The Future of Project Finance Globally

1. The Future of Project Finance Globally SAID BUSINESS SCHOOL Nick Rouse, MD, Frontier Markets Fund Managers

2. PRESENTER BACKGROUND • MD of Frontier Markets Fund Managers since 2005; previously Non-Executive Director and member of the credit committee of EAIF (managed by FMFM) since 2002 • Previously 33 years at Barclays including running Barclays corporate business in East Africa and as head of credit risk for Africa and the Middle East • FMFM is the fund manager for two funds, owned by the Private Infrastructure Development Group, in turn owned by 4 governments (UK, Netherlands, Sweden and Switzerland), with involvement of Ireland, Austria and the World Bank. The Fund’s equity is leveraged with debt from KfW, Barclays, Standard Bank, DEG, FMO and DBSA. FMFM manages: • The Emerging Africa Infrastructure Fund (EAIF), a fund providing long term project finance debt in Sub Saharan Africa in USD or Euro. The current fund size is USD 500 million. • GuarantCo, a fund providing long term guarantees for project financings and capital market issues in developing countries worldwide. The current guarantee portfolio size is USD 300 million. Counter-guarantors are KfW and Barclays. FMFM assumed management of GuarantCo in 2006; its current portfolio and pipeline involves projects in Africa, India and the Caribbean. Future of Project Finance Globally

3. PRESENTER TRANSACTION EXPERIENCE • EAIF and GuarantCo have about one third of their portfolio invested in telecommunications, approximately 40% in electric power generation, with the remainder spread over mining and port infrastructure and basic industries (e.g. cement, etc.) • Sample telecommunications financings: • The mobile networks of Zain in many African countries and MTN in others • The $600 million Seacom cable, the first undersea cable on the east coast of Africa, connecting Africa to Mumbai, India and Marseille France. The cable became live on 23 July 2009. • Sample power infrastructure financings: • The Rabai HFO and Olkaria Geothermal Independent Power Plant (IPP) projects in Kenya • The Mpanga and Bugoye run of the river hydropower plant projects in Uganda • The corporate financing and an equity investment in Aldwych, due to lack of African power developers • Sample mining infrastructure financings • Kenmare Moma Mozambique (Titanium Sands mining) power and port infrastructure • Bisha Eritrea (1st mine in Eritrea) ore concentrate port facilities • Sample basic industries financings • Eleme Petrochemicals Nigeria • Obajana cement plant Nigeria (repaid a/o due to environmental issues) • Maghreb Tubes water pipe manufacturing project in Algeria (for a Singapore/Kenyan group) • Toll road and rail infrastructure projects are still rare; some pipe-line evaluations on-going Future of Project Finance Globally

4. So what has the world been up to? Slide from O Keefe!

5. PF proves its mettle But project finance kept growing, before succumbing to the storm Source: Thomson Reuters

6. Structures have become more conservative Average Gearing has scaled down: Global PF numbers: • 2005 83:17 • 2006 84:16 • 2007 84:16 • 2008 73:27 • 2009 71:29 • Source: (Infrastructure Journal database) • Gearing reduced because of excessive risk aversion? Credit Departments too aggressive? • In Africa 70:30 has moved down to 50:50 • Will gearing go back to previous levels? • Pressure on IRRs • Re-financing when markets pick up and projects overcome construction risk • Risk profile and cash flow prospects remain sound

7. PF continues to have a bright future PF remains fundamentally attractive because: • Risks are well understood and transparent, Structures remain robust and offer protection • Demand for infrastructure remains high • Strong government support • Discipline within lenders meant no covenant-lite transactions. Even though gearing got aggressive, it needs to be viewed in the context of the high leverage seen in the past few years. • Still relationship driven – sponsors reluctant to walk away from projects despite non recourse nature. Most players remain committed • Interest rates and margins are negatively correlated. High margins today offset by low interest rates • Falling commodity prices (steel etc.) causing construction costs to fall • Acquisition opportunities in the near future as asset prices are depressed and liquidity pressures force weaker players out of the market

