need for change? (Please remember all comments are on a not-for attribution basis. Examples of issues can be generalized.)

ACTION STEPS : How would you refine the specific action steps and proposals received to date, and why?

EVIDENCE : What case studies, working papers, statistics, or other sources should be included to support the recommendations and proposed actions steps or your suggestions?

OTHER EXPERTS : What other experts should be consulted? (Please provide their contact info and an indication of the specific area they you feel they would provide insight.)

Please provide your feedback to Dr. Barbara Samuels at [email protected] (USA + 845-868-7639). Please note all input is on a not-for-attribution basis (i.e., off-the-record views of experts and not necessarily those of employer institutions).

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EXECUTIVE SUMMARYPRELIMINARY ACTION FOCUS RECOMMMENDATIONS: ENHANCING LEVERAGE OF OFFICIAL INSTITUTIONS

SUMMARY OF INITIAL ROUNDTABLE DELIBERATIONSFollowing are a number of the key issues raised thus far in the project’s deliberations. Further consultations are being undertaken to prioritize needed reforms and identify other key issues requiring attention.

1) PROJECT FEASIBILITY FUNDING. Official sector institutions need to pool project feasibility funds and make them easy-to-access, utilizing appropriate experts from across the public and private sectors to identify quality projects and develop acceptable risk-mitigating financial structures.

2) RISK MITIGATION PRODUCTS. Official sector institutions need to commit significant funding to successful risk-sharing programs in partnership with private sector companies, enhancing aid effectiveness by harnessing private sector capital and developing capital markets. Frameworks for five instruments need to be developed for immediate large-scale replication by multilateral and bilateral institutions:

Guarantee Programs that include partial loan guarantees, loan portfolio guarantees, commitment agreements for guarantees (“portable guarantees”), and bond guarantees

Risk-sharing agreements with banks and monolines Supplemental Tariff Payments to support Infrastructure Projects First Loss provisions in financing agreements Regional debt and equity funds

In certain cases, financing may need to be made conditional to the adoption of training and other programs needed to insure adequate execution of project by government and/or private sector partners. In addition, to be effective in maximizing the effectiveness of official sector resources, the official sector needs to disseminate information on these risk-sharing programs to targeted banks, companies, government officials, and other donors.

3) LOCAL CAPITAL MARKET ENHANCEMENT. Official sector institutions need to develop and mainstream new financial instruments specifically aimed at developing local capital markets and expanding local sources of available credit in direct collaboration with private sector and national government experts. Frameworks for seven additional instruments need to be developed for immediate large-scale replication by multilateral and bilateral institutions:

Local currency and tenor extension guarantees State Revolving Funds (SRFs) Regional or country local monolines Regional swap funds South-South Emerging Market Export Credit Agency Official sector counter guarantees of national guarantees Risk-sharing programs outlined in above point (Recommendation Two)

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4) REGULATORY AND FOREIGN EXCHANGE RISK. Official sector institutions need to collaborate with private sector experts in designing new financial structures that correspond to market needs in two specific areas blocking mobilization of capital, government regulatory risk and foreign exchange risk. Frameworks for two instruments need to be developed for immediate large-scale replication by multilateral and bilateral institutions:

Contingent regulatory guarantee facilities at both a country and official sector level, so that country project-specific regulatory guarantees can be counter guaranteed by creditworthy multilateral and bilateral entities

Country foreign exchange liquidity facilities at both a country and official sector level, so that country devaluation liquidity guarantees can be counter guaranteed by creditworthy multilateral and bilateral entities

5) REDEPLOYING CAPITAL OF WORLD BANK GROUP AND OTHER DEVELOPMENT BANKS. The capital structures and charters of official sector institutions need to be realigned with the specific objective of maximizing the leverage of official sector capital (i.e., the efficiency of each taxpayer dollar). Political leaders need to implement open audits and investor/client surveys immediately to remedy impediments in the following areas:

Allocation of capital to different official sector units (on global level within respective Bretton Woods institutions, at regional level within regional development banks, on national level between bilateral development agencies)

Charter rules that impede effectiveness need to be openly disclosed and changed accordingly (for example, restrictions on dealing directly with subsovereigns, working with other donors, beneficiaries not being member states, length of tenors, etc)

6) DONOR AID COORDINATION. Official sector institutions need to create streamlined standardized mechanisms for donor coordination at the global, regional, and country level, including explicit structures to leverage official sector resources by mobilizing private sector capital and expertise (i.e., above eleven instruments). Frameworks for four types of donor coordination mechanisms need to be developed for immediate large-scale adoption by multilateral and bilateral institutions:

“Public-Private Syndications ” of debt, equity, and currency transactions (at global, regional, and country levels)

“Sector Donor Tables ” to enable cost-effective donor coordination in support of national development objectives and regional economic integration (at regional and country levels)

“Global Sector Capacity-Building Kits ” consisting of principles, implementation guidelines, and tool kits that enhance developing country capacity to execute transactions

“Consultative Mechanisms to Build Country Criteria ” for official sector entities and key private sector entities to build local capital markets and global competitiveness (including business organizations, financial institutions, rating agencies, and other key actors)

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In addition, all donors need to adopt basic principles of non-compete and coordination (see below).

7) INSTITUTIONAL CULTURE CHANGES. For official sector institutions to partner effectively with the private sector and optimize use of official sector resources, senior management must take the lead in devising new management incentive programs and processes that change the behavior of officials and processes. Specifically:

Senior Political Leaders commit to creating new performance incentives, measurements, deliverables and targets, and revise management processes in line with stated mission of maximizing aid effectiveness, including strict rules against direct competition with the private sector (“no compete” rules)

All official sector officials responsible for risk management change in line with senior directives risk management policies (leverage, loss reserves, limits, surveillance, transaction approval processes, etc), and report openly on results

Explicit integration of private sector expertise into all levels of operation (e.g., third-party surveys of investors, private sector “testing” deals, meaningful broad-based business advisory groups), with open dissemination of recommendations and discussions

Training of officials and outsourcing activities that require private sector skills

Please see the attached detailed sections for details and expert proposals received to date on each of the above action focus areas. Please provide suggestions and research to refine and enhance action focus recommendations, actions steps, and specific detailed proposals to Dr. Barbara Samuels ([email protected]. phone USA +845-868-7639).

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ISSUES AND RECOMMENDED NEXT STEPS IN EACH ACTION AREA

REPORTED PROBLEMS: The ability to improve infrastructure in developing countries, critical to attracting investment and improving standards of living, is totally dependent upon the availability of funding for feasibility studies and the ability to design sustainable projects with strong financial fundamentals. Without a system that enables the financing of costly feasibility studies, quality projects cannot be defined or successfully financed and implemented. In today’s environment of high risks and uncertain profitability, investors often cite the high sunk costs of project development as a major constraint to their investments in developing countries. While the official sector does provide a number of bilaterally-managed trust funds for feasibility studies, they are reported as difficult to access and inefficient in identifying projects.

As a result, many projects critical to enhancing a country’s overall global competitiveness and living standards are never designed or implemented. Often the only projects that are viable are those attractive enough to construction companies for them to assume the development cost, leaving countries without an independent expert validating the project selection, design, and financing requirements. Mistakes in project selection and design can be very costly for countries, misdirecting scarce resources and eroding public trust. In addition, both government officials and private sector investors cite the need for more expert support in explaining concessionary arrangements and project management, including the sharing of best practices and success stories.

RECOMMENDED ACTION STEPS:

1) Create centralized easily-accessible feasibility funds

2) Staff with experts in risk-mitigation who can work with government officials and private sector participants in identifying projects and structuring transactions (i.e., operate as SWAT team)

BENEFITS: Experts from the private sector claim the benefits would be dramatic in scaling-up the ability to finance infrastructure projects in developing countries, and also in provided needed enhanced support of developing country government officials. Specifically:

Increase the number and quality of project financings in developing countries, improving country competitiveness and living standards

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1) PROJECT FEASIBILITY FUNDING. Official sector institutions need to pool project feasibility funds and make them easy-to-access, utilizing appropriate experts from across the public and private sectors to identify quality projects and develop acceptable risk-mitigating financial structures.

Significantly enhancing the ability to fund feasibility studies and resulting projects for chronically under-served sectors (e.g., water in rural areas, or wastewater in general)

Enhanced capacity of developing country governments (central and subsovereign government officials) to proactively initiate project feasibility studies, implement financings, and deliver results

OBSTACLES: Key problems in implementing these action steps are expected to be both political and technical:

POLITICAL DECISION: The dominant portion of trust funds are currently under the control of individual countries (e.g., the Executive Directors of the multilaterals, bilateral aid agencies). Countries would have to agree on merging their funds, for example within the regional development banks (see specific proposal below).

TECHNICAL REQUIREMENT: Private sector experts in risk-mitigation need to be recruited to staff this function (i.e., not public sector professionals).

DETAILED SPECIFIC PROPOSAL (submitted by experts)

In each of the regional development banks, establish a high value-added unit of highly qualified experts (Regional Project Support Unit), with access to a well-capitalized central fund to finance feasibility studies (Feasibility Study Fund).

The investment professionals would have expertise in both project design and risk mitigation structures, enabling them to use funds efficiently to develop bankable quality projects. The experts in the Regional Project Support Unit would also serve as catalysts in disseminating needed expertise and support, best practices, and success stories on project management and concessionary arrangements throughout the region.

