World Bank

Infrastructure Funds and Facilities in Sub-Saharan Africa

Final Report

BY CENTENNIAL GROUP HOLDINGS, LLC

2600 Virginia Ave Suite 201 Washington DC 20037 USA www.centennial-group.com

May, 2009

ACKNOWLEDGEMETNTS We are deeply appreciative for the time and attention given us by the more than fifty fund managers, investors and other experts in the field of public private infrastructure finance with whom we interacted. We are also appreciative of the help we received from the World Bank team led by Michael Fuchs, and comprising Jeff Delmon, Iain Menzies, Peter Mousley, Ada Karina Izaguerre, and others. They provided invaluable guidance to our work and detailed comments on the reports from which we greatly benefited. We also wish to thank our Senior Advisors for their ideas and direct assistance in preparing this report: Ryan Orr, Suman Babbar and Everett Santos. Finally, Liem Nguyen and Bogdan Prokopovych of the University of the Rhode Island School of Business deserve special recognition: the development of the EMIFFI would have been impossible without their persistent efforts. Thomas H. Cochran Michael de Angelis Johan Kruger Anthony Pellegrini March 2009

Table of Contents
1. 2. Purpose of the Study .................................................................................................... 17 The Sub-Saharan Africa Context ................................................................................ 19
2.1 Levels of infrastructure in Sub-Sahara Africa (SSA) lag other regions. ............................. 20 2.2 Gaps in infrastructure along with a high cost structure for infrastructure services are affecting country competitiveness ............................................................................................... 21 2.3 The total amount of financing needed to bridge infrastructure gaps in SSA has been estimated at $800 billion ............................................................................................................. 22 2.4 Private infrastructure investment in Sub-Saharan Africa is low ........................................ 23 2.5 Several factors contribute to the low levels of private infrastructure investment in SSA .... 23 2.6 Reforms to deal with the above constraints to private investment are being taken seriously by SSA governments ................................................................................................................... 32 2.7 While the level of private infrastructure investment is SSA is low, it has been on a rising path 32 2.8 Both the types of investors and the risk profile of investors in SSA infrastructure are changing ..................................................................................................................................... 33 2.9 IFIs, including bi-lateral institutions, play a large role in infrastructure finance in the region. China is becoming an important player. ........................................................................ 36 2.10 The current global financial crisis is having an impact on infrastructure funds and facilities in SSA ........................................................................................................................... 38

3. Key Characteristics of Existing infrastructure Funds and Facilities in Emerging Markets and Specifically in SSA ........................................................................................ 44
3.1 Preparation of the inventory of Funds and Facilities in Emerging markets ........................ 44 3.2 The methodology used for the preparation of the inventory of infrastructure funds and facilities in emerging markets. .................................................................................................... 44 3.3 The number of infrastructure funds and facilities has risen rapidly on a global basis and has been followed in recent years by growth in funds and facilities operating in SSA ................. 45 3.4 General characteristics of existing infrastructure equity funds in SSA............................... 48 3.5 General characteristics of infrastructure facilities in SSA .................................................. 53 3.6 National political stability is an investment criterion for both private funds and for private facilities, but managers of private funds and facilities with experience in SSA believe that political risks are manageable ..................................................................................................... 54

4. Recommendations for the Design of New Funds and Facilities Intended to Concentrate Investment on Core Infrastructure in SSA......................................................................... 55
4.1 More aggressively develop domestic capital markets.......................................................... 56 4.2 Support new funds and facilities with the objective of significantly extending investor exit time horizons .............................................................................................................................. 58 4.3 Build skills and develop human capital .............................................................................. 60 4.4 Reform the Institutional Framework ................................................................................. 61 4.5 Financing solutions should match project scale. ................................................................. 76 4.6 Initial geographic focus of newly formed funds and facilities should be on a limited number of countries. ................................................................................................................................ 78 4.7 Where a multi-country fund or facility is established, a strategy is needed for country and sector deal identification. ............................................................................................................ 78 4.8 Special consideration should be given to local currency debt and mezzanine facilities in SSA 80

4.9 A format without a fixed end date may be appropriate for new debt facilities and guarantee facilities that concentrate on core infrastructure ........................................................................ 82 4.10 Review opportunities for the use of pooling mechanisms to efficiently finance projects of small and medium scale. ............................................................................................................. 83

5.

Recommendations for IFIs in Supporting Specific Funds and Facilities ..................... 90

5.1 Participate in infrastructure equity funds with the objective of extending the closing date of the funds and facilities. (See recommendation 4.2) ...................................................................... 90 5.2 Expand use of partial risk and partial credit guarantees, put options, liquidity facilities and other techniques in support of locally denominated, longer tenor debt and equity. ..................... 91 5.3 Adopt a policy of seeking to maximize the leverage of IFIs own funds when setting up funds or facilities .................................................................................................................................. 94 5.4 Support mezzanine finance either directly in projects or through new facilities that offer mezzanine finance ....................................................................................................................... 96 5.5 Support debt facilities and pooled finance facilities ............................................................ 98 5.6 Support the public sector with significant additional funding of project preparation and associated technical assistance. ................................................................................................... 99 5.7 Ensure that IFI participation does not crowd out the private sector .................................. 99

Annex 1 ............................................................................................................................ 100 List of Funds and Facilities in Inventory .......................................................................... 100 Annex 2 ............................................................................................................................ 108 Characteristics of funds and facilities from inventory ...................................................... 108 Annex 3 ............................................................................................................................ 115 Philippine Water Revolving Fund -- Description of the MDFO Stand-by Credit Line .... 115 Annex 4 ............................................................................................................................ 118 MFI K-Rep Bank in Kenya loans to small water enterprises ........................................... 118 Annex 5 ............................................................................................................................ 124 List of persons interviewed............................................................................................... 124 Annex 6 ............................................................................................................................ 128 Interview Template .......................................................................................................... 128

ABBREVIATIONS

AIG AKFED CABEI CCI CEE CEO CFA COMESA DBSA DBP DCA DFI EAIF ECP EMIFFI EMP EPC EU FMO GoTN GPOBA GDP GNI ICICI IDFC IFIIMF INCA JBIC KIEF LAPEF I LGUGC LIBOR LIF MDFO MENA MIIU MWRMD NEPAD NPL NWCPC -

American International Group Aga Khan Foundation for Economic Development Central American Bank for Economic Integration Climate Change Investment Central and Eastern Europe Chief executive Officer Currency used by fourteen African countries Common Market for Eastern and Southern Africa Development Bank of Southern Africa Development Bank of the Philippines Development Credit Authority of USAID Development Finance Institution Emerging Africa Infrastructure Fund Emerging Capital Partners The Emerging Market Infrastructure Funds and Facilities Inventory Emerging Markets Partnership Engineering Procurement and Construction European Union Netherlands Development Finance Company State Government of Tamil Nadu Global Partnership for Output-Based Aid Gross Domestic Product Gross National Income The Industrial Credit and Investment Corporation of India Ltd Infrastructure Development Finance Company IFIs International Financial Institution International Monetary Fund The Infrastructure Finance Corporation of South Africa Japan Bank of International Cooperation Kagiso Infrastructure Empowerment Fund Latin American Private Equity Fund I Local Government Unit Guarantee Corporation London Interbank Offered Rate Leverage India Fund Municipal Development Fund Office Middle East and North Africa Municipal Infrastructure Investment Unit Ministry of Water Resources Management and Development New Partnership for Africas Development Non-performing Loans National Water Conservation and Pipeline Corporation

OBA output-based aid OECD Organization for Economic Cooperation and Development OPIC Overseas Private Investment Corporation PIDG Private Infrastructure Development Group PPP Public Private Partnership PPIAF Public Private Infrastructure Advisory Facility PROPARCO - Promotion et Participation pour la Coopration conomique PWRF Philippine Water Revolving Fund SACU Custom Union of Southern Africa SEASAF South East Asian Strategic Assets Fund SFC State Finance Commission SMEs small and medium-sized enterprises SSA Sub-Sahara Africa SRI Socially Responsible Investment TCX The Currency Exchange Fund TNUDF Tamil Nadu Urban Development Fund TUHF Trust for Urban Housing Finance ULB Urban Local Body USTDA US Trade Development Administration WSPWater and Sanitation Program WSPFWater and Sanitation Pooled Fund

DEFINITIONS USED IN THE REPORT

Closed investment vehicle refers to an investment vehicle that is no longer issuing shares or accepting new investments because it has reached its target size. (See open investment vehicle below) Core infrastructure is a term that refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Infrastructure is a term that refers broadly to fixed, physical assets in the telecommunications, power, transport and water and sanitation and other sectors Infrastructure facilities are separate legal entities set up for the commercial financing of infrastructure assets whose resources are accessible to project sponsors whenever project financings are ready to be taken to market and hence facilities raise capital continuously as needed.. Instruments can be broad and include debt, guarantees and other risk mitigation instruments provided by private and public institutions, including development banks. Facilities generally do not have a closing date and often have permanent staff. Infrastructure funds are separate legal entities set up for the commercial financing of a limited number of infrastructure assets, typically with money committed upfront. Funds typically have a limited number of financing instruments, have a pre-determined, finite lifespan, and are subject to minimum return expectations by investors. Infrastructure funds are often managed by an asset management company. Infrastructure facilities (see above) more typically have permanent staff. Junior Debt refers to subordinated debt (see below) Leverage can be defined as the ratio of: the amount invested (or set aside as a capital charge or reserve) by one financier e.g. equity fund, debt facility, or guarantee facility to the total project capital mobilized Liquidity Facility is a term that refers to a legally binding commitment to provide funds to purchase securities or other debt that have been tendered to the issuer or its agent but which cannot be immediately remarketed to new investors. The provider of the liquidity facility, typically a bank, purchases the securities (or provides funds to the issuer or its agent to purchase the securities) until such time as they can be remarketed. Mezzanine financing refers to a type of finance that sits between common equity and secured debt. Mezzanine debt (or preferred equity) represents a claim on company's assets which is senior only to that of common shares. Mezzanine financings can be structured either as debt or preferred stock. In the event of default, mezzanine financing is less likely to be repaid in full than senior obligations such as secured debt. Non-core infrastructure is a term that refers to infrastructure that is considered less essential to basic human needs. It generally refers to telecommunications, but could involve a road, gas line

or water treatment plant dedicated to a specific industrial operation rather than to providing general service to a population. Open ended investment vehicle refers to an investment vehicle which does not have restrictions on the amount of shares or amount of money that can be raised. Pooled financing means any bond or other debt instrument the proceeds of which are

to be used directly or indirectly to make or finance loans to 2 or more ultimate borrowers.

