Capital Markets Group Making Capital Markets Work for Infrastructure Finance

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Capital Markets Group Making Capital
Markets Work for Infrastructure Finance

• Presentation to Finance Forum 2004Prepared by
• Varsha Marathe, Michel Noel and Sophie Sirtaine

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Making Capital Markets Work for Infrastructure
Finance, a Pressing Need in LDCs

• Infrastructure investments needs remain enormous
  in LDCs in all regions
• Yet
• public funds available for infrastructure
  financing remain limited
• private funds invested in infrastructure in LDCs
  have shrunk significantly since 1997
• and, institutional investors (on the capital
  markets) have never shown much interest in
  infrastructure financing
• Therefore, mechanisms to re-attract more private
  funds, including from capital market
  participants, are crucially needed

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Infrastructure Investment Needs in Developing
Countries are Enormous
Total estimated needs over 20052010 about 500
bn
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The Traditional Public Financing Model Requires
Room for New Public Debt
Public Finance Model

• Borrowing by sovereign and sub-sovereign on own
  account
• Part of general government debt
• Headroom for general government borrowing
  varies greatly across countries, but is generally
  limited

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But, Public Finances in LDCs are often under
Strict Constraints
Total Public Debt as of GDP in Selected
Emerging Markets Worldwide
Source IMF Art. 4 and IMF International
Financial Statistics Denotes 2002 data
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PPP Models Present an Interesting Alternative
Public-Private Partnership Model

• Structures
• Concessions, BOOs and BOTs special-purpose
  company responsible for investment and operations
• Divestiture privatization of existing
  infrastructure company
• Financing
• If private sector gt50 of special purpose or
  existing company, debt no longer part of general
  government debt
• Private investor finances investments and opex
  with equity and debt

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However, Private Investments in Infrastructure in
LDCs have Shrunk Sharply

• Evolution of Annual Investment in Projects with
  Private Participation in Developing Countries

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and Capital Market Funding has Continued to Shy
Away from Infrastructure

• Only 200 bond issues worldwide in 2001 by
  infrastructure entities
• Nearly 50 of them in telecom
• Only 20 of them in LDCs (mostly in Asia and
  Eastern Europe), of which about 33 by public
  companies
• Therefore, only about 30 private issues in
  LDCs, of which about 15 by telecom companies
• Most with strict covenants and other
  protections against project risks (guarantees,
  insurance, etc)

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There are Various Impediments to Capital Market
Financing of Infrastructure in LDCs

• In General
• Deficiencies in bond market infrastructure
• Un-developed institutional investors with
  regulatory constraints for investment
• For sovereigns
• Lack of strategy to develop money market and
  long-term government bond
• For sub-sovereigns
• Deficiencies in legal and regulatory framework
  for borrowing (soft budget)
• Market segmentation
• Lack of credit enhancement instruments
• For PPP issues
• Inadequate tariff policies affecting cash flow
  level and variability
• Weakness of contractual environment
• Lack of political/regulatory risk mitigation
  instruments
• Lack of exit opportunities for equity investors

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Removing Impediments to Domestic Capital Market
Financing of Infrastructure Investments How the
World Bank Group can help
Public Finance Model
Capital market adjustment loans/TA
Development of money markets and government bond
market
Development of legal and regulatory framework in
loans/TA
Development of securities market infrastructure
Capital market adjustment loans/TA
Development of legal and regulatory framework for
sub-sovereign borrowing
PCG Facility for sub-sovereign bonds
Enhancing sub-sovereign bonds
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Removing Impediments to Domestic Capital Market
Financing of Infrastructure InvestmentsHow the
World Bank Group can help
PPP Model
PPP framework adjustment loan/TA
Strengthening regulatory framework for PPPs
OBS Budget loan/TA
Supporting transition to cost-recovery tariffs

• World Bank Infrastructure Fund
• First round Private Equity Fund
• Second round Local
• Infrastructure Investment Trust

Mobilizing equity for PPP transactions
MIGA PRI facilities IBRD PRG facility
Mitigating political risks
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Innovative Capital Market Products for
Infrastructure Finance

• PCG facility for sub-sovereign bonds

Public Finance Model
PPP Model
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The PCG Facility for Sub-Sovereign Bonds Concept
Under study in Russia

• Market failure to be resolved lack of access by
  regions to long-term financing in local currency
  at acceptable rates
• Proposed solution a IBRD partial credit
  guarantee facility to cover bonds issued by
  regions for infrastructure programs financing
• Key issues for feasibility studies
• 1. Facility with or without sovereign
  counter-guarantee
• 2. Risk management
• 3. Market test

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The PCG Facility for Sub-Sovereign
Bonds Alternative Structure
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The PCG Facility for Sub-Sovereign
Bonds Structure with Sub-Sovereign
Counter-Guarantee
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The PCG Facility for Sub-Sovereign Bonds
Expected Impact

• Reduced spread
• Increased maturity
• Improved market discipline
• Improved capacity for investment
  programming/project selection at regional level

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World Bank Infrastructure Fund Concept
Used frequently by investment banks

• Market failure to be resolved inadequate
  climate, legal and regulatory framework for PPI
• Proposed solution a fund which provides an
  interim solution to attract PPI while legal and
  regulatory framework matures
• Key issues and challenges
• 1. Equity investment by the Bank
• 2. Requires strong project appraisal
  skills locally, including in
• environmental and social matters
• 3. Board reluctant to delegate decision
  making power.