The Feasibility Study Fund would be funded by aggregating existing official sector funds (e.g., from country trust funds, etc), and might be augmented with appropriate budgetary resources. An annual budget of $20 million might fund an average of 100 feasibility studies annually.

One critical feature of the Regional Project Support Unit could be its catalytic nature in mobilizing private sector capital and expertise, and building capacity in the recipient countries. Feasibility Study Funds would be available to local firms in target countries, supervised by FSF professional staff with knowledge of required risk mitigation techniques and services. This will create the local capacity to consistently develop first-rate feasibility studies and develop knowledge of risk mitigation services. In addition, projects are likely to be designed more appropriately for the country environment, with the local firm better able to factor in local regulations, laws, risks, and costs.

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Benefits: There are a number of additional benefits in addition to increasing feasibility studies and project finance transaction with all the improvements to country infrastructure, such as:

Creation of in-country capacity for generating bankable feasibility studies among local engineering companies

Enhanced in-country and development bank consciousness of infrastructure, its catalytic role for competitiveness and as a base for social equity

Establishment of a role model within the regional development banks of rapid, non-bureaucratic action

Optimized project designs and performance metrics, as experts in each Regional Project Support Unit develop shared success cases and best practices

Criteria: Of critical importance, along with the rapid and non-bureaucratic decision-making of the Regional Project Support Unit, will be the focus of the funds and the locus of fund activity. Key criteria must focus around the creation of country global competitiveness – in other words, these projects would not be public works projects, but strategic projects that will produce extraordinary value for the host country, and with a solid financial structure that will satisfy the requisite financial obligations. The aim is to radically increase the production of bankable (not lobbying) projects that are properly sized, properly budgeted and properly maintained.

Grant Funding: The FSF would likely need to use a grant mechanism to avoid increasing the host country’s foreign debt, and time-consuming Central Bank approvals related to the sovereign debt ceiling. To aid sustainability, the grant could have a success-fee payback clause (i.e., common replenishment mechanism that requires the repayment of 50% of the grant at the project financial closing).

Targeted Results: Each Regional Project Support Unit is expected to produce at least a 75% success rate with projects funded within a year of the completion of the feasibility study (or a minimum of 15 new projects funded per year).

Initial Actions: Given the current focus on infrastructure projects in developing countries, it would be useful to target one or two development institutions for immediate creation of pilot Feasibility Fund Agencies. The Inter-American Development Bank and the African Development Bank are two strong candidates.

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In certain cases, financing may need to be made conditional to the adoption of training and other programs needed to insure adequate execution of project by government and/or private sector partners. In addition, to be effective in maximizing the effectiveness of official sector resources, the official sector needs to disseminate information on these risk-sharing programs to targeted banks, companies, government officials, and other donors.

REPORTED PROBLEMS: Despite the widespread official sector interest in guarantees and other risk-sharing programs, in actually the amount of such programs available to the private sector is exceedingly small. {ADD NUMBERS HERE} In addition, many investors claim the existing risk-sharing programs add no or little value in covering the high risks constraining investments, either because they are perceived as not covering the specific risks of concern, or are not dependable in providing timely payments. These developments are documented in detail in several studies. [HERE WINPENNY, etc]


1) Multilateral and Bilateral entities should establish or significantly increase the resources for risk-sharing programs with the private sector.

2) To determine the appropriate level of funding, each entity should perform a due diligence impact assessment of the current use of the development resources, comparing current uses against risk-sharing programs. (This action step is detailed in Action Area Five.)

3) A menu of options for risk-sharing instruments should be developed, drawing on best practices with extensive private sector involvement, including the large-scale application of the following five instruments: Guarantee Programs that include partial loan guarantees, loan portfolio guarantees, commitment agreements for guarantees (“portable guarantees”), and bond guarantees; Risk-sharing agreements with banks and monolines; Supplemental Tariff Payments to support Infrastructure Projects; First Loss provisions in financing agreements; and Regional

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2) RISK MITIGATION PRODUCTS. Official sector institutions need to commit significant funding to successful risk-sharing programs in partnership with private sector companies, enhancing aid effectiveness by harnessing private sector capital and developing capital markets. Frameworks for five instruments need to be developed for immediate large-scale replication by multilateral and bilateral institutions:



debt and equity funds. (For details, please see below section on detailed proposals).

BENEFITS: The impact of these types of agreements with private sector companies can be much greater than straight loans or grants for a number of reasons:

Maximizes Leverage of Scarce Official Resources – By mobilizing abundant supplies of private sector sources of capital, these types of programs can exponentially increase the effectiveness of official sector funds. (For example, the US government claims that its Credit Guarantee Program is able to leverage each dollar of US government funding with up to $50 in local lending.)

Promotes Private Sector Investment – The size and depth of the private sector in developing countries is increased, since official sector guarantees provide local and foreign investors with the confidence to invest funds in developing countries that would not otherwise be available.

Increases Availability of Local Sources of Financing – Risk-sharing programs increase the ability of local banks and capital markets to provide funding to private sector companies, as private sector sources of credit in developing countries are extremely constrained in their ability and willingness to extend credit by the high level of country and credit risk.

Provides a Venue for Building Local Bank and Capital Market Capabilities – Donors can supplement risk-sharing programs with professional training and advisory support, strengthening the long-term capacity of local markets to provide credit.

OBSTACLES: A number of cultural and operational procedures hinder the ability of official sector entities to implement these types of programs. Most, if not all, official lending institutions have an underlying incentive to lend over guarantees as they can enjoy the inherent institutional advantages that exist by virtue of their ownership. The Treasury profits are often what allow them to stay financially self-sustaining.

A significant reduction in business volume in an official scheme could lead not only to losses and an unbalanced portfolio, but also that the level of business undertaken and so income earned may fall below the critical mass which is necessary to maintain a credible and effective infrastructure of experience, expertise, and information.

The other big obstacle is the bureaucratic inertia that exists within these institutions, whether the size of EFIC with 100 people, or the size of the World Bank. When the market dictates that change is justified, it is extremely difficult for these institutions to harness an entrepreneurial approach and respond to the changing market place, as often this means backing away from certain business lines with consequent human

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resource implications. But, without such dynamism, the institutions themselves become either ineffective at best or market distorting at worst.

Experts from the private sector claim that effective large-scale public-private programs in risk-sharing requires a fundamental change in official sector programs and roles:

Programs Geared to Private Sector Standards : Partnerships by definition have to be shaped by the needs of both partners. To meet due diligence requirements to shareholders and clients, private sector companies must comply with strict nonnegotiable requirements. For official sector entities to employ private sector capital they need to better adapt to the needs and standard operating procedures of private financial institutions.

Official Sector Adoption of Strict “No Compete Policy” with Private Sector: Over the years official creditors have been repeatedly reported as competing with private sector financial companies, and in effect crowding out private sector investment. Official guarantors need to constantly reaffirm in word and deed that they have no interest in competing with the private sector, but that their sole objective is to induce companies to invest to the maximum extent feasible in developing countries.

Explicit Public Sector Role in Assuming Unacceptable Risks: Official sector entities need to acknowledge explicitly that they are suppose to take unacceptable risks that private sector companies cannot assume without violating their fiduciary and due diligence requirements. Examples of critical risk roles for the public sector include:

Provision of full-term or partial term first loss guarantees, including partial term first loss to cover construction and ramp-up risk

Matching the longer final maturity terms now typically being provided by private financial guarantors such as monolines (including changes in charters if necessary)

Allow the private sector creditor or guarantor control of workouts if the official sector is not taking the majority of the exposure or providing partial term or full-term first loss (e.g., loss recovery strategies, remedial restructurings, exercise of rights and remedies when technical or financial defaults occur except potentially the special agency-required defaults such as environmental, labor law and other social policy requirements);

Pay claims or draws under their guarantors in as timely a fashion as the private sector financial guarantors with which they are willing to share risk (i.e., in the case of monoline insurers that means timely payment of scheduled principal and interest, with no “outs”)

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The key obstacle according to experts is that official sector institutions are employing the same risk management guidelines as private sector companies, and therefore keen to avoid the same risks. (Recommendations on official sector management processes are detailed out in Action Area Seven.)

SPECIFIC PROPOSALS (submitted by experts):



FOR ALL PROPOSALS ABOVE, MORE INFO NEEDED HERE

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REPORTED PROBLEMS: The constraints on local currency financing in developing countries are multiple and are extensively documented by experts; for example:

Inability of local banks to provide affordable long-term financing (common problems include crowding out with funding of government deficits, limited risk capacity, etc.)

Insufficient development of local capital markets (limited bond and stock markets)

Constraints of national governments in providing lending or guarantee programs given high levels of fiscal indebtedness (for example, national exporters in developing countries lack the official support that developed country private sector companies have with their home country ECAs).

Virtually all stakeholders agree on the importance of using donor resources to increase the availability of local currency financing (especially in the wake of foreign currency crises), yet large-scale programs enabling the creation of meaningful volumes of new local currency instruments in developing countries have not yet been formulated or launched. A number of innovative structures and programs have been explored and implemented, but donors have not converged with a menu of instruments to enable the large-scale replication needed for meaningful progress.