Put Option is a term that refers to a financial contract between two parties, the seller and the buyer of the option. The buyer acquires the right, but not obligation, to sell the underlying instrument at an agreed price and/or within an agreed time frame. If the buyer exercises the right granted by the option, the seller has the obligation to purchase the underlying asset. In exchange for having this option, the buyer pays the seller a fee (the option premium). Subordinated debt refers to debt that has a lower priority in repayment than that of another debt claim on the same asset (also called junior debt.) .

EXECUTIVE SUMMARY

1.

Purpose of Study

The purpose of this study is to review the experience of infrastructure funds and facilities that have been set up in emerging markets and based on that experience, to develop principles that would apply to new funds and facilities to finance infrastructure in Africa. As part of this study, an inventory of emerging market infrastructure funds and facilities was created, The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI). The inventory contains information on 262 funds and facilities that are currently operating or in the process of raising funds. The inventory covers all emerging market regions including Eastern and Central Europe, Latin America, South and East Asia and Africa. It includes purely private, publicprivate and donor supported infrastructure funds and facilities. The inventory is available as a separate document. (See EMIFFI Inventory.xls) Some 53 senior managers were interviewed to gain information on lessons learned. These were selected from the funds and facilities in the inventory, project sponsors and others that have offices in Washington DC, New York, London and Johannesburg. These interviews along with a literature review of infrastructure financing in Africa, were used in the formulation of recommendations. The interview template is shown in Annex 6. The list of the funds and facilities covered in the Inventory is presented in Annex 1. Annex 2 provides information on the characteristics of the funds and facilities in the Inventory. Based on these results, key principles and recommendations for the design of infrastructure financing solutions for Africa were developed. Several definitions are important for this report: Infrastructure refers broadly to fixed, physical assets in the telecommunications, power, transport and water and sanitation and other sectors Core Infrastructure refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Infrastructure facilities are separate legal entities set up for the commercial financing of infrastructure assets whose resources are accessible to project sponsors whenever project financings are ready to be taken to market and hence facilities raise capital continuously as needed.. Instruments can be broad and include debt, guarantees and other risk mitigation instruments provided by private and public institutions, including development banks. Facilities generally do not have a closing date and often have permanent staff.

Infrastructure funds are separate legal entities set up for the commercial financing of a limited number of infrastructure assets, typically with money committed upfront. Funds typically have a limited number of financing instruments, have a predetermined, finite lifespan, and are subject to minimum return expectations by investors. An asset management company often manages infrastructure funds. Infrastructure facilities (see above) more typically have permanent staff.

. Other definitions of technical terms are listed following the Table of Contents. 2. Sub-Saharan Africa Context The SSA region generally lags behind other regions in all the sectors of public infrastructure required to promote economic development. The regions shortfall in infrastructure and the relatively high cost for infrastructure related public services leads to supply bootlenecks, communications problems and logistical troubles that seriously undermine international economic competitiveess. The total infrastructure financing needs in SSA over a ten year period has been placed at almost $800 billion. The factors that contribute to the low level of private infrastructure investment in SSA include: the lack of locally denominated long term capital due the underdeveloped domestic capital markets; the poor state of the business environment; low incomes that affect affordability; small country size that affects economies of scale and service delivery costs; and weak institutions, and lack of skills. Because of limits in budgets, SSA governments have been encouraging private investment in infrastructure as part of the overall reform process. Private investment of infrastructure in Africa has in recent years been increasing consistently from a low base. Several Africa infrastructure fund managers expressed a strong belief that a consensus about the need for consistent macro-economic policy and sector reform now exists in most countries of Sub-Saharan Africa. They believe that the launching of such initiatives as the NEPAD and the African Peer Review mechanism are evidence of this and expressed confidence that the basic commitment to reform was durable. . In the SSA region, donor aid comprises a far larger, more influential component of the financial landscape of recipient countries than it does in other regions. This places a greater burden on IFIs in Africa. China has become a major player in Africa infrastructure development. Much of Chinas recent official economic aid and loans to Africa are backed by natural resource commitments and many are targeted at infrastructure projects aimed at development of the petroleum and mineral extraction industries. By 2003, Chinese investors had established 602 businesses in 49 African countries.

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The global financial crisis is beginning to affect Africa. African banks generally did not invest in sub-prime markets or related derivatives. However, because international banks need to reduce risks, the region is seeing a decrease in private investment flows that will negatively affect the financing of many infrastructure projects.

3. Characteristics of existing funds and facilities in emerging markets and specifically in Sub-Saharan Africa

The rate of growth of infrastructure funds/facilities in emerging markets has accelerated sharply in recent years. However, most investments supported by existing funds and facilities in Africa have focused on telecoms. This is because of the relatively short and uncomplicated process of project preparation in comparison with other sectors and the relatively short payback period offered in the telecom sector. Very little private investment from funds and facilities in Africa has taken place in the sectors of transportation, water supply and electric power. Equity fund managers throughout the developing world including in Africa have been most successful investing in telecommunications. Relatively little private equity investment, especially in Africa, has taken place in the core infrastructure sectors of transportation, water supply and sanitation or even power. This has significance when considering the development impact of funds and facilities. It also suggests that IFI involvement in funds and facilities should aim at shifting investment to the basic sectors of transportation, water supply and sanitation and power. Finance by construction and operating companies is far greater than by independent infrastructure funds. The reason for the dominance of construction and operating companies may have to do with differences in the cost of capital. Private equity funds that are not leveraged at the fund level are likely to have the highest costs of equity capital defined by the return expectations of the limited partners and other contributors of equity. Construction firms, nonregulated power project developers and operators, and transportation concession operating companies have often been able to lower the actual cost of the equity capital which they are expected to contribute to projects through the use of debt raised on a corporate finance basis, e.g. shareholder subordinate debt from commercial lenders or bond issues the proceeds of which are used to make equity investments at the project level. Equity funds exceed debt facilities by a wide margin in all regions. Equity fund managers operating in Africa believe that equity is far easier to raise than debt. They see a significant role for IFIs in using their funds to extend the tenor of domestic debt. They believe that this would increase the attractiveness of investments in core infrastructure. Mezzanine financing is sparingly used - especially in Africa. Most infrastructure equity funds rarely use mezzanine financing as part of the funds own capital structure because of high carry costs and only opportunistically provide mezzanine financing for project investments. While a good many equity funds are allowed by their mandate to provide mezzanine financing to individual projects - yield considerations are a deterrent. Most only provide mezzanine financing if they see a reasonable chance of equity-like returns on the mezzanine commitment.

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Sovereign risk per se did not seem to be a significant concern to experienced Africa fund and facility managers. A number of them pointed out that the global investor community is still perceives Africa as a continent filled with sovereign risk. However, one manager expressed the view that this perception provides his fund with a distinct competitive advantage as it suppresses competition he would otherwise face if the true level of sovereign risk were more broadly understood.