8. The growth sectors :Emerging markets • Power • Stable, established business with huge unmet demand • Basic necessity for economic activity • Re-emergence of interest in nuclear power, though projects to remain scarce (high capital costs, security & environmental concerns) • Scepticism re carbon credits: Post 2012 uncertainty, and fundamental tensions (CDM projects need PF structures but CDM seeks new technologies, projects with borderline financials. PF seeks established tech, healthy financials) • US$182bn committed by governments in recent stimulus government packages • Telecoms • New on the scene but the darling of international investors. • Currently dominated by telephony and will take time for internet to catch up • High income multiplier effect of Telecom Capex • Mining • Many emerging markets rich in minerals. Global demand to pick up again. • Labour intensive, high employment sector • Good source of cash for funding other infra sectors with higher multiplier effects • Public utilities – water, social infrastructure • Crying need for investments but political aspect and shambolic state of service providers a deterrent • Transportation • Great geographical disparities to persist. Toll road and rail financing to remain difficult in Africa.

9. TRENDS IN AFRICA • Sub Saharan Africa is the market I know best, hence I will provide a more detailed view: • African governments have gained experience with project finance and regulation; this e.g. has lead to an increase in activity in the power sector (outside Nigeria at least): Before 2008 few power plant IPPs reached financial close. • While Africa is and will be affected by the global financial crisis (e.g. in mining activity), it will in my view be affected less than other markets; Project Finance has continued good long term growth prospects. • OECD country commercial banks are for now less active; demand for financing from Development Finance Institutions has risen significantly. Local financial institutions other than South African banks continue to have limited involvement in long loan tenor project financings, but some interest in longer term project finance is emerging. • Debt/Guarantee Pricing has risen and is likely to remain high in terms of margins (though with lower USD/Euro base rates), with lenders also requiring at least some upside participation instruments and strong sponsor back-up commitments (e.g. stand-by’s, completion guarantees, etc.) • The market remains one of “bespoke” classical Project Finance with “clubs” of lenders and little pre-packaged syndicated loan market or bond market debt financing. New infrastructure oriented equity funds (e.g. PAIDF of South Africa) are emerging. Deals sizes are in the 100s of millions; mega deals are rare with the exception of some large natural resource projects. Availability of financing drives projects. • Political stability – necessary to provide certainty to contracts and stable economic environment • Growing intolerance of regime changes – within emerging markets and in developed countries • Relative political stability in several African countries

10. TRENDS IN THE MIDDLE EAST • While affected by the global economic crisis, the region remains wealthy; international commercial banks appear to be building up their project finance teams in the region and equity infrastructure funds are being raised. FMFM sees long term growth in the Middle Eastern project finance market • Mega sized (several USD billion in size) projects in natural resource development will continue; due to the growth of the population and urban centres, significant large urban infrastructure projects will continue to be developed (roads, power, sewerage, etc.) • Lack of transparency in corporate and national governance; and falling oil revenues to cash a shadow on otherwise good prospects. UAE to continue feeling significant pressure. • “Islamic” Sharia compliant infrastructure funding structures are being developed and Sharia compliant infrastructure funds are being raised and set up. International banks and institutions (e.g. HSBC, Citigroup, Standard Bank) are active in joint ventures in Sharia compliant financing, as are development banks such as the Islamic Development Bank and Asian Development Bank • The trend so far is for large transactions to have a Sharia compliant component, but to FMFM’s awareness the number of large transactions solely on a Sharia basis remains very small. • Sharia compliant and other private equity infrastructure funds are being raised.