RECOMMENDED ACTION STEPS:1) Multilateral and Bilateral entities should establish or significantly

increase the resources for local currency programs. 2) To determine the appropriate level of funding, each entity should perform

a due diligence impact assessment of the current use of the development resources, comparing current uses against local currency programs. (This action step is detailed in Area Focus Five.)

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3) LOCAL CAPITAL MARKET ENHANCEMENT. Official sector institutions need to develop and mainstream new financial instruments specifically aimed at developing local capital markets and expanding local sources of available credit in direct collaboration with private sector and national government experts. Frameworks for seven additional instruments need to be developed for immediate large-scale replication by multilateral and bilateral institutions:

Local currency and tenor extension guarantees State Revolving Funds (SRFs) Regional or country local monolines Regional swap funds South-South Emerging Market Export Credit Agency Official sector counter guarantees of national guarantees Risk-sharing programs outlined in above point (Recommendation Two)

3) A menu of options for local currency instruments should be developed, drawing on best practices with extensive private sector involvement; including the large-scale application of the following instruments: local currency and tenor extension guarantees, State Revolving Funds (SRFs), Regional or country local monolines, Regional swap funds, official sector counter guarantees of national guarantees, and local currency variants of the risk-sharing programs outlined in above action area. (For details, please see below section on specific proposals).

4) Donors should agree to contribute to establishing a South-South Export Credit Agency (ECA).

BENEFITS: Extensive research has documented the benefits of expanding local currency instruments in developing markets, with widespread agreement of the critical priority of immediate results for country growth and living standards. In addition, recent assessments conducted on the potential benefits of a South-South ECA document its value in advancing developing country growth, South-South economic integration, more balanced global trade, and greater overall financial stability.

DETAILED PROPOSALS (submitted by experts) Local currency and tenor extension guarantees State Revolving Funds (SRFs) Regional or country local monolines Regional swap funds South-South Emerging Market Export Credit Agency Official sector counter guarantees of national guarantees

1) Proposal for Local Currency Lending and Tenor Extension Guaranties

Multilateral development banks and bilateral donors should offer guaranties of local-currency lending by commercial banks, as a way of mobilizing local-currency financing for those projects in countries that do not have local-currency bond markets. In some cases, official sector entities could possibly economize their guarantee capacity by offering local banks put options, under which the banks would be able to sell their local-currency loan to the official sector institution at a specific time in the future, before the ultimate maturity of the loan. If local banks have options to sell the loan at par before the ultimate maturity date, they may be able to offer longer-term financing than would otherwise be the case.

Rationale: In the last few years, multilateral institutions and bond insurers have completed a series of financings in which they guaranteed local-currency bonds

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issued in the domestic market of a developing country such as Chile, Mexico or Colombia. Many of these financings have been for toll roads and other infrastructure projects with revenues denominated in local currency. If these projects had borrowed in dollars or other hard currency, project investors and creditors would have been exposed to losses in the event of local currency devaluation. But by financing the projects with local-currency debt, investors and creditors have a natural hedge, with revenues and debt service both denominated in the same currency. The local-currency guaranty approach appears to be a particularly successful way to protect infrastructure projects against currency risk, and project participants believe the bonds could not have been issued in the local markets without the guaranties.

Can this approach be used in countries that do not have local-currency bond markets? Infrastructure projects typically require financing with a longer maturity than commercial banks can typically provide. Banks that fund their loans with deposits or other short-term liabilities simply may not be able to provide longer-term financing, even in cases where the borrower’s credit is supported by a multilateral guaranty.

The most promising way to overcome this asset-liability mismatch may be a variant of the local-currency guaranty approach, in which a multilateral institution (or other financial institution) would offer the bank a put option, under which the bank would be able to sell its local-currency loan to the multilateral institution at a specific time in the future, before the ultimate maturity of the loan. If the bank has an option to sell the loan at par before the ultimate maturity date, it may be able to offer longer-term financing than would otherwise be the case.

EXAMPLE: An example of this put option (or tenor extension guaranty) is the Societé Camerounaise de Mobiles (SCM) wireless telecom financing in Cameroon that closed in 2002. A group of local banks led by Societé Generale lent SCM the CFA Franc equivalent of $45 million, of which a total of 25% was guarantied by IFC and Proparco, the French development finance institution. The banks also were granted an option to require IFC and Proparco to refinance 100% of the outstanding debt in the sixth and seventh years after disbursement. This feature (the functional equivalent of a guaranty) allowed the banks to treat the seven-year loans as having a five year maturity for regulatory purposes, which reduced the amount of capital they were required to set aside for the loans and enabled them to extend the maturity of the financing they could provide.

This approach envisions that the local banks will take project credit risk as long as they hold the loan. One implication of this is that the banks cannot exercise the put option if the loan is in default on the put exercise date. If banks did not have an appetite for project credit risk, this structure could in principle be modified to combine the put option with a credit guaranty from the multilateral lender, similar to the guaranties that the multilateral lenders already provide for bond offerings. In the modified structure, the guarantor would take credit risk at all times, and in addition would give the local banks an option to sell the loan on specified dates,

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whether or not the loan was in default. The effect of combining these features would be to transform the role of the local banks in the transaction into that of a local-currency funding vehicle for the multilateral guarantor.

Benefits :

The tenor-extension guaranty may allow an infrastructure project to attract local-currency financing that would not otherwise be available, even in countries that do not have local-currency bond markets.

The tenor-extension guaranty could help mobilize local savings to fund local investment in infrastructure in countries that do not have well-developed local bond markets.

By using local-currency debt, an infrastructure project is protected against devaluations of the local currency.

From the guarantor’s perspective, since the guarantor’s exposure is denominated in local currency, a devaluation has the effect of reducing the guarantor’s exposure to the project – a benefit that is not present with hard currency loans.

Obstacles: Banks tend to offer floating rate debt, which will not be attractive to borrowers (or guarantors) unless there is some assurance that the borrower’s revenue will increase to cover the increase in debt service expense associated with increases in interest rates. The borrower may be able to hedge this risk if it has an offtake contract or host government concession agreement that authorizes it to pass along the variable element of its capital cost to the project’s customers. In addition, if the borrower is permitted to increase its prices in line with local inflation, it will have some protection against interest rate increases if the interest rate increases result from higher local inflation rates.

To achieve significant extensions of the tenor of bank loans, it might be necessary to offer the banks the right to put the debt to the guarantor on a series of dates, and not just on one date.

The credit risk profile of infrastructure projects may not be attractive to local banks. As a result, it may be necessary to combine the put option with a credit risk guaranty to induce banks to lend.

The infrastructure project loans – with or without a credit guaranty – must be priced to be competitive with other assets available to the local banks.

In particular, the pricing on the local bank debt has to be attractive enough so that the local bank has an incentive to continue to hold it, instead of exercising the put option. The purpose of the structure is defeated if the local-currency lender does not stay in the deal, because the multilateral lender (for its own hedging purposes) will typically require the loan to convert to hard currency once the loan is acquired by the multilateral, which has the effect of destroying the project’s currency hedge from the moment the loan is acquired.

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Some multilateral institutions have policies against refinancing that might make them reluctant to participate in this kind of structure (even if the put option is a key feature of a structure that attracts new investment for a greenfield project).

2) Proposal for Establishing Regional or Country Monolines

Regional and country monoline insurance companies would offer to countries and municipalities credit insurance for infrastructure projects. The coverage would be made available for states and municipalities willing to adhere to a pre-determined pattern of fiscal discipline.

The risks inherent to such coverage would be underwritten by market players to the extent available in current conditions, including insurance companies, guarantee funds, banks and multilateral institutions. Coverage against regulatory risks and municipal and state government defaults would be guaranteed by the Federal Government. The Federal Government would have access to federal tax revenues shared with States and Municipalities to recover any payments made under such programs.

Benefits: The benefits offered by a monoline structure as outlined above would be: i) access to low cost funding for infra-structure projects, ii) a triple AAA credit risk for investors, including institutional investors, which could be enhanced by tax benefits to make these investments even more attractive, iii) a voluntary acceptance of fiscal discipline by States and Municipalities, and iv) development of alternative channels for savings to be applied in a secure way in infra-structure projects, resulting in a growth of domestic savings. Such a structure could also eliminate or mitigate in certain projects the devaluation risk, because the multilateral and international support would be given to underwrite risks and not to as foreign currency loans. Finally, resources invested in a monoline insurance company could be leveraged to a considerable extent (e.g., risks underwritten by US monolines are up to more than 100 times equity).

Obstacles to date: The implementation of such program would require the enactment of a law creating the institutional framework for such monoline insurance companies. In addition, regulations for their activities would have to be created. The narrow scope of existing credit insurance programs is one of the main obstacles which would have to be removed in order to implement this idea. Finally, attention should be given to remove legal, regulatory and other impediments which make project finance and PPPs difficult or impossible to conclude in the country.

Next Steps for Implementation: Creation of a multi-disciplinary group to define and establish such program. The group should consist of representatives of: i) a US monoline, ii) regional development bank, iii) IFC, iv) host country Ministries of Planning, and Finance, v) interested parties of the private sector, and vi) legal

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advisor. The work of this professional group should be funded by a Development Agency.