4. Recommendations for the design of new Funds and Facilities in SSA intended to concentrate investment in core infrastructure Three key themes relevant to Africa emerged in discussions with infrastructure fund and facility managers and others that represent key challenges to infrastructure financing. The recommendations of the report follow the key themes . Theme 1: The domestic capital market and financial environment The underdeveloped domestic capital markets in Africa leads to difficulties in provision of long-term finance denominated in domestic currency, especially debt finance. Recommendations: Aggressively develop local capital markets Domestic finance of infrastructure is preferred when feasible because it avoids currency mismatches. Portfolio managers of domestic contractual savings pools in most countries welcome the appearance of wellstructured securities issued by prudently managed public and private entities providing infrastructure services because these instruments can provide both a positive yield spread above similar maturity sovereign securities and enough safety to meet stringent fiduciary guidelines and other relevant regulatory requirements. Substantial effort is being devoted by governments throughout Africa in a range of initiatives intended to encourage the emergence and growth of capital markets. This effort should be continued and substantially expanded. This often goes hand in hand with the reform of the locally domiciled commercial banking, pension fund and insurance sectors. Support newly created equity and debt infrastructure funds and facilities with the purpose of extending exit time horizons Some international investors with longer time horizons e.g. developed country pension funds, insurance companies, sovereign wealth funds, philanthropies have been interested in the higher yields associated with emerging market investments. However, the global financial crisis will increase perceived risks and will affect the readiness of international investors to come forward. Give special attention should to establishment of facilities that provide debt and /or guarantees of debt. Managers of equity funds in Africa indicated that the lack of longer tenor local debt financing was an important factor that led them to favor telecom projects over investments requiring a longer payback period. There appears to be space for

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additional debt facilities such as revolving loan facilities, bond banks, and guarantors of debt, particularly those focused on single countries that would make more use of indigenous pools of long term savings, e.g. domestic pensions funds, military pension funds, insurance companies, etc. for investment in infrastructure. Generally debt facilities and guarantee facilities concentrating on core infrastructure should not have fixed exit dates. Infrastructure facilities with no fixed exit date may be an appropriate institutional structure for providing longer-term debt to infrastructure projects. The open-ended character of such facilities is far better suited to the origination of relatively long-dated lending for infrastructure, than are the structures with a fixed end date of ten years that are seen in most equity funds.

Theme 2:

Institution building and skills development

At the project analysis level, there is a need for improved development of project proposals with sound technical, economic and financial analysis and with an appropriate risk sharing structure. At the level of management of institutions, there is a need for better systems and procedures and timely decision making based on sound policies; and at the level of frameworks there is the need for credible legal and regulatory frameworks. Recommendations: Reform the legal and regulatory frameworks to improve the environment for core infrastructure finance A major factor determining whether investment can be successfully developed is the policy, legal and regulatory framework governing business formation, operation and taxation. A simple, clear, and coherent set of policy, legal and regulatory frameworks lowers project preparation and financing costs as uncertainty is reduced in areas such as (i) profit repatriation, (ii) tax regimes, (iii) regulatory and judicial corruption, and (iv) the effectiveness of investors recourse in the case of problems. The sector environment must be aligned with the business environment to facilitate international or local private sector investment rather than constrain and inhibit it. This involves reexamining sector policies and sector structures, legal system issues, regulatory issues, PPP frameworks and fiscal issues. Many fund managers emphasized that legal/regulatory frameworks and tax systems set the conditions for prudent infrastructure finance that attracts skilled private sector managers and investors. Improve the intergovernmental framework that governs sub-national functional responsibilities and their fiscal resources. Governments need to improve the legal and regulatory framework that controls sub-national service delivery, financial resources and debt. Develop a larger, more robust pipeline of bankable core infrastructure projects. Infrastructure agencies and project preparation facilities in SSA are not developing a sufficient number of well prepared core infrastructure project opportunities that are of interest to private investors.

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To improve the development of project pipelines, governments should: o Develop systems within each sector agency for project selection, screening and prioritization: o Clarify the bidding and competition processes: o Make Project Preparation Facilities more user friendly for private project sponsors/financiers. o Ensure staff has relevant technical qualifications. o Use outside financial advisory staff o Include funding in agency budgets for experienced transaction advisors o Adopt clear processes for annual budgeting of funds for the facility. o Encourage more end-to-end funding of project preparation o Test systems to recover the costs of project preparation o Develop strong links to agencies o Develop projects in conjunction with explicit PPP frameworks

Review and change, as necessary, laws, regulations and tax codes that constrain the use of pooling mechanisms to efficiently finance projects of small and medium scale. Pooled debt funds and facilities can be useful in the local currency financing of the many small and medium sized core infrastructure projects needed in any country. Pooled debt facilities have been employed in a number of advanced economies in the world including the USA, Canada, and Europe and are being developed in India, Mexico, Columbia, and Poland. The Tamil Nadu Urban Fund Pooled Bond Facility is and interesting example as is The Infrastructure Finance Corporation of South Africa (INCA) Develop VGF policies for PPP projects. Ideally, projects should be financially viable on their own, but government financial support is often necessary make a project viable. Such support should be limited, transparent, affordable, properly accounted for and managed to serve priority objectives. With limited resources, a formal prioritization mechanism with clear criteria is important. Develop data and information systems permitting more reliable service demand projections and other key analytic activities necessary to develop sound project financing plans. The absence of reliable information is seen by some fund managers as inhibiting the design, appraisal and successful closure of core infrastructure transactions. Information deficiencies cover the entire spectrum from the most basic demographic and national macro economic data to basic information on service delivery and demand, even the location of underground facilities. Adopt proven management principles to increase the probability of success. Key principles include: o Ensuring good country knowledge on teams o Developing competitive compensation to attract staff with proper expertise

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o o o o

Combining deal origination and portfolio management in same teams Proactive deal origination especially for equity funds Use of well-established, credible local partners Governance, investment decision-making, and portfolio management practices in conformance with international standards o Investment guidelines that give strong guidance to staff but are flexible enough to permit new opportunities which conform to the basic risk/reward profile originally intended o Control over key decisions in project entities o A formal strategy to minimize severity of loss in projects that go sour Develop local institutional and individual capacity to support core infrastructure project development, finance, operations, and maintenance. Many of the fund managers indicated that building skills and developing human capital to improve the quality of indigenous project preparation and governmental decision-making is vitally important. It will be a long and difficult process requiring the sustained commitment and cooperation of IFIs, donors and host government

Theme 3: economies.

Financial solutions corresponding to the size and scale of African

The large number of countries and small size of many, leads to a need for a variety of types of financing structures and vehicles to accommodate projects of small medium and large scale. Initial geographic focus of newly formed funds and facilities should be on a limited number of countries There are substantial differences among the 48 countries of SSA. A detailed understanding of how the infrastructure systems operate within each country and good relationships with both majority and opposition leaders in each country is essential to making successful investments in core infrastructure. This means that at least the initial geographic focus of new funds and facilities should be on only one or a few countries. A framework should be applied for country and sector deal identification for multicountry funds or facilities Once a fund or facility targeting multiple SSA countries has become operational, the identification and origination of a pipeline of bankable core infrastructure transactions becomes the critically important priority. A starting point would be to adopt a country-differentiated approach. One useful way is to distinguish between countries where a largely reactive approach to deal origination will likely be most cost-effective and those where a more proactive plan is warranted Measures to improve the affordability of civil works and the financial capital which pays for them should be adopted and steps taken to reduce the annual cost of capital Measures to reduce the cost of capital by re-examining equity vs. debt ratios, using credit enhancements to reduce spreads in senior debt, using mezzanine debt and possibly equity

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markets, and extending tenor to reduce annual principal amortization burdens, etc. all must be considered. Consider pooling

5. Recommendations for IFIs in Supporting Specific Funds and Facilities IFIs can play a key role in supporting the development of infrastructure funds or facilities in SSA. This is especially true in the aftermath of the financial crisis. Recommendations for IFIs in support of funds and facilities include: Participating in infrastructure equity funds with the objective of extending the closing date Expanding use of partial risk and partial credit guarantees, put options, liquidity facilities and other techniques in support of locally denominated, longer tenor debt facilities and equity funds, and local guarantee facilities Adopting a policy of leveraging IFI funds Supporting new facilities that offer mezzanine finance. Supporting debt facilities and pooled loan facilities Supporting technical assistance and training on international best practice to encourage sound fund/facility management techniques, particularly vital when funds/facilities are local/small regional. Ensuring that IFI support does not crowd out commercial financing
.

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MAIN TEXT

1.

Purpose of the Study

The purpose of this study is to review the experience of infrastructure funds and facilities that have been set up in emerging markets and based on that experience, to develop principles that would apply to infrastructure finance in Africa. The project: Analyzed the experience with existing infrastructure funds and facilities in emerging markets in different regions, and Developed principles and options for improving infrastructure-financing mechanisms for Africa.

The project is motivated by the fact that the level of infrastructure investments in Africa that is needed to support economic growth and development is too large to be met solely through public resources. Private sector infrastructure finance can play a complimentary role to public finance in improving access to infrastructure services. Private investment funding for infrastructure is needed in the form of both long-term debt and equity capital. In recent years infrastructure funds and facilities backed by private capital have emerged as important investment vehicles in many regions, primarily in developed countries but increasingly in emerging markets. A number of funds and facilities have been established in Africa. As part of this study, an inventory of emerging market infrastructure funds and facilities was created, The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI). The inventory contains information on 262 funds and facilities that are currently operating or in the process of raising funds. The inventory covers all emerging market regions including Eastern and Central Europe, Latin America, South and East Asia and Africa. It includes purely private, publicprivate and donor supported infrastructure funds and facilities. The inventory is available as a separate document. (See EMIFFI Inventory.xls) Some 53 senior managers were interviewed to gain information on lessons learned. These were selected from the funds and facilities in the inventory, project sponsors and others that have offices in Washington DC, New York, London and Johannesburg. These interviews along with a literature review of infrastructure financing in Africa, were used in the formulation of recommendations. The interview template is shown in Annex 6.