11. TRENDS IN WESTERN EUROPE • Despite on-set of global recession a deep, but in the short term contracting infrastructure project finance market remains. Medium term, FMFM sees an upturn in activity where governments sponsor infrastructure projects as counter-recessionary investments. • Government focus to be on renewables, cleantech, healthcare and education. However, significant spending likely only in 2010, once governments are relieved of the pressures of stress sectors like banking. Limited borrowing room available will limit spending. • The market is somewhat more standardized than the “bespoke” African market, with a variety of “Private Finance Initiative” style public private partnerships structures about relative contributions of government and private sector parties well developed. • Unlike the North American market, the European (including the UK) project financing market has always on the debt side been more a bank/loan financed than a bond/capital market financed market. FMFM sees limited change in this situation. • The financial crisis in OECD countries having creates stress or defaults in a number of project finance structures, refinements in the existing “semi standardized” structures are emerging. FMFM sees a trend back toward more bespoke classical project finance, a reduction of leverage levels and an increase in pricing of transaction in the medium term. • Although there will be a slow down due to government budget deficits and economic recession, FMFM sees a long term trend to increased use of project finance due to a need to renew and modernise aging infrastructure and to reduce reliance on e.g. imported natural resources such as gas and oil. FMFM sees growth in alternative energy. Future of Project Finance Globally

12. TRENDS IN EASTERN EUROPE & RUSSIA • As in Western Europe, in Eastern Europe outside Russia and central Asia, project finance in the gas and electricity sectors will remain limited, due to the presence of large integrated western European and Russian groups, raising financing on a corporate basis. • Significant scope for project financing remains in central European markets outside Russia and central Asia for municipal infrastructure (waste management, sewage, shared thermal heating) and national infrastructure (roads, including toll roads and rail networks). • The Russian and Central Asian market for project finance remains potentially very large, due to a combination of both large potential natural resource projects and a large need to renew aging inefficient and build new infrastructure in power, telecommunications, water, roads and urban and municipal infrastructure. A number of projects in natural resources or common infrastructure will remain financed by corporate financings by groups (e.g. Gazprom) or governments. • On the debt side, the trend remains for bank-led, “bespoke” classical project finance, with the size of projects including both mid and mega sized transactions, rather than for bond market transactions. • In Russia, the role of local banking state owned or controlled or quasi state owned banking groups (such as Sberbank, Vnestorgbank, Gazprombank) is growing with their increasing expertise. Future of Project Finance Globally

13. TRENDS IN NORTH AMERICA • North America remains a very large sophisticated project finance market in which a wide range of instruments ranging from traditional bank loan project financing structures through project capital market bond structures (whether backed by municipal or state credit or on a stand alone “revenue bond” basis) remains in use. • The financial crisis has effected the market, but the need to renew ageing infrastructure e.g. in roads, electricity generation and distribution, gas and oil pipeline networks and water distribution remains large. In their anti-crisis programmes, North American governments have also placed emphasis on infrastructure investment, including renewable energy, giving an outlook for medium term growth in the market. • Notwithstanding stress on their balance sheets, FMFM believes there will, for the medium term, be more of a reliance on projects involving forms of government support than on purely private sector led projects. • Apart from the involvement of private sector corporates engaged in infrastructure industries, the involvement of private equity groups engaged in infrastructure projects (e.g. in the power sector) to develop new projects will remain significant. Future of Project Finance Globally

14. TRENDS IN SOUTH AMERICA • Except that the size of projects is on average larger, the South and Central American project finance markets remain, like Africa, characterised by bespoke traditional project finance structures, negotiated transaction by transaction, but with many common characteristics. • The involvement of local banking groups, including local national development banking groups is larger than in Africa. FMFM expects this trend to continue. The involvement of international development finance institutions remains significant and is likely to remain so for the medium term. • The market is – and in FMFM’s opinion, granted not based on an active involvement in the market – will remain one with a mixture of medium and large sized transactions. Corporate financing for projects by large local or international groups (e.g. CVRD or PetroBras in Brazil) for e.g. large industrial or natural resource projects will compete with pure project financings as alternative forms of financing. • Capital markets have grown in development, but their use for project finance remains more limited. Project Finance Infrastructure oriented funds have emerged.