3) Proposal for Multi-lateral Sponsored Regional Swap Facilities

Outline of Proposed Concept: Apart from convertibility and transfer risk, one of the major issues facing emerging market issuers is currency exchange rate volatility and depreciation. Due to limitations imposed by the ability to raise capital in the local markets, lack of liquidity, size of the market, availability of long term capital, etc. issuers frequently need to rely on the international capital markets and foreign currency denominated debt. As the projects and/or companies typically generate local currency revenues they have inherent asset/liability mismatches which they need to resolve. However, in the majority of cases, derivative markets are not developed sufficiently to allow the issuers of foreign currency denominated debt to hedge their exposures via the local markets. In addition, the international providers of hedging mechanisms (major financial institutions such as Citibank, JP Morgan Chase, Deutsche Bank, etc.) are often unwilling to enter into transactions due to country risk limits, credit restrictions, political/currency risk, size and tenor of the transactions, counter party risks, etc.

To address these and other issues this proposal calls for the establishment of a Special Purpose Vehicle (“SPV”), or Multi-lateral Sponsored Regional Swap Facility (“MSRSF”) analogous to the SPV’s created by Investment Banks such as Goldman Sachs Financial Products, Lehman Brother Financial Products, Salomon Swapco, and others. These SPV’s were established for the sole purpose of intermediating a wide variety of derivative products such as interest rate and currency swaps and options.

The proposed MSRSF would be established as a Special Purpose Vehicle sponsored and “owned” by the Multi-lateral community such as the World Bank (or IFC), Inter American Development Bank, European Bank for Reconstruction and Development (“EBRD”). In addition, regional development banks would be the key sponsors and “owners”, such as CAF, Bladex, and CABEI in the case of a Latin American sponsored Swap Facility. Similar regional SPV’s could be established in Asia, Middle East and Africa, as well as Eastern Europe.

Proposed key considerations for the MSRSF are:

Legal Risks: The SPV should be established as a separate legal entity, bankruptcy remote and subject to preferably UK or US law.

Financial Risks: Capital for the SPV would come from equity injections by the sponsors (owners) and contingent capital and access to liquidity lines from the parents. In addition, the SPV will need to monitor closely its leverage of existing capital and its credit exposure to maintain a high investment grade rating. Agreements with the owners to enter into offsetting transactions to mitigate the risks should be considered and

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analyzed. To what degree existing preferential creditor status of the sponsors could be transferred upon the facility would need to be explored, however, if applicable would serve to enhance the functionality of the facility and reduce financial risk.

Operating Risks: To ensure that the operating risks are minimized, a strong management board will need to be created and clear operational guidelines will need to be established. Through a transfer of existing experienced personnel from the sponsors these risks can be controlled and mitigated.

Product Lines: The facility should focus on a narrow product array which addresses the key hurdles faced in the region to attract foreign capital and risks associate therewith for the local market participants. It is the author’s recommendation that products offered by the MSRSF be interest and currency swaps and related derivates. The purpose of the facility is to provide for risk mitigation in asset/liability mismatches arising from local vs. foreign currency issues.

Counterparty Risks: In order to minimize the counterparty risks and to build on the experience of the owners/operators of the facility, it is proposed that the MSRSF would act as a counterparty to regional sovereigns, local Governments, and local/regional financial institutions. The local financial institutions are best equipped and have the credit experience and knowledge to intermediate for the local and or regional corporations. The facility would provide those financial institutions with the ability to lay of the interest and currency risk, but not the credit risks of the financial institutions’ counterparties. In turn, the MSRSF would look to enter into offsetting currency and interest rate as well as credit derivative transactions with the owner institutions, international financial institutions or regional sovereigns.

Benefits:

Ability to hedge cross currency and interest rate exposures which are a key deterrent for foreign capital to enter the local markets.

Potential to address tenor extensions by providing local financial institutions with the ability to hedge assets and liabilities.

Potential for intermediating between generators of hard currency revenues (with local currency liabilities) and local currency generators (with foreign currency liabilities).

A pooling of resources and a coordinated approach by the Multi-laterals for the region.

Channeling of technical assistance to further the development of the local capital markets.

Attract additional sources of funding from the international financial community which might otherwise be restricted due to country risk exposures (i.e. currency risk due to perceived government risks).

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Obstacles: Clearly there are a large number of obstacles to overcome, not withstanding the “competitive nature” of the Multi-lateral community itself. Questions that come to mind are (and these are by no means all inclusive):

How to enlist a Regional Multi-lateral as the champion of the Facility? How to coordinate and meet the individual Multi-lateral objectives as well

their charter mandates within the context of the facility? How to staff the facility with experienced people from the region or with

Multi-lateral personnel? Should a Regional Multi-lateral, in the case of a Latin American Facility,

such as CAF be the main partner which would coordinate the involvement and resources of the facility? Would they be prepared to assume this role and provide the necessary resources and management?

Would Governmental agencies need to be involved, such as the US treasury, to provide the impetus needed?

Would the IMF support and endorse this type of facility? Especially if Sovereigns use the facility to manage their debt, and or support the facility’s activities by acting as counterparties to currency swap transactions?

What role can and should domestic financial institutions play in the initial phase of the facility and should they be allowed to take equity stakes in the facility?

Can undeveloped local markets and lack of appropriate local hedging instruments and government debt markets/instruments and yield curves be overcome?

Next Steps for implementation:

Discussion with Multi-laterals on a coordinated approach to creating a Special Purpose Vehicle channeling their combined efforts for a region

Lobbying Multi-laterals as well as IMF (and possible US Treasury) to provide support for the concept and refine and define proposed structure as well as strategy

Stress developmental impact of facility on local/regional capital markets and how existing Multi-lateral sponsored technical assistance projects targeted to capital market developments can be tied to the facility

Stress the potential for attracting foreign direct investments by providing infrastructure as well as project capital raising activities ability to hedge currency-asset/liability mismatches

Develop clear understanding of scope of the products and services the proposed facility can deliver (should the facility only provide political risk guarantees for swap transactions, or should it intermediate between International Financial Institutions and the end users of Swaps –both pure interest rate as well as cross currency swaps?)

Provide the regional/local financial market participants (banks, investment banks, etc.) ability to assume greater responsibility and ownership of the facility over time (exit strategy for Multi-laterals?)

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Discuss and develop structure to meet rating agency criteria for investment grade ratings.

Additional Steps to be explored and addressed:

Feasibility to replicate ADB transaction on a larger scale and or in more countries, i.e. Multilateral Swap with host Governments to raise local currency for domestic on-lending (Local Currency swap mechanism)

Domestic regulatory environment and issues which will need to be addressed to encourage and foster longer term domestic capital markets

Are domestic resources within the investment community able to invest in project risk, ie. Pension plans, mutual funds, retirement funds, insurance companies?

Encourage and assist local financial institutions to actively intermediate swap transactions between domestic companies which complement each other through their generation of foreign currency receivables with those of foreign currency liabilities. How could multilateral or international financial institutions aid in the further development of this market?

5) Proposal for official sector counter guarantees of national guarantees

Proposal: Provision of partial political risk breach of contract (PR-BoC) guarantees by the multilaterals to support Developing Country Export Credit Agencies for financing long-term infrastructure projects.

Problem: Export Credit Agencies in developing countries often have sufficient funding capacity for more financing but are constrained by country risks that prevent them from increasing their exposures.

Benefits: Such programs would advance South-South investments benefiting both the country that financed the tranascation and the host country. The exporting country would improve its economy and blaance of payments, and the host country will benefit from better infrastructure services at lower costs. Overall this mechanism would contribute for the stabilization and the growth of developing countries.

Obstacles: It appears that there are political obstacles for multilaterals to guarantee public sources of finance, even when these operate in a commercial basis. [NEED TO RESEARCH]

6) Proposal for Conditionality (for use of external official guarantee mechanisms of local currency borrowings)

Official guarantors should condition their agreement to guarantee local transactions in any developing country to improvement of the business

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environment. Complementary training and technical capacity-building programs can be tied to availability of guarantee programs. Examples of key areas critical as building blocks for the development of local debt and equity markets include:

Appropriate legal and regulatory frameworks for bank lending and/or capital market fixed income transactions, including reliable means of registering and enforcing security interests in cash flows, real and personal property, transparent financial reporting, etc.;

Securities laws providing for full and continuing disclosure of financial performance information by capital market borrows;

Law enforcement and court systems prepared to enforce laws governing bank and capital market debt markets, etc. fairly and swiftly;

Reliable dispute-resolution mechanisms capable of researching and resolving issues of interpretation and implementation (e.g. of concession agreements, construction contracts, etc.) more quickly than and as fairly as the official court system;

Relatively high scores on honesty measures, (e.g. Transparency International)

Pools of high quality professional legal and accounting talent; Evidence of private savings accumulation, e.g. through insurance

policies, pension funds, certificates of deposit, etc.; Rational credit quality spreads in capital market and/or bank lending

markets; If sub-sovereign entities such as provinces, municipalities, regional

or local special purpose entities, etc. are permitted to borrow in any form, appropriate legal and financial structures that permit such entities to be reliable borrowers, (e.g. taxing power and the legal latitude to use it to secure debt, means of pledging intergovernmental flows from higher levels to lenders or bondholders, etc.)