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The list of the funds and facilities covered in the Inventory is presented in Annex 1. Annex 2 provides information on the characteristics of the funds and facilities in the Inventory. Based on these results, key principles and recommendations for the design of infrastructure financing solutions for Africa were developed. Definitions of technical terms used in the report are provided after the Table of Contents. Several definitions are particularly important. Infrastructure is a term that refers broadly to fixed, physical assets in the telecommunications, power, transport and water and sanitation and other sectors. Core Infrastructure is a term that refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Infrastructure facilities are separate legal entities set up for the commercial financing of infrastructure assets whose resources are accessible to project sponsors whenever project financings are ready to be taken to market and hence facilities raise capital continuously as needed. Instruments can be broad and include debt, guarantees and other risk mitigation instruments provided by private and public institutions, including development banks. Facilities generally do not have a closing date and often have permanent staff. Infrastructure funds are separate legal entities set up for the commercial financing of a limited number of infrastructure assets, typically with money committed upfront. Funds typically have a limited number of financing instruments, have a predetermined, finite lifespan, and are subject to minimum return expectations by investors. An asset management company often manages infrastructure funds. Infrastructure facilities (see above) more typically have permanent staff.

. .

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2.

The Sub-Saharan Africa Context

This section of the report discusses the infrastructure gaps in Sub-Sahara Africa and the current level of private investment in infrastructure. It discusses the factors that affect private investment in Africa including the lack of long term domestic capital, underdeveloped domestic capital markets, poor business environment, low incomes affecting affordability, small project size, and weak human capacity. It discusses recent trends in private investment including the global financial crisis and the role of the IFIs. Africa faces a number of economic, financial, institutional and technical constraints that reinforce each other and affect infrastructure finance. Figure 1: Financial, institutional and structural constraints facing Africa

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2.1

Levels of infrastructure in Sub-Sahara Africa (SSA) lag other regions.

The SSA region generally lags behind other regions in all the sectors of public infrastructure required to promote economic development and create opportunities for private investment. The following graph clearly illustrates this gap compared to other developing regions. Figure 2: Infrastructure Access in SSA vs Other Developing Regions

In addition to deficiencies in physical infrastructure noted in the above figure, supporting business infrastructure is also lacking. A traveling businessperson may not find convenient access to the Internet outside the capital city of many countries. Spare parts or skilled repair technicians may be difficult to find. The composite satellite photograph below, of electric light usage at night, illustrates the stark differences in the levels between most of the SSA region and all other densely populated parts of the world.

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Figure 3: Africa by night

Source: Econobrowser Technological development is extremely dependant on the availability of electricity at reasonable costs. The SSA regions deficit in power generation and transmission is a contributing factor to its lagging rate of development in sectors ranging from manufacturing to social services such as healthcare and education. In manufacturing, this means that less value is added to the few finished products that are consumed locally or exported. In agriculture, it means that commodities are seldom turned into food products suitable for export. And in mining, it means that little beneficiation takes place downstream in the production process before export. In healthcare, it imposes limitations on everything from refrigeration to use of diagnostic equipment; and in education, a lack of residential electricity limits the hours during which students can prepare for classes while lack of electricity in schools limits everything from lighting to the ability to use computers. 2.2 Gaps in infrastructure along with a high cost structure for infrastructure services are affecting country competitiveness

A comparatively expensive cost structure for most public services persists in many Sub-Saharan African countries. This has been attributed to factors such as the relatively small scale and

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inefficient technologies used in projects.1 The comparison with other developing regions shown in Figure 4 underlines this disparity. The regions shortfall in public infrastructure and relatively high cost structure for public services leads in turn to supply bootlenecks, communications problems and logistical troubles that seriously undermine international economic competitiveess. For example, a rubber tire manufacturer in Nigeria was forced to close down as a result of the inability of the power supplier to guarantee an uninterrupted supply. For the many land-locked countries in SubSaharan Africa in particular, the costs imposed by poor infrastructure are extraordinarily high. The World Bank estimates that to transport a container from Baltimore in the USA to Tanzania would cost about US$1,000, but to transport that same container from Tanzania to neighboring Burundi would cost about US$10,000.

Figure 4:

Cost of infrastructure services Africa vs other developing regions Unit SSA 0.02 - 0.46 0.86 - 6.56 0.04 - 0.14 2.6 - 21.0 0.44 -12.5 6.7-148.0 Other Developing regions 0.05 -0.10 0.03 - 0.60 0.01 - 0.04 9.9 2.0 11.0

Power Tariifs Water Tariifs Road Freigt Tariifs Mobile telephony International telephony Internet Dialup

$/KWH $/Kl $/ton-km $/Month $/Minute $/Month

Source: Vivien Foster & Cecilia Briceo-Garmendia, Meeting Africas Infrastructure Needs: The Twin Challenges of Financing and Sustainability, Presentation to AICD, October 9, 2008

2.3 The total amount of financing needed to bridge infrastructure gaps in SSA has been estimated at $800 billion The total amount of infrastructure financing needs in SSA over a ten year period has been placed at almost $800 billion. This is allocated by sector as shown in Figure 4. Figure 5: Sector ICT Power
1

Annual infrastructure financing needs for Sub-Sahara Africa by sector Capex 0.8 23.2 Opex 1.1 19.4 Total 1.9 42.6

See: Vivien Foster & Cecilia Briceo-Garmendia, Meeting Africas Infrastructure Needs: The Twin Challenges of Financing and Sustainability, Presentation to AICD, October 9, 2008

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Transport WSS

10.7 2.7

9.6 7.3

20.3 10.0

Figures in $ billion per annum over 10 year period Source: Vivien Foster & Cecilia Briceo-Garmendia, Meeting Africas Infrastructure Needs: The Twin Challenges of Financing and Sustainability, Presentation to AICD, October 9, 2008

The needs vary considerably by country and sector with the needs in the Democratic Republic of Congo representing 70% of GDP while in Cape Verde they represent only 1% of GDP. It is important to note that current actual spending on infrastructure is on average, about half the requirement. Of this amount, on average, approximately 50% of expenditures is mobilized internally through taxes, fees and other means 2.4 Private infrastructure investment in Sub-Saharan Africa is low

Because of limits in budgets, SSA governments have been encouraging private investment in infrastructure as part of the overall reform process. A recent analysis of the PPI database 2 indicates that Africa had the smallest historical share of all regions in private investment in infrastructure over the period 1983-2004, at 5% of the emerging market total. Total private spending on infrastructure in SSA over this period was estimated at just over $28 billion3.

2.5

Several factors contribute to the low levels of private infrastructure investment in SSA

The factors that contribute to the low level of private infrastructure investment in SSA include: the lack of locally denominated long term capital due the underdeveloped domestic capital markets; the poor state of the business environment; low incomes that affect affordability; small country size that affects economies of scale and service delivery costs; and weak human capacity. These are discussed below. 2.5.1 Lack of locally denominated longer term capital

The availability of long-term debt at reasonable interest rates is vitally important to the efficient financing of infrastructure. Private investors in infrastructure need to be able to leverage their own investments in projects with debt that is well protected from foreign exchange risk. With thinly traded currencies such those of most SSA countries, the best foreign exchange risk
2

Private Participation in Infrastructure data base maintained by Public-Private Infrastructure Advisory Facility (PPIAF) and managed by the World Bank
3

Annez, Patricia Clark Urban Infrastructure finance from private operators: What have we learned from recent experience? World Bank Policy Research Working Paper 4045, November 2006

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protection is the use of locally denominated debt in the first place. If debt is to be denominated in local currency, that debt will ultimately have to be some form of domestic savings. The formal structures for aggregation of savings into sizeable pools available for significant investment have not yet been well established in most African economies. Substantial domestic savings are diverted into informal burial societies, savings clubs and other alternative mechanisms. An estimated 80% of Africans do not have bank accounts. Country gross domestic savings in the region averaged about 18 per cent of gross domestic product (GDP) in 2005, compared with 26 per cent in South Asia and nearly 43 per cent in East Asia and Pacific countries.4 There are many reasons for Africa's low voluntary savings rates. First, low incomes leave less of a surplus for savings after basic needs expenditures. But in addition, there are other reasons including (i) inadequate financial services provided by commercial banks, (ii) physical distance from banking institutions, (iii) high minimum deposit and balance restrictions complicated by overly complex documentation requirements, (iv) very low savings interest rates offering little or no incentive to save, and (v) traditional indigenous lifestyles. Most savings use simple passbook accounts. The use of certificates of deposit exceeding one year maturity is very rare. This means that banks cannot normally offer the long-dated debt instruments to public or private infrastructure project developers that would be most suitable for the delivery of reasonably priced essential public services. There has been a recent growth of deposit-led micro-finance institutions and mutual building societies such as K-Rep and Equity Bank in Kenya that suggests that such institutions could become increasingly important aggregators of savings in Africa and potential sources of capital for infrastructure. As the savings accumulate more rapidly than micro-loan originations, these institutions are finding that they must broaden their array of credit products well beyond microloans and a few are finding that basic community infrastructure can be an attractive lending opportunity. The full description of this initiative, including details on the roles being played by each institutional participant is attached as Annex 4. The CEO of Equity Bank, another Kenyan micro finance institution (MFI) and the managing director of Micro-Credit Ratings International both indicated that other MFI institutions are beginning to include community-level infrastructure finance (e.g. small scale water projects) in a broadened array of credit products, alongside of such products as small and medium-sized enterprise, mortgage and homeimprovement loans, etc. In most SSA countries some form of banking reform has been undertaken in the last decade as part of more comprehensive reform programs. One of the most dramatic examples is the Nigerian banking reform which created a strong and relatively highly capitalised banking sector. However, the degree of consolidation and sophistication varies considerably from country to country.