15. TRENDS IN INDIA • Resilient market! 5 of the top 10 deals in 2009 in India (source Thomson Reuters) • Immense financial market depth, but challenges remain on attracting more state owned banks, insurance companies and pension funds. GuarantCo role • PF market to continue to be dominated by Banks/ FIs, with bonds market still in nascent stages. Equity markets not receptive to Project listings, but holdco concept gaining acceptance • Dominated by power and transportation projects in the private sector • Sectors like mining to follow in the footpaths of Transportation and Power in increasing transparency. • Urban infra to rise on the back of governmental support. Government push on cost recovery to improve social infrastructure viability. • Financial market development to continue, but be tightly controlled. India already has one of the most sophisticated financial markets in emerging countries. • Government push on renewable energy to increase energy independence • Government control over banking sector means it is able to direct lending through ‘softer’ means along with measures like targeted tax breaks • Nuclear energy projects to come up on the back of Lack of public opposition, unlike in developed countries. But unlikely to involve significant private sector participation. • USD 100bn/ year of infrastructure capex unlikely to be met, but expect this region to be one of the most active in the world for the next few years Source: Thomson Reuters

16. TRENDS IN OTHER ASIAN COUNTRIES • Outside the People’s Republic of China and major markets such as Japan, South Korea and Taiwan, involvement of multilateral financial institutions remains significant. • Classical bank loan financed project finance structures remain in common use; bond issues with e.g. partial risk guarantees by multilaterals or governments occur from time to time. • Within the PRC, while there is some scope for involvement of private sector and multilateral institutions, PRC financial institutions and the government remain the main backers of project financings. The number of such financing has risen, with government stimuli for the Chinese economy. FMFM sees this as a continuing trend. • For Asian nations where Islam is a significant religion, such as Malaysia and Indonesia, there is a clear though still recent growth of Sharia based financing initiatives. Sharia Compliant Infastructure funds are being set up and Sharia compliant financing structures are being developed. Countries like Malaysia are seeking a role as islamic finance centres. FMFM believes such structures will be developed over time and gain market share. • The Asian Project Finance market has significant growth potential in urban infrastructure, power generation, telecommunications, water and sewage and natural resource sectors.

17. TRENDS IN AUSTRALASIA • FMFM has no familiarity with the Australasian Infrastructure and project finance markets • FMFM believes the market will continue to be marked by a mixture of traditional project finance instruments in competition with corporate and municipal financings. • FMFM believes the market has growth prospects. Other TRENDS • FMFM is cautious on the outlook for undersea fibre optics cables, given the global recession and significant capacity e.g. in Africa recently having come on line or being planned. • There remains modest growth potential in markets such as space based satellite systems and undersea cables. FMFM believes the satellite or satellite constellation market has continued growth prospects to meet unsatisfied growth in broadband and tele-communications infrastructure in emerging markets (e.g. for broadband or mobile backhaul); however it will also be constrained by availability of financing sources. Prospects for long term power transmission projects are in FMFMs view far off due to the need for further technology development. • Temporary withdrawal by commercial banks and diminishing risk appetite means renewed prominence of ECAs and DFIs. Need to rope in new players – insurance companies, pension funds who currently stay away because of regulatory reasons and low risk appetite. Role for GuarantCo • Redeployment of resources as developed countries PF markets dry up – demand for infrastructure in place, and capital available for good credit risk projects.. But they are few and far between in Africa! Stable political environments and robust project structures to continue driving growth in Asia particularly in India and China, but Africa to begin catching up slowly.

18. So, what’s in store for PF? . • Banks need to start lending; PF seen as defensive and low risk. • How does PF compare with the alternatives? • Corporate Lending – Have full access to all assets and cash flows of the borrower but limited disciplines. Covenant-lite could (will?) drift back as competition for good deals re-emerges. • Project Finance – ring-fenced re assets and cash flow but protection for the lender comes from the structure. Syndication model of PF naturally superior to securitsation model since market practices mean originators stay with the deal? Credit analysis more trustworthy, unlike rating agencies that don’t have skin in the game. • Other asset classes - Mortgages, bond issues, securitisations. New business models will have to emerge to attract long term investors. • Expect supply of transactions to exceed demand. • Long-term future for project finance is bright because it is fundamentally good banking.