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TEXT NEEDED HERE FOR OTHER PROPOSALS State Revolving Funds (SRFs) South-South Emerging Market Export Credit Agency

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REPORTED PROBLEMS: When questioned as to why investment levels are low in developing countries, investors report that the largest deterrents are perceived unacceptable levels of regulatory risk and currency risk.

Both domestic and international investors perceive unacceptable risks of governments changing government policies that are critical to project success, such as changes in tariffs and laws. Failure to address regulatory risk is equivalent to abandoning the international capital markets in favor of local currency markets or of deciding to wait until each developing country has achieved an acceptable country risk rating and track record to overcome investor fears about developing country exposure.

Currency risk is also a critical impediment, as even countries with local capital markets require offshore funding, given the huge unmet need for financing. Therefore, a precondition for developing country access to private sector capital is the provision of targeted risk mitigation services to investors that covers regulatory and currency risks (including inconvertibility and currency mismatch risk).

RECOMMENDED ACTION STEPS:1) Multilateral and Bilateral entities should establish or significantly

increase the resources for mitigating regulatory and currency risk programs.

2) To determine the appropriate level of funding, each entity should perform a due diligence impact assessment of the current use of the development resources, comparing current uses against regulatory and currency risk programs. (This management process action step is detailed in Area Focus Five.)

3) A menu of options for regulatory and currency risk instruments should be developed, drawing on best practices with extensive private sector

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4) REGULATORY AND FOREIGN EXCHANGE RISK. Official sector institutions need to collaborate with private sector experts in designing new financial structures that correspond to market needs in two specific areas blocking mobilization of capital, government regulatory risk and foreign exchange risk. Frameworks for two instruments need to be developed for immediate large-scale replication by multilateral and bilateral institutions:

Contingent regulatory guarantee facilities at both a country and official sector level, so that country project-specific regulatory guarantees can be counter guaranteed by creditworthy multilateral and bilateral entities

Country foreign exchange liquidity facilities at both a country and official sector level, so that country devaluation liquidity guarantees can be counter guaranteed by creditworthy multilateral and bilateral entities

Please see the specific proposals below for details.

involvement, including the large-scale application of the following instruments: contingent regulatory facilities, liquidity reserve facilities, and regional swap facilities. (For details, please see below section on detailed proposals).

BENEFITS: Enormous increase in both domestic and international investments, with resulting benefits to countries and their citizens: If adequate instruments can be developed to mitigate regulatory and currency risks, the current impasse in infrastructure finance would come to a rapid close, opening up sources of private capital from both equity and debt markets in-country as well as overseas.

OBSTACLES: While numerous studies and papers such as the Camdessus Report have called for such instruments, public sector officials currently lack the mandate to establish such facilities. The appetite for innovation is stymied by fears of failure, and the current risk management guidelines that mimic private sector due diligence requirements of avoiding these types of risk. For needed changes in internal management processes, please see Action Area Seven. [VERIFY & ADD HERE]

SPECIFIC PROPOSALS (submitted by expert)

Facility for Contingent Guarantee to Mitigate Regulatory Risk Facility for Liquidity Devaluations

1) Proposal: Multilaterals set up mega facilities for Contingent Guarantees to Mitigate Regulatory Risk that can be used to guarantee local government guarantees

Structure: Few developing-country infrastructure projects have explicit contractual undertakings from the host country government that are capable of serving as the basis for traditional breach-of-contract political risk insurance coverage. What is proposed here is a project-specific guarantee that could, in turn, be guaranteed by a multilateral agency or other appropriate entity. The host government would promise to abide by certain critical features of the regulatory regime that it established at the time new infrastructure investments were made by private investors (domestic or foreign). These critical features would include items such as the manner and timing of tariff adjustments and other features such as performance standards, which could fundamentally affect the amount of revenues earned by the project and, thus, its ability to meet its debt service obligations. The guarantee would not have to freeze all aspects of the regulatory regime: certain performance standards could be changed so long as enforcement were by means of fines that are limited in size or subordinated to payment of the project’s debt service.

The amount payable under the guarantee would be large enough to insure that the host government will take its obligations seriously and to raise the local currency rating of a project covered by the guarantee to investment-grade. The guarantee would be contingent in that it could be called only if the government were to change

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the pre-established regulatory regime. The host government would, therefore, have no liability under the guarantee so long as it continued to enforce the regulatory regime that it had designed and implemented.

Contingent guarantees should continue to be used (1) until the host-country government is viewed as having a sufficient amount at risk that change of the regulatory regime is no longer viewed as a practical possibility or (2) until the government has established a track record of regulatory stability. In the first case, the measure of success will be the ability of new infrastructure projects to obtain investment-grade local currency ratings without the use of a contingent guarantee. In the second case, the ability of projects subject to such guarantees to obtain investment-grade local currency ratings without them could allow the guarantees to fall away and terminate the contingent guarantee program.

Although this type of guarantee could be used in many infrastructure sectors, the following example illustrates its use in the electric power sector. The project covered by the contingent guarantee is assumed to sell power pursuant to power purchase agreements (“PPAs”) which have been reviewed and approved by the host government. The government will make the following commitment:

In the event of a payment default under a PPA, the government would require the independent system operator or market settlement agency to:

Give dispatch priority to the project, and Establish a minimum market price equal to the price of power in the

defaulted PPA, or Subject to a cure period (both for the defaulting purchaser and for the

government) make a payment to the project equal to 40%-50% of the project’s senior debt amount. The amount of the guarantee (40%-50% of senior debt) is based on the amount of contingent support which each of the three major rating agencies have indicated is necessary to raise to low investment grade the rating of a transaction which in the absence of support would be several notches below investment grade.

Benefits: This structure will provide substantial benefits to host-country governments, project sponsors, and lenders:

Host-country governments would benefit because the structure will promote needed investment at lower cost. (To be effective, contingent guarantees would have to be combined with inconvertibility coverage and foreign exchange liquidity facilities to achieve investment-grade foreign currency transaction ratings.)

To the extent that multilateral agencies do not reduce the host country’s lending limit dollar-for-dollar with the amount of the contingent guarantee, the host country will make a more efficient use of its borrowing capacity.

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The structure addresses one of the major concerns of project sponsors, which are currently reluctant to make new equity investments in countries that they perceive as posing significant regulatory risk.

The structure also addresses lenders’ major concerns, which include both regulatory risk and the lessening credibility of partial credit and co-financing schemes involving multilateral agencies.

If used in conjunction with inconvertibility coverage and a foreign exchange liquidity facility, contingent guarantees could provide a structure in which a project’s debt rating is significantly de-linked from the sovereign’s rating. Emerging markets investors (who choose to take sovereign risk) provide little financing for infrastructure projects; but the “buy-and-hold” investors, who finance highly structured infrastructure projects, do not want to take sovereign risk.

Contingent guarantees represent the least onerous means of addressing regulatory risk: The host government promises to do what it should want to do anyway, and its guarantor takes little real exposure on a guarantee which is substantially less in both amount and risks covered than a direct debt guarantee capable of mobilizing a similar amount of private capital.

Obstacles to Date: Although there may be one or more transactions in process which involve this type of guarantee, it represents an approach which, in effect, has not yet been tried. One potential obstacle is the fact that multilateral agencies will account for their exposure under the contingent guarantee as equivalent to a full debt guarantee, rather than taking account of the fact that they are exposed to a narrow segment of risk defined by the prospect of the host government’s breaching its commitment to maintain its regulatory regime for the sector in question. It would clearly be better for all concerned if the accounting used for the transaction were similar to that used by monoline insurance companies, but even in the absence of such an approach, contingent guarantees represent a more efficient use of multilateral resources.

Another obstacle is failure to recognize that this is an issue that must be addressed. In the 1990s, numerous capital markets transactions were executed for projects in low investment-grade countries or, in some cases, in below investment-grade countries. These transactions did not utilize structures to deal with regulatory risk (or devaluation), but these transactions could not get done today.

2) Proposal: Multilaterals set up mega facilities for Foreign Exchange Liquidity to Mitigate Currency Risk that can be used to guarantee local government guarantees

Governments can establish their own FX liquidity facility programs, with multilaterals guaranteeing their obligations. A foreign exchange liquidity facility is designed to protect developing country projects by providing funds to cover cash flow shortfalls resulting from exchange rate fluctuations. Developing country

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infrastructure projects are particularly in need of this protection because they typically receive all of their revenues in local currency but may be financed with long-term debt denominated in US dollars. Foreign exchange liquidity facilities are designed to be used with projects that receive revenues adjusted in accordance with local inflation. The resulting US dollar value of the project’s cash available for debt service varies with changes in the FX rate, but historical evidence indicates that, for most countries, sharp declines in the real FX rate tend to be self-correcting within a reasonable period. An FX liquidity facility provides cash to cover debt service shortfalls when the real FX rate has declined dramatically, and the facility is repaid by the project on a subordinated basis from surplus cash when the real FX rate recovers. The structure of an FX liquidity facility is illustrated in the diagram below.

