Mobilizing Private Capital: Guarantees and Contingent / Risk Finance

1. Mobilizing Private Capital: Guarantees and Contingent / Risk Finance Workshop on Tools for Risk Mitigation in Small-Scale Clean Infrastructure Projects November 19-20, 2003 World Bank Paris Office

2. The Setting New lending to emerging markets was close to zero from 1998 through 2002. Total private capital flows to emerging markets were about $112.5 billion in 2002 against an average of $185 billion / yr. during the 1990s. From a project finance perspective, there is an increasing acknowledgement that deals simply will not get done in emerging markets without the multilateral financial institutions (MFIs), bilateral development agencies and export credit agencies (ECAs).

3. Risk Mitigation and the MFIs • “Traditional” Political Risks War and Civil Disturbance Expropriation and Confiscation Currency Convertibility/ Transferability • Contractual and Regulatory Risks • Credit Risks • Foreign Exchange Risks.

4. Risk Mitigation and the MFIs “Traditional” risks have changed. EXPROPRIATION – fashionable until the 1970s / 1980s but virtually nil now. The tendency now is to regulate rather than expropriate. CONTRACT FRUSTRATION – probably the main problem facing foreign investors in LDCs

5. Risk Mitigation and the MFIs Commercial vs. Non-Commercial Risks When the government is the offtake buyer or regulator, their “commercial” behaviour can result in situations that make it difficult to define whether a non-commercial or commercial risk has materialised.

6. Partial (Political) Risk GuaranteesNeeds Sovereign Guarantee IBRD PRG Debt AsDB PRG for Public Sector Debt IsDB Credit Insurance Debt IsDB Master Insurance Debt Covers War/Civil Disturbance, Expropriation/Confiscation, Currency Convertibility & Transferability

7. Partial (Political) Risk GuaranteeNo Sovereign Guarantee Needed MIGA Political Risk Ins. Debt/Equity IsDB Foreign Inv. Ins. Debt/Equity IADB PRG (Private Sector) Debt AsDB PRG (Private Sector) Debt Covers War/Civil Disturbance, Expropriation/Confiscation, Currency Convertibility & Transferability

8. Regulatory & Contractual Risk Instruments Offered by the MFIs • Breach of Contract • Changes in Law • License Requirements • Approval and Consents • Obstruction in Process of Arbitration • Non-payment of a termination amount Products offered by MIGA are well understood but market is not as familiar with regulatory risk products offered by IBRD, AfDB, IADB, AsDB and IsDB – need more effective marketing of these services by MFIs.

9. Credit Risk Instruments Offered by the MFIsPartial Credit Guarantees IBRD (IDA) – covers latter maturities / extends tenor – will IBRD drop the sovereign counter-guarantee requirement? IADB – covers up to 40% of project cost up to $75 million, no sovereign guarantee needed – where are the deals? AsDB - $500 million to PSALM (Philippines) approved with sovereign guarantee in 2002. IFC – started providing cover in 2001 and now doing the business, flexible product, mostly financial sector but also some sub-sovereign infrastructure deals.

10. IDA PRG: “Asia Power Deal of the Year 2002”(Project Finance International) IDA Partial Risk Guarantee covers lenders in case the Government of Vietnam does not meet its commitments under the PPA. Loans ANZ, Société Générale, Sumitomo Mitsui Mekong Energy Company Government Undertakings Guarantee Indemnity Agreement Government of Vietnam World Bank

11. Credit Risk Instruments Offered by the MFIsPartial Credit Guarantees Need to have viable domestic financial institutions MFI has to evaluate commercial risk – private sector skills

12. Foreign Exchange RiskLocal Currency Financing Options AsDB, AfDB, EBRD and EIB: direct local currency financing / local bond issues. IFC, AsDB, AsDB: lending local currency and swapping IFC & IADB: also guarantee local bond issues

13. Foreign Exchange RiskDevaluation Backstop Facility World Bank recently announced intention to test a currency devaluation backstop facility in 2004/2005. • What are the devaluation trigger points? • What if the currency never bounces back and the host government can’t pay?