See for example Efam Dovi, Boosting domestic savings in Africa in Africa Renewal, Vol.22 #3 (October 2008), page 12

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The pension and insurance industries are important sources of long term savings. They present a very similar picture to the banking sector but with reform lagging slightly behind banking sector reform. The pension fund and insurance industries are building assets under management to sizes which are now or soon will be theoretically capable of providing debt and equity for infrastructure. However, regulators in many Sub-Saharan African countries like those in most other developing countries with relatively small pension fund sectors -take a conservative enough approach to prudential standards for credit quality that in the absence of wide-spread use of third party credit enhancement, the use of fixed income securities to mobilize these funds for indigenous infrastructure is still rare outside of South Africa. For example the pension fund industry in Nigeria has the potential to invest $3 billion in infrastructure if transactions can be structured to meet the stringent standards imposed by the pension fund regulator. To date, no infrastructure investments have met that standard. The weakness of the indigenous insurance sector also deprives the local capital markets of an important potential source of institutional demand for infrastructure debt and equity. The whole and term life sectors of the insurance industry are still in an infant stage in most SSA countries. Further pension fund and insurance reform will be critical to the development of pools of locally denominated capital. This in turn should create demand for a diversified array of relatively safe mid- to long-term fixed income investments such as bonds or syndicated loans with predictable long benefit pay-out schedules that are capable of match-funding obligations such as annuities and guaranteed investment contracts from pensions and insurance companies.

2.5.2

Under-developed capital market institutions

Local currency financing in the emerging markets appears to have embarked on a period of secular growth. According to various sources, the compounded annual growth rate of local currency financing from 2000 to 2004 in Mexico was 18%; in Chile, 35%; and in South Africa, 54%. There are a substantial number of developing countries where locally denominated financing is becoming an increasingly attractive option, displacing foreign currency financing, and creating an environment where local investors are seeking well-structured private sector fixed income securities as an alternative to central government treasury bills. Among the countries where members of our team have witnessed this trend are Indonesia, Vietnam, South Africa, Chile, Brazil, Poland, and Ukraine. Most countries with sovereign ratings in the BB to A range have established or are making strides toward establishing reasonable legal and regulatory frameworks for local capital markets, and a sufficiently promising macro-environment to permit local currency infrastructure investments. A number of lower-rated countries are also moving in the same direction. The lack of long term domestic financing is leading to strong interest in reform of domestic capital markets in Africa as well. African economies generally have a need for significant further development of market institutions including stock exchanges, broad based bond markets, securities trading and

25

clearance organizations, secondary trading facilities for fixed income instruments, credit rating agencies, and instruments to facilitate transactions such as hedging instruments and yield curves for benchmarking. In most Sub-Saharan countries, except South Africa, and to a lesser degree Botswana, Nigeria, Namibia and Kenya, both primary and secondary capital markets are still in an early stage of development with little sophistication and tight regulatory oversight. Stock markets or combined bourses have been created in a number of countries as part of the financial reform programs. These are very important to investors in infrastructure funds. Most infrastructure equity funds have an average life of 10 to 12 years. Fund managers typically seek to sell their investment in a project (exit the project) with a profit, after the project is up and running and before the end date for the fund. Stock markets provide a platform for initial investors in infrastructure to exit through Initial Public Offerings (IPOs) and/or bond issuance. However, with the exception of South Africa, the publicly traded equity and debt markets are generally still unsophisticated. Until the recent past the bond capital markets of virtually all SSA countries were largely dominated by central governments using them as a source of locally denominated sovereign debt finance. Corporate bond markets are fairly thin. Because the primary markets are rudimentary, secondary trading of fixed income securities is mostly informally arranged. A strong secondary market, with mark to market prices, can encourage buying of longer tenor securities by investors with a shorter time horizon. As domestic capital markets develop, secondary-trading institutions will be a positive factor in markets beginning to offer longer tenor debt. Formal, independent credit rating processes are un-developed or severally under-developed in all but a few SSA countries. Experience has shown that equity investors place a much lower premium on independent rating reports regarding specific companies or investments than do lenders and bond investors. For example, none of the African-based equity investment funds we interviewed indicated any substantial reliance on credit ratings to guide their investment choices. However, a key hallmark of well-developed local debt capital markets is the establishment of a hierarchy of market based credit spreads for investments with different credit ratings. When credit spreads are based on objective risk criteria as measured by independent analysts, rather than simply the historic relationships between specific borrowers and lenders (name-lending) which characterize less well-developed credit markets, opportunities for a far broader range of passive financial investors such as pension funds and insurance companies which must meet stringent prudential standards in their investment practices to emerge rapidly. Ratings-based credit spreads also facilitate the introduction, rational pricing and use of a variety of third-party risk mitigation and credit enhancement products such as full or partial credit guarantees, partial risk guarantees, and the like. In order to price such products, interest rate savings, increased secondary market liquidity and other benefits to the issuers and investors for using them need to be reliably estimated in advance of the financing. This can be done only in markets that exhibit market based credit spreads. Local capital markets with these characteristics are found in most but not all middle- and upper-income emerging market countries in Latin America, Central Europe, and Asia. SSA, apart from South Africa, has lacked such markets,

26

although they are now beginning to emerge in a few countries such as Uganda and Kenya, Nigeria and Ghana. The recent growth in the number of clients requiring ratings is an encouraging indication of the possible future growth of domestic debt markets. In South Africa, credit ratings also play a crucial role in secondary debt market trading operations and portfolio management, assisting portfolio managers to stay within the exposure and concentration limits set by their respective boards. Other developed-world instruments that can be used to encourage investments from nondomestic sources in foreign exchange such as swaps, hedges and related instruments including caps and collars are not yet available in most of SSAs nascent capital markets, although they are in widespread use by both corporate and public sector borrowers in South Africa. Despite the volume of government issues, even basic yield curve benchmarking with government-issued securities has been difficult or impossible. Many central governments in the region prefer to use short-term treasury bills to fund shortfalls. Without benchmark yield curves on which to base credit pricing decisions, credit pricing tends to be arbitrary, with personal relations and marketing skill playing a major role. For example, in a recent potential local bond issue in an East African country of planned 7 years maturity, the yield quoted for a corporatized utility was 10 basis points below the governments Treasury bond yield of like maturity 2.5.3 Poor local business environments

Both general business climate factors and corruption affect private investment. General business climate factors: In Sub-Saharan Africa, the general business environment, already difficult for the business entrepreneur as a result of the lack of infrastructure like telecommunications, broadband, energy and potable water, etc. is further aggravated by governmental bureaucracy, according to Africa fund managers interviewed as part of this study. For example, the World Bank estimates that it takes 47.8 days to start a business in Sub Saharan Africa compared to 22.6 days in Eastern Europe and Central Asia and 32.5 days in South Asia. 5 A further source of concern about Sub-Saharan Africa for an investor considering a regional fund in Africa is the different regulatory and tax frameworks in different countries. The region includes 48 sovereign states varying from the relative giants like South Africa and Nigeria to very small countries like The Gambia and Togo. In addition, many of the frameworks within which infrastructure operators must do business are often still in the midst of transformation from those characteristic of centrally planned economies to current globally accepted standards. The need to understand the highly disparate regulatory and tax environments in up to 48 countries, contrasts with the investor considering South Asiaa region with twice the populationwho has to consider only 8 country regulatory and tax frameworks. Many in the global investment community see the problem of relative governmental fragmentation as being compounded by the multitude of languages spoken throughout Africa.
5

http://www.doingbusiness.org/exploretopics/startingbusiness/

27

The Africa fund managers regard the fact that little or no policy or regulatory harmonization has taken place on crucial issues like taxes, customs procedures, air traffic control, etc as extremely negative because it hampers the development of large regional projects with significant economies of scale.

Figure 6: Population and numbers of countries by emerging market region Population in Millions Number of Countries 24 26 29 14 8 48 Average population per country (millions) 79.125 17.730 19.172 22.214 187.375 16.291

East Asia & Pacific Europe and Central Asia Latin America & Caribbean Middle East & North Africa South Asia Sub Saharan Africa

1899 461 556 311 1499 782

Corruption: Fund and facility managers see corruption in most of Africa as another important negative factor of the business climate. The heavily regulated utility sectors are a particular source of concern. It is often pointed out that the more governmental bureaucracy there is watching over a sector, the more opportunity there is for corruption. With essentially regulated rates of return to equity in the utility sectors, comparatively thin margins may be compressed further by corruption. Finally, the higher the risk of corruption, the higher the risk of reputational damage to all parties, including equity and debt investors.

2.5.4

Low incomes

Low incomes in SSA affect affordability of infrastructure at the household level and the government level. Providers of essential public services face difficult challenges of affordability due to the fact that most users of the services in emerging market countries have relatively low per-capita income. Full cost recovery tariffs take a far more significant slice of that income than they do in higher income countries. Thus, political leaders, regulators and opinion leaders such as the editors of print and electronic media may find reasons to work to hold tariff rates down. The table below shows regional differences in per-capita gross national income (GNI). The fundamental characteristics of low income and high incidence of poverty combine to make the affordability problems facing providers of essential public services far more challenging in most of Sub-Saharan Africa than in other regions.