A US$30 million FX liquidity facility provided by the US Government’s Overseas Private Investment Corporation (“OPIC”) was used in Brazil for the US$300 million AES Tietê transaction in 2001. The transaction refinanced short-term debt incurred by subsidiaries of AES in acquiring a ten-dam hydroelectric generation company that was privatized by the State of São Paulo in 1999. The Tietê securities, which had a 15 year final maturity and a ten-year average life, were rated Baa3 and BBB- by Moody’s and Fitch, respectively. Although electric power rationing in Brazil resulted in the Tietê transaction’s being restructured in 2004 so as to eliminate the OPIC coverage, the coverage worked as intended during the continuing currency decline which followed the closing of the transaction.

Benefits: FX liquidity facilities offer benefits to host governments and their public, to those agencies that provide the liquidity facilities, to project sponsors, and to lenders:

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Line 1: Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection)

Line 2: Annual debt service requirements in US$ (principal and interest)Line 3: Actual value in US$ of cash in local currency, indexed to host country

inflation rate

0

Line 2: 67%

Line 1: 100%

15

1.0

1.50

Time (in years)

Value in US$

Debt ServiceCoverage RatioLine 3

Amount repaid to the Liquidity Facility

Debt service shortfall amount to be recovered by drawings under the liquidity facility

Structure of a Foreign ExchangeLiquidity Facility

Lengthen tenors of US dollar-denominated debt to finance infrastructure projects

Lower cost of financing (both spreads and cost of risk mitigation structures) Lower costs and longer tenors enable infrastructure services to be provided

to the public at lower tariffs Protect the public from having to bear pass-through of FX-related costs Protect sponsors from having projects default as a result of adverse

exchange rate movements Increase the attractiveness of developing country debt to lenders Leverage support provided by governmental / multilateral agencies (e.g., in

the Tietê transaction, OPIC’s US$30 million FX liquidity facility attracted US$300 million in private financing)

Obstacles to Date: Although the Report of the World Panel on Financing Water Infrastructure (“the Camdessus Report”), published in March 2003, recommended the use of FX liquidity facilities for infrastructure projects, no transactions other than Tietê have utilized FX liquidity facilities. Among the reasons for this lack of follow-up, some are temporary and Brazil-specific, while others are more significant and require additional effort to overcome.

Immediately following the closing of Tietê, Brazil instituted rationing of electric power because of drought and low reservoir levels in its primarily hydroelectric national generation system. Following the end of rationing, consumer demand remained depressed and new capacity was not needed in the near term.

Two other factors, however, are more important in determining the subsequent use of FX liquidity facilities. First, although project sponsors are always interested in protecting their projects from devaluation, the FX liquidity facility structure requires explanation and few parties are available to provide it. The Tietê transaction was documented as a standby loan commitment, which meant that OPIC was required to keep its terms confidential. There has been very little effort to educate potential project sponsors regarding the benefits of the structure.

Second, and even more important, is the difficulty of obtaining an appropriate local currency rating for transactions which might be candidates for use of an FX liquidity facility. The Tietê transaction breached Brazil’s sovereign ceiling by using US$85 million of political risk insurance covering the risk of currency inconvertibility. On a local currency basis, the transaction was regarded as investment grade because of its low operating risk and because Tietê sells the bulk of its output to Eletropaulo, a distribution company that at the time the transaction was closed had an investment-grade local currency rating. (OPIC’s FX liquidity facility prevented the transaction’s US dollar debt from driving the transaction rating down to the foreign currency sovereign ceiling.)

Most infrastructure sectors are viewed as politically sensitive and subject to political interference in tariff adjustments. As a result of this regulatory risk, the

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local currency ratings of infrastructure projects are almost always capped by the sovereign’s local currency rating. Unfortunately, few developing countries have investment-grade local-currency sovereign ratings. Without a mechanism for mitigating regulatory risk, most transactions that could be structured using inconvertibility coverage and an FX liquidity facility will remain with below investment-grade (local and foreign currency) ratings. Under these circumstances, the cost and effort required by the transaction’s structure would be wasted.

REPORTED PROBLEMS: With the sole exception of the EBRD, official sector agencies were all created with mandates and charters that did not include the objective of mobilizing private sector capital. In the case of the BWI, only in ________ was the IFC created, and thereafter the private sector units of the other regional development banks. In addition, the sovereign structure did not accommodate the current expansion of decentralized political authority to states and municipalities, or the use of regional organization to advance regional economic integration.

The ability of official sector entities to work effectively with the private sector has been uneven, with investors reporting little or no progress. The issue is compounded by management structures and charters that largely reflect political considerations, with no systemic way to integrate input from the private sector on how to mobilize private sector capital and expertise.

While these issues have been debated in a number of studies over the years, there has been an impasse in making any progress given the political sensitivity and practical problems of devising action steps.


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5) REDEPLOYING CAPITAL OF WORLD BANK GROUP AND OTHER DEVELOPMENT BANKS. The capital structures and charters of official sector institutions need to be realigned with the specific objective of maximizing the leverage of official sector capital (i.e., the efficiency of each taxpayer dollar). Political leaders need to implement open audits and investor/client surveys immediately to remedy impediments in the following areas:

Allocation of capital to different official sector units (on global level within respective Bretton Woods institutions, at regional level within regional development banks, on national level between bilateral development agencies)

Charter rules that impede effectiveness need to be openly disclosed and changed accordingly (for example, restrictions on dealing directly with subsovereigns, working with other donors, beneficiaries not being member states, length of tenors, etc)

MORE HERE?

1) Political leaders issue new directives for official donor entities, stating that they must demonstrate in concrete measures their performance in maximizing the leverage of official sector capital (i.e., the efficiency of each taxpayer dollar) by partnering effectively with private sector and other donors, complementing rather than substituting private sector or other donor funds

2) Political leaders institute the requirement for external third-party audits specifically geared to measuring how official resources have been leveraged (including extensive confidential investor and government client surveys), and openly disclose results

3) Based on the results of the audits and investor/client surveys, political leaders with their constituencies realign official sector resources and change charter rules, outsourcing operations to other donors and private sector entities as most effective Move internal capital Change needed charter rules

MORE HERE?

BENEFITS: By more effectively allocating capital and easing charter rules, enormous progress would be made in meeting the development objectives set forth in the Monterrey Consensus and Millennium Development Goals.

OBSTACLES: The impediments to changing capital allocation and charter rules are enormous, encompassing the obstacles noted in the earlier recommendations. For example:

Inherent organizational bias for lending (rather than guarantees or outsourcing), given larger organizational size, portfolio, profitability, and individual rewards

Political desire to control disbursements and maximize political influence Bureaucratic inertia (e.g., vested interests benefiting from status quo) Difficulty of reducing or eliminating services/products, and making the

resulting staff reductions

SPECIFIC PROPOSAL (submitted by expert)

Proposal to Unbundle Official Support: Senior-level executives declare their commitment to maximize private sector participation in leveraging official sector resources, execute a systemic audit, and unbundled/realign product and service offerings accordingly.

For each official sector entity, a third party expert organization conducts an openly disclosed “private sector mobilization audit” of its use of taxpayer funds. The results of the audit would be used to reallocate its capital to further leverage official sector resources. In essence, official sector entities would “unbundle” their

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offerings to the maximum extent needed to enhance private sector participation and leverage official sector resources.

Each current business line or product offering would be assessed against the ongoing activities of the private sector. The audit would include extensive interviews with relevant private sector actors. Each product must be “unbundled” such that the basic components will be put to the test:

1. Is the official institution operating in an area where there are private players? Specifically, is the institution ever in direct competition with the private players? If so, is the playing field at least level and do private sector competitors report that the official sector is reducing private sector participation or increasing it?

2. Are the same products also available in the private market, and is do, what is the value-added of the official sector offering?

3. Are there parts of the product delivery that could be assumed by the private sector? For example, in credit insurance, could the use of brokers replace sales staff?

4. To what degree are the official sector resources focused on the required areas for increasing private sector participation? Specifically, are there parts of the product that only the official sector can offer? What are the specific risks that the private sector simply cannot take or certain quantities of risk that is too large?

Background: Official bilateral and multilateral institutions have been established to meet needs which exist in the market, whether it is to finance national exports (Export Credit Agencies), whether it is to finance foreign development (Bilateral and Multilateral Development Finance Institutions) or whether it is to finance domestic development (National Development Banks). The market gaps that these institutions were originally designed to address change over time as both the private sector sources of finance evolve and as the needs of the market change. What is more difficult to adjust is the focus and behavior of the official institutions to address the market gaps.

If an official institution is restricted to operating only in market gaps, then it is vital to review in considerable detail what constitutes a market gap, and also to bear in mind that the gaps may change significantly in a relatively short period, partly as perceived risks change, but also as available capacity in the private market fluctuates.

It is imperative that official sector institutions operating in the market gap stay abreast of market developments in order to understand and work with the private sector players and adjust their approach accordingly, to ensure that they neither crowd out the private sector, nor indeed help create the very market gaps they are designed to fill by offering market distorting pricing.

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The case under review is Export Finance Insurance Corporation in Australia, the official ECA. In 1997 EFIC introduced a guarantee program for capital goods and project exports. Prior to that EFIC only operated as a direct lender. Driven by the government’s “competitive neutrality” policy which dictated that Government Business Entities should not compete with the private sector given the institutional advantages inherent in government ownership, they analyzed what parts of their business could be undertaken by the private sector.