14. Credit Enhancement, Guarantees & InfrastructureMulti-Stakeholder Funds & Initiatives • Emerging Africa Infrastructure Fund • GuarantCo • DevCo

15. The Global Environment Facility (GEF) “The GEF shall operate, on the basis of collaboration and partnership among the Implementing Agencies as a mechanism for international cooperation for the purpose of providing new and additional grant and concessional funding to meet the agreed incremental costs of measures to achieve agreed global environmental benefits in the following focal areas[1]: (a) Climate Change, (b) Biological diversity, (c) International Waters, and (d) Ozone Layer Depletion.” [1] “ Instrument for the Establishment of the Restructured Global Environment Facility” (1994, amended 2002) http://www.gefweb.org/Documents/Instrument/instrument.html

16. Contingent Finance - GEF Contingent financing is conceptually attractive when there is substantial uncertainty about the existence and extent of incremental costs. Instead of committing to a grant which may subsequently prove to have been unnecessary, contingent financing recognizes the potential need for support but draws on public resources only when justified later, on the basis of actual rather than projected costs.

17. Contingent Financing Mechanisms - GEF • Contingent Grant: Unlike a conventional grant, a contingent grant is repaid to the GEF if the project is successfully financed. If the project is unsuccessful, the GEF funds paid out become a grant. • Contingent or Concessional Loan A contingent loan treated as debt and has a higher repayment priority than the converted grant. Treated as project equity or an asset unless another arrangement is negotiated. Could be forgiven if the project fails. A concessional loan is a loan at below-market rates. The availability of the concessional loan could be contingent upon participation of other commercial lenders to achieve co-financing and leveraging of non-GEF funds.

18. Other Financial Instruments – GEF • Partial Credit Guarantees GEF Partial credit guarantees are similar to those provided by the multilaterals. Used encourage private-sector lenders, such as commercial banks and leasing companies, to make loans for projects that they would otherwise not lend to. The risk of the loan is shared with the private lender. • Investment Funds For-profit, private sector, environmental funds that receive grant and/or non-grant funding from the GEF. The objective is to provide commercial or quasi-commercial financing to subprojects through a fund manager, with a possible financial return on capital.

19. Quick Look at Insurance for RETs • Pre-Construction Phase • Transit – marine, air, road – damage or delay • Construction Phase • Contractor’s All Risks (CAR) • CAR – Advanced Loss of Profits • Business Interruption (BI) • BI – Advanced loss of Profits • Latent Defect / Decennial • Operation Phase • Property Commercial All Risks All Risks Business Interruption

20. Advance Performance Third Risk Construction Resource Property Business Loss of Environmental / technology Contractors Workers Party Categories All Risks Exploration Damage Interruption Profits Liabilities risk overall risk Comp. Liabilities Wind Solar PV Wave / Tidal Geothermal Biogas Small Hydro Biomass Comprehensive cover Partial Cover No Cover Quick Look at Insurance for RETs Example RET Risk Transfer Heat Map Existing Insurance Products Courtesy of Marsh

21. Insurance for RETs: small is beautiful • Global Sustainable Development Group • ForestRe: New Global Forestry Insurance Capacity Need niche players with low overheads to cover small projects.

22. Contingent Risk Finance & ART Structures Risk Finance vs. Risk Transfer The Retention Decision Captives: the example of Forest Re (and the potential use of public contingent capital)

23. ART Deal in the Power Sector - Example Steep rises in premiums have increased the attractiveness of these structures. Munich Re described a double-trigger deal recently done with the power company Aquila for Business Interruption risk for gas-fired turbines in the USA as follows: IF a gas-fired turbine faced an unscheduled inoperative period THEN the reinsurer would finance the purchase of power in Aquila’s name. The two triggers for activation of the product are; 1) An unplanned outage at the facility AND 2) A spike in spot electricity prices – the contingent event for which the product would provide financial coverage.

24. Escrow Accounts Project Finance Reserve Accounts Liquidity Facilities Structured Finance (quanto hedges etc.) Tapping Islamic Financial Instruments GEF and the Private Sector Working with the MFIs and Bilateral Agencies Practicalities of Public-Private Interactions Some Topics for the Breakout Group

25. Thank You. Edmund Olivier eolivier@treebiz.com +44 (0)20 8674 1102