28

Figure 7:

Gross national income by region GNI /capita(2007) 952 5440 6051 2180 2794 37566 7958

Sub Saharan Africa Latin America & Caribbean Eastern Europe & Central Asia East Asia and pacific Middle east & North Africa OECD World Source: World development indicators World Bank Data

When GNI is displayed at the country level, we can see where the affordability challenge is likely to be most acute.

Figure 8: Country

GNI per capita by country in SSA Population in m 8.5 62.4 GDP in GNI Billion /capita US$ (2007) 1 110 9 140

Burundi Democratic Republic of Congo Liberia Guinea Bissau Ethiopia Eritrea Malawi Sierra Leone Niger Madagascar Mozambique Rwanda The Gambia

3.7 1.7 79 4.8 13.9 5.8 14.1 19.6 21.3 9.7 1.7 29

0.7 0.4 19 1 4 2 4 7 8 3 0.6

150 200 220 230 250 260 280 320 320 320 320

Togo Central Africa Republic Guinea Tanzania Burkina Faso Mali Chad Benin Ghana Comoros Kenya Senekal Mauritania Sao Tome e Principe Cote dIvoire Nigeria Somalia Sudan Lesotho Cameroon Djibouti Congo R Cape Verde Angola Swaziland Namibia Mauritius South Africa Botswana Gabon Seychelles Equatorial Guinea

6.6 4.3 9.3 40.4 14.7 12.3 10.7 9.0 23.4 0.6 37.5 12.4 3.1 0.15 19.2 147.9 8.7 38.5 2.0 18.5 0.8 3.7 0.5 17.0 1.1 2.0 1.2 47.5 1.9 1.3 0.09 0.5

3 2 5 16 7 7 7 5 16 0.5 30 11 3 0.1 20 166 n/a 48 2 21 1 8 1 59 3 7 6 278 12 11 0.7 10

360 380 400 400 430 500 540 570 590 680 680 820 840 870 910 930 Est <950 960 1000 1050 1090 1540 2430 2560 2580 3360 5450 5760 5840 6670 8960 12860

Source: World Bank Development indicators

2.5.5

Small country size

Many projects in SSA are relatively small in scale, which can add to average costs. The above table also illustrates another daunting problem facing much of Sub-Saharan Africa: the relatively small size of the economies of most Sub-Saharan African countries. More than

30

ever before, capital is going to economies with two important featureslarge economic size and attractive business environment. Together these factors account for 75% of the variance in global foreign direct investment flows.6 If they are of smaller size, countries can compensate by developing a strong business environment. Indeed, the 10 economies that topped the business environment rankings published by The Economist magazine in 2007 attracted more than half of all global capital flows. Small size also limits the ability of governments, project sponsors and financiers to take advantage of the economies of scale available in medium sized and large countries. Small countries are hindered in every phase of infrastructure project development: construction, finance, operations, and regulation. For example, small countries are likely to have more difficulties than medium- and large-sized countries mobilizing a critical mass of expertise they need to design and execute reforms necessary to develop local capital markets, develop highquality PPP organizations, and regulate utilities over the operational phase. The small scale of many Sub-Saharan African countries also puts a premium on finding ways to plan, develop, execute and operate infrastructure projects of value to entire sub-regions of the continent. For example, COMESA has launched the COMESA Fund, with two windows: an Adjustment Facility which will provide budget support to facilitate policy reforms that deepen regional integration; and an Infrastructure Fund [the CIF] to finance regional infrastructure projects that do not have a sufficient rate of return to attract purely private financing. However, the number and diversity of the nations involved present daunting governance, management and other challenges that will not be easily resolved

2.5.6

Weak human capacity

The human capacity to support infrastructure project development, finance, operations, and maintenance is weak in most countries. Developers and fund managers focused on the SSA region report that in most SSA countries critical skill areas such as civil engineering, law, finance, and management are perceived as relatively scarce. With a labor force characterized by low rates of secondary and post-secondary education and high rates of emigration among those who do manage relatively high levels of educational attainment, indigenous human capacity in the professions necessary to plan, develop, construct, operate and maintain infrastructure systems are often lacking in many SSA countries. Familiarity with international standards is lacking. Developing sufficient institutional capacity in such areas
6

World Investment Prospects to 2011, co-written by Columbia Program on International Investment and the EIU, (2007) http://www.cpii.columbia.edu/pubs/documents/WorldInvestmentProspectsto2011.pdf provides evidence that with globalization the handful of countries with the best business environments attract a disproportionate share of the worlds capital. The report shows that in 2006, across a panel of 80+ countries, fewer than 10 countries attracted more than 50% of the FDI inflows and that two-thirds of the variation in FDI inflows across all countries was explained by two factors: the business environment score and the size of the market (pg. 60). The business environment score consists of an aggregation of more than 100 factors across 10 key areas (political environment, macroeconomic environment, market opportunities, policy towards private enterprise and competition, policy towards foreign investment, foreign trade and exchange controls, taxes, financing, labor market, and infrastructure). The small size and low business environment scores of many African countries restrict inflows of capital.

31

as the law, financial markets, government and other sectors to support a robust program of core infrastructure facility planning, construction and operation is challenging in labor market environments characterized by low educational achievement and high emigration. While individual capacity is important, equally important to effective performance is the system within which people work. African institutions responsible for infrastructure are relatively new and interact little with peer institutions in other countries. They lack the traditions and systems that provide incentives and continuous learning.

2.5.7

Lack of well prepared projects

Most experienced managers of infrastructure funds in Africa believe that the key constraint is not the availability of finance, but the lack of well prepared, financeable projects. There are many reasons for this including the lack of human capacity mentioned above, the lack of appreciation for the need for detailed feasibility studies and a lack of understanding of the expectations of investors in projects, a lack of willingness to budget for the high cost of qualified financial advisors and technical advisors, and insufficient donor support for project preparation.

2.6 Reforms to deal with the above constraints to private investment are being taken seriously by SSA governments

A number of the fund and facility managers in SSA emphasized that a welcoming environment for infrastructure investment can begin with the achievement of a consensus by a countrys political and economic leadership both those in the majority, and those in the loyal opposition - on the need to adopt and stand by fundamental economic management and reform policies. Several of those Africa fund managers expressed a strong belief that such a consensus about the need for consistent macro-economic policy and practice now exists in most countries of SubSaharan Africa. One African fund manger stated that when African leaders could look beyond former colonial masters and the US to newly emerging Asian economic powerhouses such as China and India for their models of macro-economic management, they found these examples more persuasive than entreaties from the IMF, the World Bank, and the EU. Fund managers and investors working in Africa with whom we talked believe that the launching of such initiatives as the NEPAD program and the African Peer Review mechanism are a manifestation of a genuine desire within Africa to get its house in order. They expressed confidence that the basic commitment to reform was durable.

2.7 While the level of private infrastructure investment is SSA is low, it has been on a rising path

32

Albeit starting from a low base, private investment in Sub-Sahara Africa is beginning to rise. Ettinger7 et al found that as of 2003, [F]or Africa, the average investment for each sponsor is the least ($52 million) of all the regions, reflecting the smaller average size of its economies. However, it is the only region with a clear increase in total investment over the period. The largest share of investment in between 2003 and 2006 was in Europe and Central Asia followed by Latin America then East Asia and South Asia. South Asias share grew three times between 1996 and 2000. The Middle East and North Africa and Sub-Saharan Africa saw similar growth, though from much lower levels.8 It is notable that investment has now become more evenly distributed across country income groups and more evenly distributed across regions including sub-Saharan Africa The share of low-income countries grew from 7 percent in 1996 2000 to 23 percent in 200406. While many low-income countries saw increases, India and, to a lesser degree Nigeria and Kenya accounted for most of the growth.9

2.8 Both the types of investors and the risk profile of investors in SSA infrastructure are changing 2.8.1 The composition of private investors in infrastructure in SSA is shifting

A critical development in the private financing of infrastructure in emerging markets globally and in Africa has been the shift in its composition from global multi-national firms headquartered in the developed world to a preponderance of firms headquartered in the emerging markets themselves.10: In the early 1990s, large corporations from developed countries played a big part in a wave of private investment. Among the most active companies were: AES Corp, Electricit de France, Enron, Suez, Veolia, Telefnica, France Telecom, and Deutsche Telekom. However major problems emerged by the end of the 1990s. In Latin America, an estimated 40 percent of contracts for infrastructure projects were renegotiated (Guasch, 2005). One survey of 65 international investors in the power sector shows that about half reported being less interested in, or retreating from developing countries (Lamech and Saeed 2003). Another survey illustrates that more than 65% of concession agreements in the power sector in developing countries were ultimately renegotiated in the 1990s (Woodhouse, 2005)11. To some extent the large number of renegotiations reflects the intrinsic difficulty of formulating long term PPP service delivery contracts. Many factors can change in unanticipated ways over the life of a project including levels of inflation and therefore costs, exchange rates, sector policies and institutions, demand,
7

Stephen Ettinger, Michael Shur, Stephan von Klaudy, Georgina Dellacha, and Shelly Hahn, Developing Country Investors and Operators in Infrastructure, PPIAF Trends and Policy Options, May, 2005