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World Bank Infrastructure Fund Structure
Assumptions Project is financed through 100 mm
debt and 200 mm equity
Management contract to private project sponsor
Infrastructure Project
World Bank (IFC or IBRD)
Inv.Loan 50 mm.
Commercial Bank
50 mm.
100 Equity
Guarantee
200 mm.
75 Equity
Host Government
World Bank Infrastructure Fund
Institutional Investors 100 mm. Project
Sponsors 50 mm
Bonds
150 mm.
150 mm.
Total Return Equity Swap
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World Bank Infrastructure Fund Expected Impact

• Structure highlights
• Project Sponsor participates as management and
  debt holder
• Government receives necessary financing and is
  given time to develop stable regulatory framework
• The Bank lends its balance sheet and AAA rating
  to raise capital market financing for the project
• Through a Total Return Equity Swap, fund only
  takes credit risk on government, but no equity
  risk on the project
• The Bank intermediates potential conflicts
• Direct benefits
• Fund able to attract institutional investors,
  including pension funds
• Private investors do not need to invest equity
  until environment is adequate for PPI
• Increases local currency financing, thereby
  reducing FX risk
• Creates a commonality of interests so that
  governments and private investors have both
  interest in ensuring the company to be privatized
  is doing well

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Local Infrastructure Investment Fund Concept
Under discussion in ECA

• Market failure to be resolved lack of exit
  opportunities for first-round private equity
  funds in local infrastructure
• Proposed solution a fund investing in equity
  in infrastructure projects after first round
  investors have turned company around (hence
  providing a long-term low return investment)
• Key issues for feasibility studies
• 1. Redemption requirements and fund
  liquidity
• 2. Investment focus
• 3. Legal/regulatory framework at fund and
  project level

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Local Infrastructure Investment Fund Structure
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Local Infrastructure Investment Fund Expected
Impact

• Improved exit opportunities for first round
  infrastructure private equity funds
• Long term private sector commitment to improved
  management and operations
• Diversification of quality securities available
  for local and international institutional
  investors

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PRG Facility to Protect against Political and
Regulatory Risks Concept
Under preparation in Peru demand from several
countries in LAC

• Market failure to be resolved lack of
  appropriate political/regulatory risk coverage
  instrument resulting in heavy losses by private
  investors despite contractual protection.
• Proposed solution A 300mm facility entitled to
  award IBRD partial risk guarantees to Perus
  future infrastructure projects (approximately
  1.5 bn project debt guaranteed against
  government-related risks
• Key issues and challenges
• 1. Requires strong project pipeline
• 2. Requires strong project appraisal
  skills locally, including in
• environmental and social matters
• 3. Board reluctant to delegate decision
  making power.

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PRG Facility to Protect against Political and
Regulatory Risks Expected Impact

• Direct impact
• Improves the credit rating of projects by several
  notches
• Enables banks and pension funds to provide
  project finance to non viable projects
• Increases the volume and tenors of available
  financing and decreases its cost.
• Benefits for PPI
• Decreases required equity by increasing access to
  bank and bond financing
• Decreases exposure to foreign exchange risk by
  increasing local currency financing
• Eliminates exposure to government risk
• Long term benefits for Peru
• Increases the probability of success of the
  government PPI program
• Decreases cost for the government (lower
  subsidies or higher price, resulting from lower
  financing costs and increased bidding
  competition) and tariffs for consumers
• Enables pension funds to diversify away from
  sovereign risk without increasing risk
• Develops local capital market by extending
  tenors.

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Partial Risk Guarantee Facility to Cover Against
Sub-Sovereign Breach of Contract Risk
Under study in Romania

• Market failure to be resolved reluctance of
  private investors to invest in local utilities
  due to high risk of breach of contract with local
  governments and low possibility of contract
  enforcement in judicial and extra-judicial
  proceedings
• Proposed solution a IBRD partial risk guarantee
  facility to cover sub-sovereign breach of
  contract risk
• Key issues for feasibility studies
• 1. Legal and regulatory framework for PPP
  transactions
• 2. Risk management
• 3. Market test

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Partial risk guarantee Facility to Cover Against
Sub-Sovereign Breach of Contract Risk Structure
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Partial risk guarantee Facility to Cover Against
Sub-Sovereign Breach of Contract Risk Expected
Impact

• Reduced spread
• Maturity extension
• Improved market discipline

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The Investment Promotion Finance Facility,
Bangladesh Concept
Under preparation in Bangladesh

• Market failure to be resolved
• lack of access to long term finance and poor
  infrastructure identified as two major hurdles to
  private sector development. Bangladesh has one
  of the lowest infrastructure indicators in the
  world (Bangladesh Investment Climate Assessment).
• Proposed solution
• Separation of IDA support into Capital Grant
  Market Based funds to allow substantive
  investment discretion for investment managers
• Taka facility to finance smaller projects through
  Credit line, partial credit Guarantee, Takeout
  interest rate support (CGT)
• Able to offer a wider range of support senior
  subordinate debt, preferred stock, equity etc.
  for large small projects
• Allows private sector investment advisers to work
  with promoters to develop private infrastructure
  term capital investments

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Investment Promotion Finance Facility, Bangladesh
AES Meghnaghat Reflow Income
Private Financial Institutions
Other Donors
IDA
Market Based Funding
Concessional Funding
Government of Bangladesh
Market Based Fund
Capital Grant Fund
Concessional Funding
Social Development Review
Market Based Funding
Infrastructure Project
Infrastructure Project
Potential Ownership
Promotion for Profit
Alternative Promotion
IDCOL or Swiss Challenge Arranger
Project Public/Private Arranger
Private Sector Promoters
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The Investment Promotion Finance Facility,
Bangladesh Expected Impact

• Provide long term finance to fill gap not
  provided by local markets
• Provide technical assistance to develop projects
  establish governmental processes to support
  public private partnerships
• Build local private sector capacity for term
  finance

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