The analysis concluded that the commercial banks were now able to offer long-term foreign currency finance, but may not always be in a position to take the credit risk associated with foreign borrowers in emerging markets. As a consequence, EFIC introduced a guarantee as an option for exporters who then had the choice of asking EFIC to finance or EFIC to guarantee the financing bank. From EFIC’s perspective, they became completely neutral as to whether EFIC lent or guaranteed, as the government then required it to pay its Treasury Profits into a special account.

Benefits: In the case of EFIC, the main benefits to Australia were:

De-monopolizing of export finance in Australia Domestic (e.g. ANZ) and international (ABN Amro) commercial banks

becoming significant players in the export finance market, domestically and abroad

No clear impact of the initiative to increased Australian exports, but improved competition in the export finance market

However, in the advent of import-originated financial packages, the importance of a global bank with whom the importer does direct business being able to influence the procurement decision is critical. Without having an internationally competitive export credit guarantee, Australian exporters might not have seen possible procurement opportunities brought to their attention.

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REPORTED PROBLEMS: For decades the need to insure greater donor coordination has been widely acknowledged, with a number of proposals and initiatives launched to enhance “aid effectiveness.” However, success has been limited given the different political interests and operating processes of the respective donors. Redundancy erodes effectiveness while both central levels and subsovereign government officials lack basic support tools for developing infrastructure and basic services. The need for coordination is particularly acute given the increasing number of both donor entities and developing country recipients (i.e., thousands of donor organizations from countries and NGOs; developing country recipients increasing to include more subsovereign and regional entities as well as NGOs).

The imperative for improvement in this area is compelling, given the continued massive costs of redundancy, failed programs, and waste of public resources. Given the recognized need to better leverage private sector resources, such coordination frameworks need to include private sector providers of capital and experts who can help design effective strategies to achieve regional and national development objectives and advance regional economic integration.


1) Signal priority of donor collaboration with a publicly declared mandate: A clear signal needs to be sent to aid officials in their respective agencies:

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6) DONOR AID COORDINATION. Official sector institutions need to create streamlined standardized mechanisms for donor coordination at the global, regional, and country level, including explicit structures to leverage official sector resources by mobilizing private sector capital and expertise (i.e., above eleven instruments). Frameworks for four types of donor coordination mechanisms need to be developed for immediate large-scale adoption by multilateral and bilateral institutions:





In addition, all donors need to adopt basic principles of non-compete and coordination (see below).

Senior political leaders need to clearly state the high-level commitment of donor agencies to prioritize aid efficiency in advancing national development objectives and regional economic integration, rather than be driven by home country bureaucratic and political guidelines. Governments must agree not to fight over whose flag dominates any particular project, but rather coordinate to maximize the respective core competencies with open consultation and use of private sector experts. (Question: Should there be a protocol signed at FfD high-level meeting?)

Create official sector syndication framework building on private sector syndication success stories: For decades the private sector has used syndications to bring together dozens of financial institutions to fund large transactions. By establishing a standard set of procedures, donors could cost-effective pool funding for debt, equity, and currency transactions at global, regional, and country levels. Two immediate actions can be taken:

Other countries can follow the lead of US AID and JIVC, agreeing to participate on a country basis in guaranteeing local transactions. MORE HERE

A central coordination committee of experts drawn from the public and private sectors could be tasked to develop new streamlined structures and procedures for donor pooling building on precedents used by the private sector for large syndication transactions, and disseminate the guidelines complete with logistical information on respective donor services and contacts.

4) Create Sector-focused Donor Tables on a Country and Regional Basis : Ad hoc donor tables have been established in many countries over the years, but no standard framework exists for facilitating cost-effective coordination. Establishing a sector orientation for each donor table would best facilitate the financing of national development objectives and regional integration efforts, as global competitiveness strategies are increasingly articulated through sectoral strategies. Involving private sectors will be critical to success, given the imperative for harnessing private sector expertise and capital. Two immediate actions can be taken:

Developing country governments and regional organizations can immediately set up Sector Donor Tables, using the assessments on global competitiveness and development objectives as a basis for prioritizing projects. (The World Bank has implemented this process in developing countries.)

A central coordination committee of experts drawn from the public and private sectors could be tasked to develop new streamlined

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structures and procedures for sector-focused donor tables, and to disseminate end recommendations to all parties.

Critical again is the systemic involvement of the private sector in both process design and actual donor tables, to insure the actions taken will maximize the mobilization of private sector capital.

5) Create “Global Sector Capacity-Building Kits” consisting of principles, implementation guidelines, and training guides that enhance developing country capacity to execute transactions: Much of the expertise needed for sectors is uniform across countries and regions, so there is an opportunity to enhance efficiency in donor resources by producing global capacity-building kits that include the broad principles needed to be successful, as well as implementation guidelines, and actual training guides.

6) Create “Consultative Mechanisms to Build Country Criteria” for official sector entities and key private sector entities to build local capital markets and global competitiveness (including business organizations, financial institutions, rating agencies, and other key actors): The building block for mobilizing private sector capital begins at the country level: what are investor perceptions of risk and what are the best ways to minimize that risk? Consultation with rating agencies, targeted project sponsors, capital market participants, and other experts will enable the precise identification of the current impediments blocking finance in the country, as well as the possible deal structures and risk mitigation tools that can specifically address those risks. These consultations can be utilized to develop a “country criteria” to focus the use of donor funding on the critical risks and mitigating mechanisms needed to unlock finance for that country’s priority development objectives.

BENEFITS: Again, the enormous benefits to all parties from enhanced donor coordination are widely acknowledged, given enhanced aid effectiveness and overall growth in developing countries and increases in living standards.

OBSTACLES: The extraordinary difficulty of enhancing coordination between donors is well-known. Reported impediments are political, as well as logistical. The lack of focused political commitment is reported as a key impediment.

SPECIFIC PROPOSAL (submitted by expert):ANY MORE HERE TO ADD RE:



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Host Government Market Research Proposal (to incorporate donors?)

Proposal and Background.

As a form of “market research,” governments seeking to attract foreign direct investment in infrastructure should engage in systematic dialogue with potential investors to identify the features that specific projects will need in order to attract capital. In particular, this dialogue should seek to identify perceived regulatory risks and identify specific steps the governments could take to address investor concerns about those risks.

In the last few years, potential infrastructure project investors have become much less interested in pursuing projects in developing countries. One important reason is the perception that such projects face significant regulatory risks.

In this environment, governments seeking to attract foreign direct investment need to be prepared to design projects in ways that will overcome investor concerns and perceptions of risk. But without direct dialogue with investors, it may be impossible for governments to develop a clear and accurate understanding of market perceptions, and of the features that projects must have to attract capital. Ideally, governments would invite bids on projects only after engaging in a dialogue with the market, so that the project design ultimately offered to the market would be one with a high likelihood of success.

Benefits:

Projects that successfully address likely investor concerns are more likely to attract significant investor interest.

Projects designed to address investor concerns are more likely to be executed successfully.

Projects that do not successfully address investor concerns at the beginning may be more vulnerable to renegotiation later.

Governments might benefit from assistance in

identifying potential investors to speak with; focusing the discussion with those investors; and formulating viable responses to those investors’ concerns.

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Next Steps: Multilateral or bilateral institutions to provide technical assistance for the purpose of starting government/investor dialogues of this kind.

OTHER SPECIFIC PROPOSALS???

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REPORTED PROBLEM S : A huge divide separates the officials and private sector, eroding the potential for leveraging official capital and enhancing the scope and effectiveness of development aid. Issues as noted in prior sections are multiple:

Low Risk Appetite : Experts in the private sector report that official creditors are competing with private sector and other donors (“everyone chasing the same small number of deals”). The issue is evidenced by the low usage in many official sector of existing approval lines for working with the private sector.

Inconsistent Treatment of Risk-Sharing Instruments : Official sector entities vary widely in their views of the risk associated with guarantees, with some treating them as equivalent risks as loan exposures, some riskier (counting interest payments), while others treat them as less risky (4:1 scoring). None are reported as compiling with the private sector guidelines given by Basel II.

Ineffective delivery of services failing to maximize private sector participation: Investors report that partnering with official sector entities is too costly, in effect a “specialized business.” One key issue is the lengthy decision process, with as many as five committee approvals needed. The lengthy decision process is allegedly complicated by human resource staffing problems (for example, creating positions for senior officials with no other responsibilities). MDBs approval process can get stuck or delayed for internal reasons difficult to assess for the private sector clients. Delays are highly detrimental to successful closing of deals and involve high extra costs. In addition, complying with requirements of MDB is today more

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7) INSTITUTIONAL CULTURE CHANGES. For official sector institutions to partner effectively with the private sector and optimize use of official sector resources, senior management must take the lead in devising new management incentive programs and processes that change the behavior of officials and processes. Specifically:

Senior Political Leaders commit to creating new performance incentives, measurements, deliverables and targets, and revise management processes in line with stated mission of maximizing aid effectiveness, including strict rules against direct competition with the private sector (“no compete” rules)

All official sector officials responsible for risk management change in line with senior directives risk management policies (leverage, loss reserves, limits, surveillance, transaction approval processes, etc), and report openly on results

Explicit integration of private sector expertise into all levels of operation (e.g., third-party surveys of investors, private sector “testing” deals, meaningful broad-based business advisory groups), with open dissemination of recommendations and discussions


difficult due to the increased complexity of environmental and social requirements.