Clemencia Torres de Mastle and Ada Karina Izauirre, Recent Trends in Private Activity in Infrastructure What the Shift Away from risk Means for Policy, PPIAF Gridlines, May 2008 9 Ibid 10 Stephan von Klaudy, Apurva Sanghi, Georgina Dellacha, Emerging Market Investors AND Operators -- A New Breed of Infrastructure Investors PPIAF Working Paper NO. 7, 2008 11 Woodhouse, E.J., 2005. The Obsolescing Bargain Redux: Foreign Investment in the Electric Power Sector in Developing Countries Erik Vol 38, N.Y.U. Journal of International Law and Politics

33

competing service providers, etc. Renegotiation can mean that the project survives where it otherwise might have failed. Nevertheless, contract difficulties led many of the original multinational investors to reduce their exposure in developing countries. New players from developed countries emerged. In the water sector, for example, they included: Aquamundo, Germany; Acea, Italy; Aguasde Bilbao, Spain; Aguas de Portugal; and municipal water utilities from France, and Germany (Harris 2003). The new companies tended to engage in investments on a smaller scale in developing countries than their earlier counterparts. Meanwhile, local and regional investors and operators headquartered in emerging markets were accounting for increasing shares of private investment in infrastructure, although there is significant variation among sectors.12 The figures below illustrate these important trends

Figure 9:

Private investment commitments by type of investor

12

Stephan von Klaudy, Apurva Sanghi, Georgina Dellacha, Emerging Market Investors AND Operators -- A New Breed of Infrastructure Investors PPIAF Working Paper NO. 7, 2008

34

Figure 10: Developing country investors share of investment by sector

The authors found that the shift to heavier dependence on local and to a lesser extent other developing country-based investors was strongest in South Asia (SA), where investors located in the developed world accounted for only 34% of infrastructure investment. However, the trend was also quite pronounced in Sub-Saharan Africa. Developing foreign investors had become the dominant source of infrastructure investment with a 38% share, attributable largely to South African investors. Developing foreign investors (mainly from South Africa) have become the largest single group accounting for 38% of the value of investments. They are also the largest in terms of investments per project, at $104 million, compared to $58 million from local investors and only $35 million from developed country firms. They are dominant in energy and, to a lesser extent, telecommunications, while developed country investors have been the main investors in transport and water. Local investors have been active mainly in the telecommunications sector. 13 The

13

Stephen Ettinger, Michael Shur, Stephan von Klaudy, Georgina Dellacha, and Shelly Hahn, Developing Country Investors and Operators in Infrastructure, PPIAF Trends and Policy Options, May, 2005

35

Figure 11 illustrates these distinctive African trends by breaking out the share of investment in each sector in Africa, by category of investor. Three possible explanations have been posited for these shifts, including that the emerging market-based investors and operators are likely to possess (i) increasing expertise built on a base of earlier infrastructure investment experience, frequently as partners with developed country investors; (ii) a better understanding of the political and economic environments in the projects host countries; and (iii) access to locally denominated capital as a result of improvements in local savings and to the growth of local capital markets. Figure 11: Share of investment in sectors by category of investor

2.8.2

Investors are seeking projects with a lower risk profile

Torres de Mastle and Izaguirre have documented an important shift downward in the risk profile of private investments in infrastructure, by examining the type of investment being made. They found that private investment in emerging market infrastructure is becoming more concentrated in less risky contract categories and less risky sub-sectors, reflecting a lower appetite for risk among private investors. They also found that many concessions signed in 200106 included a mix of public and private financing of investment. This trend towards mixed public and private financing is consistent with a reduced risk profile for private investors. Mixed investment was primarily seen in electricity and water and now increasingly in transport. Of the 108 transport projects closed in 2006, about 27 percent had some government financing to cover part of the project cost or to provide support to project revenues. This shift to lower risk is being exacerbated by the recent global financial crisis. (See below)

2.9 IFIs, including bi-lateral institutions, play a large role in infrastructure finance in the region. China is becoming an important player.

36

In the SSA region, donor aid comprises a far larger, more influential component of the financial landscape of recipient countries than it does in other regions. For example, net aid received as measured by the World Bank outweighed foreign direct investment by more than 2:l in SSA, while in all other regions, this pattern is completely reversed with ratios ranging from less than 1:12 in the Europe and Central Asia region to about 1:1.5 in the Middle East North Africa region. 14 In the SSA region, the IFIs are a larger, more influential component of the environment in which infrastructure fund and facility managers operate than they are in other regions of the developing world. Figure 12: The Relative Aid-Dependence of Sub-Saharan Africa, 2006

Region

Foreign Direct Investment Billion $ 105 124.6 70.5

Net Aid received Billion $ 7.9 6.2 6.9

Total Foreign Debt Billion $ 660 1047 734

East Asia & Pacific Europe and Central Asia Latin America& Caribbean Middle East and North Africa South Asia Sub Saharan Africa

27.5

16.8

141

22.9 17.1

9.3 40.5

227 174

Source: World Bank, World Development Indicators database, April 11, 2008

The net aid received by different regions vis a vis direct foreign investment is shown above. In the SSA region, aid flows (including humanitarian aid) comprise nearly twice as much as other foreign investment flows. This dependence on aid flows on the one hand and the dominance in some countries of the IFI investments places a particular responsibility on the IFIs. Only through well- coordinated planning and joint action by IFIs and host governments, can the investment climates for infrastructure be rapidly and effectively improved. This chapter suggests a joint IFIhost government action agenda for accomplishing the necessary improvements in that environment.

37

The implications of the regions relatively high levels of aid-dependence for the development of infrastructure are mixed. On the one hand, the poorly coordinated provision of aid in the form of grants and deeply concessional loans can and often does delay the application of market discipline to the development and delivery of essential public services. On the other hand, with good coordination amongst donors and with host governments, financial assistance in new forms such as Output-based Aid can play crucial, high-leverage roles in the infrastructure development. China has become a major player in Africa infrastructure development. Over the past decade, China has been consolidating its economic relationship with various African countries. Chinese aid does not impose political and economic conditionality requirements, making it an attractive source of aid to many governments. China is investing in physical infrastructure, industry and agriculture. Much of Chinas recent official economic aid to Africa is in the form of China Ex-Im Bank loan financing. Beijings loans are often backed by natural resource commitments and many are targeted at infrastructure projects aimed at development of the petroleum and mineral extraction industries. Angola received $ 2 billion in loans in 2004 and is reportedly close to securing an additional $ 1 billion loan. It appears that Chinese aid is not yet affected by the global financial crisis. Tanzania plans to sell a 49% stake in its state-run Air Tanzania to a Chinese firm. In Liberia, China Union just signed a $ 2.6 billion contract to develop the Bong iron-ore deposit. By 2003, Chinese investors had already established 602 businesses in 49 African countries, covering such areas as trade, industry, and agriculture. Chinese firms have been investing in African infrastructure (hydropower plants, pipelines, factories and hospitals). Chinese companies have been active in the mineral rich countries of central and southern Africa 15. Chinese firms are competitive in countries where political situations, sanctions or other potential liabilities keep multinationals from investing. 2.10 The current global financial crisis is having an impact on infrastructure funds and facilities in SSA The full extent and depth of the global credit and equity markets crisis, which started in mid2007, is still not clear. However, it is clear that external finance for emerging market governments, commercial banks, and corporations has become both more costly and less available from commercial sources as credit risks have been re-priced and global banks lending capacities have shrunk with balance sheet assets being written down and regulators pushing financial institutions to rebuild reserves. An increasing number of emerging market economies are entering recessions of varying severity as demand from developed markets drops. Emerging market GDP may actually have declined in
15

http://peoplemove.worldbank.org/en/content/will-the-global-financial-crisis-affect-the-presence-of-china-in-subsaharan-africa

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2008 and appears to be continuing to shrink in the first months of 2009. The pace of the turnaround [in emerging market GDP] has caught policy makers and investors off guard. In a matter of months, gauges of growth in trade and industrial production in a number of countries went from passable to falling off a cliff; even domestic demand is suffering. Asia's economies have posted the starkest declines, but the slide is evident from Latin America to Eastern Europe. 16 Demand for essential public services such as transportation, electric power, water and sanitation tends to be linked to GDP growth rates in developing countries, so the implications of sudden, severe recession for the economic viability of infrastructure transactions that are substantially dependent on revenue generated by the projects, or taxes closely tied to services (e.g. motor fuel taxes) can be quite negative in some cases. Crisis Impact on SSA Unlike the situation in developed economies, Africa's banking system is not strongly affected by the current global financial crisis. African banks generally did not invest in sub-prime markets or related derivatives. However, Africa is nevertheless certainly being affected. As a recent World Bank note observed, there are several emerging sources of risk: (i) increases in nonperforming loans resulting from the slow-down in economic activity, declining commodity prices, currency depreciation and the sharp drop in equity prices, (ii) tightening of liquidity due to reduced trade credit flows and withdrawal of liquidity from local subsidiaries of foreign banks reflecting the fall-out of distress in the banks home countries, and (iii) possible contagion risks from less well-supervised regional banks.17 The authors go on to observe that remittance flows are weakening depending on the destination of migrant workers and thereby on where these flows originate. The danger is that the gains made in reforming and deepening of financial sectors in Africa over the recent decade or so, especially with regard to defining and containing the role of government and harnessing the benefits of globalization through financial integration, could stall or be reversed. As banks de-leverage and as their liquidity declines, access to credit of small and medium enterprises.18 Because international banks need to reduce risks, the region could see a decrease in private investment flows that will negatively affect the financing of many infrastructure projects. Foreign bond and equity market providers of FDI are also pulling back from the SSA and other emerging markets, directly threatening SSA countries ability to finance their private and publicprivate infrastructure projects. The withdrawal of foreign direct investors is likely to be a phenomenon that can take a number of years to reverse. Local investors will inevitably play a larger role both in filling gaps in financing created by the departure of foreign investors and tin easing the path when foreign investors do return.