High transaction costs , making difficult smaller size transactions and excluding less sophisticated sponsors with potentially good projects. MDBs are reported as not learning from their own past experience in deal transactions, for example with entire new analysis is required for a project similar to one already financed/guaranteed.

PROPOSED NEXT STEPS:

1) Senior Political Leaders make a public commitment to creating new performance incentives, measurements, deliverables and targets, and revise management processes in line with stated mission of maximizing aid effectiveness. Progress reports would be made regularly in public forums and documents.2) All official sector officials responsible for risk management change in line with senior directives the following risk management policies, and report openly on results in public douments:

Establishment of explicit loss reserves for “unacceptable” high-risk exposures and first-loss risk mitigation partnership programs with private sector (i.e., explicit assumption of risk unacceptable to private sector)

Maximization within prudent guidelines of leverage “scoring” policies (if applicable, in consultation with rating agencies to insure consistency with AAA rating criteria)

Revision of internal country limit policies with expert guidance from third-party experts, insuring different risk profile of guarantees and other risk-sharing exposures is recognized in sublimits

Revision of internal policies to meet private sector due diligence requirements in all private sector programs (for example, timely payouts when guarantees called; coordination of surveillance, remediation and work-out strategies carefully coordinated through intercreditor agreements, continuing communications, etc.,) with the full knowledge and participation of the host sovereign government

Disciplined streamlining of transaction approval processes, with open disclosure of decision-making process and decision-makers

Specific changes in management relations with private sector Explicit policy of “no compete” with private sector Engagement of private sector in “testing” deals, with the market guiding

the needed official sector interventions and supports Establishment of meaningful, broad-based business advisory groups at the

global, regional, and country levels on how to enhance official sector effectiveness, with open dissemination of recommendations and discussions

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BENEFITS: Again the potential benefits are enormous, given increased productivity and mobilization of private sector capital and expertise.

OBSTACLES: The issues overlap with those of either recommendations, given the political nature of official sector entites and the natural tendency to resist business-oriented practices. The only way to override these issues is thought to be senior political leadership enacting new incentive frameworks, coupled with disciplined open progress reports that have clear performance critiera.

SPECIFIC PROPOSALS (submitted by experts)

Measuring Performance to Incentivize Organizational Change Changing Official Sector Processes Building Private Sector Expertise in the Official Sector Creating Demand Risk Mitigation into Host Government Programs

1)Measuring Performance to Incentivize Organizational Change For all relevant institutions, develop a broad-based list of performance measures, including input, output and impact measures, which consider the universality of stakeholders and link to the clearly defined strategy of the institution as it is articulated and understood by all employees.

Rationale: Measuring performance is like measuring risk. If you can’t measure it, you can’t manage it. The key concept in modern day risk management is that risk must be identified, measured, managed and monitored. Similarly, good performance must be defined, and then progress against that standard must be measured, managed and monitored.

There has been much research conducted on the relationship between measuring performance and organizational change. The Balanced Scorecard methodology developed by Kaplan and Norton has been applied to many organizations that have seen change. This change has typically been driven by:

The selection of appropriate performance measures reflecting the strategic objectives of the organization;

The setting of targets that are ambitious but achievable; The communication of these targets throughout the organization and their

relevance to an individual’s day-to-day activities; and Financial incentives (i.e., bonuses) for achievement of targets

In a healthy organization, human nature is such that if goals can be well articulated and clearly understood, individual will strived to accomplish those stated goals.

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It is much more difficult for official institutions to identify what good performance means than private institutions whose mandates are more straightforward. The challenge for official institutions is to balance financial viability (i.e. profit optimization rather than profit maximization) with other stakeholder needs.

Using EDC in Canada as an example, there has been much success in focusing on its key objectives:

Increase number of customers Increase business volume supported Financial sustainability

Taken together, these seem, on the surface, to be relevant and appropriate objectives. However, it is not axiomatic that growth is a good thing for official agencies. They need to measure not just their output but their impact. For example, within EDC there has traditionally not been a focus on maximizing the involvement of private sources of finance or insurance. Without the focus on collaborating with the private sector, Canada is in a difficult position of having few export finance alternatives but EDC.

Benefits: The benefit of having well defined measurable performance targets that are related to the strategy of the organization is clear. This is true for private sector companies, as well as official institutions.

Targets must always be linked to strategies and strategies must reflect the universality of stakeholders. It is a mistake for official institutions to forget that their existence is due to the fact that the private market is not functioning in a certain way and therefore these institutions are by design mandated to fill that gap. Therefore, without performance measures that monitor the extent to which the gap is being filled or the private sector is being catalyzed, the scorecard is not balanced.

Obstacles: The most significant obstacle for official institutions in measuring their performance is to appreciate and incorporate the views from the full range of stakeholders in defining the institution’s strategy. Many official institutions are good at defining their input measures (e.g. # of employees), their output measures (e.g. # of new loans signed) and even some of their impact measures (e.g. #of jobs created). However, other impact measures, such as the extent to which incremental private sector lending is catalyzed, are not monitored.

In addition, the human tendency to think growth is better than decline means that, on the face of it, an official institution that decreases its outstandings from one year to the next is often judged to have performed badly. If, however, in decreasing its outstandings, the institution facilitated more finance (i.e., market was able to function with less intervention from the official institution), the institution’s success needs to be documented, acknowledged, and rewarded.

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2) Proposal to Change Official Sector Processes

In instances where there is any degree risk-sharing between multi-lateral or bi-lateral lenders/guarantors and private sector lenders/guarantors, surveillance, remediation and work-out strategies should be carefully coordinated (through intercreditor agreements, continuing communications, etc.) with the full knowledge and participation of the host sovereign government.

Long term debt is essential for concession and other forms of public private partnership in infrastructure. Lending and guaranty guidelines and regulations should be reviewed to ensure maximum incentivization for aligning interests of debt and equity. Surveillance and enforcement procedures should also be reviewed to ensure adherence to the lending/guaranty guidelines and regulations for the transaction’s life.

Structural features of infrastructure transactions deal should continue to guard the clear seniority of the debt in the waterfall. Dividend lock-up features designed to maintain comfortable debt service coverage cushions and other devices are essential and they should be maintained for the life of the deal to maintain the incentives for equity to perform as near to closing base case expectations as circumstances permit.

Strict arms-length relationships between concessionaires and related construction contractors (which are often shareholders in the concessionaire) need to be maintained to prevent some shareholders from effectively getting their equity out at the start of the transaction’s life.

Protections like political risk insurance provided to equity should always be provided in equal or greater quantity and quality to debt as to equity; otherwise, equity has an exit strategy not available to debt. When equity has a means of exiting before debt via PRI, it loses the most compelling reason for acting in the best long-term interests of both debt and equity.

3)Proposal to Build Private Sector Expertise in the Official Sector

Official sector entities need to develop either in-house or through reliable joint venture agreements with the private sector the full range of capabilities necessary to execute financial transactions successfully in developing countries. Critical success factors include the following:

Local knowledge of and 24/7 presence in each country which qualifies for participation, including a good relationship with the

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sovereign government memorialized by a financial stake by each host nation in the external guarantee entity itself.

Close linkages with reliable sources of project preparation assistance to every borrower;

Close linkage with reliable sources of local debt market development assistance;

Deal design and closing skills akin to those of investment bankers or monoline insurers active in the international markets;

Risk analysis and underwriting skills akin to those of the major rating agencies and monoline insurers active in the international markets;

A well-established relationship with the international and affiliated or non-affiliated local rating agencies;

Back book surveillance and proactive deal remediation capacity akin to that possessed by the best international commercial bank lenders or private sector financial guarantors;

Back offices capable of providing the administrative and systems support characterizing high quality private sector financial guarantors and lenders.

2) Proposal for Creating Demand Risk Programs Fair, transparent demand risk mitigation programs should be developed by host countries for use in cases where demand forecasts turn out to be too high due to circumstances beyond the private sector partners’ control. Multilaterals and bi-laterals should play their part by setting and maintaining very high standards for the quality of demand forecasting for any infrastructure projects.

Demand forecasting in emerging market countries is often going to be wildly inaccurate for a variety of reasons, including difficulty obtaining reliable data, the unfamiliarity of demand forecasters with country-specific circumstances for specific sectors (e.g. willingness to pay for trip-time savings in a given country’s vehicular transport sector, etc.)

Some statistical techniques can be employed to obtain a better understanding of the range of uncertainty inherent in demand forecasting, but these will be of limited use if the underlying data is poor or if historically unprecedented risks emerge (e.g. 9/11).

Sponsor bias has been strongly suggested by the rating agencies as a major contributing factor in the demand forecasting error.

Chile seems to be leading the way recognizing the need for demand risk mitigation available in case it is needed to remediate a transaction. its mechanism for the distribution of income (“mdi”) program mitigates

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demand risk for those concessionaires that need it by providing a variable concession term in place of the initially fixed concession term, effectively transferring all or most ultimate highway and air traffic demand risk back to the government from the private sector. this concession agreement modification is provided to the private sector partners at a price set by formula to make sure that it is “revenue neutral”.

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summary of key recommendations on enhancing official...

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