16

Wall Street Journal, February 10, 2008

17

The Impact of the Global Financial Crisis on Financial Markets in Sub-Saharan Africa, April, 2009 Michael Fuchs, Antonio David, Smita Wagh, Giulia Pellegrini, Uzma Khalil Marilou Uy, Finance & Private Sector Development Africa Region, The World Bank, page 1
18

Ibid

39

Figure 13: Regional distribution of infrastructure projects with private participation and impact of the crisis in Aug-Nov 2008 Impact of crisis EAP ECA LAC MENA SA SSA Total No major impact reported 7 11 23 3 9 7 60 Raised financing but at higher cost 2 2 1 2 7 Project restructuring due to crisis 1 1 Delayed 4 6 5 1 13 29 Delayed potentially 16 19 11 7 16 1 70 Canceled potentially 1 1 Canceled potentially (more than financial crisis issues) 1 1 Canceled 2 1 1 4 42 Total 29 42 11 38 11 173 Source: World Bank and PPIAF, Impact of the financial crisis on PPI database

Figure 14: Investment commitments in infrastructure projects by region and impact of the crisis in Aug-Nov 2008 Impact of crisis (US$ million) No major impact reported Raised financing but at higher cost Project restructuring due to crisis Delayed Delayed potentially Canceled potentially Canceled potentially (more than financial crisis issues) Canceled MEN A 3,215 333

EAP 2,909 1,116 1,070

ECA

LAC

SA 2,475 8,900

SSA 1,144 375 -

Total 25,313 4,003 2,500 25,955 56,028 35 3,500 2,800 120,13 4

2,675 12,896 1,524 2,500 6,825 989 8,827 8,297 35 1,900

12,258 17,296 3,500 450

1,788 15,997 -

392 450 2,361

Total 17,353 34,770 32,943 5,336 27,372 Source: World Bank and PPIAF, Impact of the financial crisis on PPI database

40

Depending on whether one is looking at the number of projects or their dollar value, SubSaharan Africa appears to have suffered the least or second least severe impact of the global crisis on its current pipeline of PPP project financings for infrastructure, in percentage terms.

Country dimensions of crisis impact: no two SSA countries are alike The specific way in which the global credit crisis is constraining infrastructure financing depends on the macro-economic characteristics of each country and on the relationships between the countrys domestic banks and international banks. The Nigerian case suggests how important it will be to understand these particularities in order to develop effective IFI interventions. The Africa Markets Daily issue of January 16, 200819 reports Nigerian banks are finding it considerably more difficult to obtain credit lines and guarantees from international banks secured against local projects. International banks are now reportedly turning down requests for projects in the energy, power and infrastructure sectors as a result. Substantial stock market declines, uncertainty about the degree of exposure of Nigerian banks to stock market losses as a result of extensive share lending, and questions about the willingness of Nigerian central bank authorities to defend the local currency exchange rates are all contributing factors to this manifestation of the global credit crisis.
The financial system in Kenya appears well capitalized, but increased levels of non-performing loans (NPL) can be expected because of a slow down in economic activity especially in tourism and construction. There was deprecation in the exchange rate of 13 percent and a loss in stock market value of 31 percent during September/November 2008 as the crisis unfolded. 20

The impact on other African countries depends on the steepness of stock market declines, bank credit exposure, and exposure to foreign exchange risk. Impacts of crisis on existing private infrastructure funds and facilities Fund managers and private project developers and operators believe that it is certain that the crisis will impact funds and facilities which have reached financial closure and have started investing in projects in several ways. Perhaps the most obvious of these effects is on each funds ability to access credit of sufficient size and structure with which to efficiently leverage their projects. One major project developer/operator in the power sector reported that large project financings are particularly vulnerable due to the deep mistrust which has developed among the worlds commercial banks and other financial institutions which had heretofore routinely joined debt syndicates and equity clubs to support large infrastructure financings. However, some large infrastructure transactions have closed in middle-income markets such as India and Brazil,

19

Ebbing International Credit Lines Tighten the Screws on Nigerian Banks, Africa Markets Daily, January 16, 2008
20

The Impact of the Global Financial Crisis on Financial Markets in Sub-Saharan Africa, April, 2009 Michael Fuchs, Antonio David, Smita Wagh, Giulia Pellegrini, Uzma Khalil Marilou Uy, Finance & Private Sector Development Africa Region, The World Bank, page 24

41

in some cases with additional participation from government owned financial institutions.21 If debt can be accessed at all in either international or local markets, credit spreads will be far wider and covenants will be tougher than they were before the crisis. Even those equity funds that have raised all of their target equity and have reached financial closure are never fully funded with cash: they typically rely for actual investment disbursement in a project on the callable capital commitments of their investors. Thus far, we have not learned of any failures of equity funds that have achieved full financial closing, to fund disbursements for specific projects. However, this must be considered a distinct possibility as formerly liquid fund investors find themselves suddenly illiquid and attempting to recover after sizeable portfolio losses. At the project level, arranging debt financing will be more difficult because of the crisis. Debt financing from banks will be costlier, will require more documentation and loan tenors will be shorter. . It is no longer possible to finance projects by selling bonds to the international capital markets. Increased concern with risk has led to rating agencies being asked to rate bank loans that are being used to finance infrastructure investments in Asia and Latin America. Project risks, especially demand risks, are being scrutinized more carefully. Concern with risk is leading to more requests for backup guarantees from government. Where a project depends on revenues from consumers such as in toll roads or even water supply and distribution systems, demand risk is receiving more scrutiny from investors. Several investors indicated that despite political risks, government off-take agreements are considered less risky than projects that earn revenue directly from consumers given the effects of the crisis on incomes and thus on demand. Additionally, there is widespread belief that the guarantees of IFIs will also be more in demand. For example, financiers working on PPPs in several countries indicated that they are more interested in the use of PRGs and/or PCGs now than prior to the on-set of the crisis. The general consensus of those interviewed in the course this project, is that projects that are very close to financial closing may still close because of the sunk cost of investor preparation though on less favorable terms. Projects not near closing will have more difficulty in raising private finance. Several fund and facility managers also indicated that this potentially very challenging environment for equity funds investors would provide opportunities for higher return for the relatively few debt funds operating in this space. It should also mean much more attractive returns to capital for private sector full and partial credit guarantors as their products pricing varies with the local market credit spreads between enhanced and un-enhanced loans or bonds. Of course, this means that for project sponsors, debt capital will be more scarce and more expensive. It is clear that the crisis is putting even more pressure on governments and on IFIs to develop projects that properly allocate risks between the public and private sectors and to reduce risks to private investors.
21

Tom Cochran discussions with Ada Karina Izaguerre

42

43

3.

Key Characteristics of Existing infrastructure Funds and Facilities in Emerging Markets and Specifically in SSA

This section of the report briefly describes the inventory of funds and facilities that has been prepared under this project. Definitions and a description of what types of funds and facilities are covered in the inventory are described. General characteristics of SSA funds and facilities are also presented. Details on the Inventory are presented in Annex 2 and in a publication of the inventory. 3.1 Preparation of the inventory of Funds and Facilities in Emerging markets

As noted earlier, a key task of this assignment was the preparation of a comprehensive inventory of existing infrastructure funds and facilities operating in emerging markets around the world. In preparing the inventory, we included all funds and facilities operating in emerging markets that are privately founded and which have raised private capital. We also included those facilities such as GuarantCo that have been founded by or financed by IFIs and which have as their purpose to leverage private finance for infrastructure. This includes funds like the Tamil Nadu Urban Fund (India) which is a debt facility that has raised funds on the local bond market, and Findeter (Columbia) a debt facility which leverages private bank lending. We have excluded institutions such as DBSA, which, even though they use a fixed fund as the source of their capital, operate much like a state-owned development bank. We also excluded: social fund types of facilities that are highly subsidized (often offering grants) to support small scale infrastructure and that do not raise money from commercial markets; Sovereign Wealth Funds, although many of which have made infrastructure investments in emerging market countries; Construction companies and others with an interest in infrastructure development and/or operations in emerging markets which may make equity or debt investments in some projects but which have not organized a legally separate entity for such purposes; Funds or facilities whose infrastructure investments have included only those Central European countries which are already members of the European Community; and Bond investment funds that include passive exposure to infrastructure through a portfolio of investments -- including emerging market infrastructure but are not strategic investors in infrastructure assets.

3.2 The methodology used for the preparation of the inventory of infrastructure funds and facilities in emerging markets. The two key elements in our research into infrastructure funds and facilities was the creation of a database of independent funds and facilities, and conducting structured interviews with managers of key funds and facilities.

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The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI or Inventory) that was prepared as part of this assignment is published as a separate report. The information in the Inventory was gathered from publicly-available sources accessible electronically via the Internet, from searches of infrastructure publications, discussions with industry practitioners and from referral to The 2008 Preqin 2008 Guide Infrastructure Review: a Guide to the Unlisted Infrastructure Market, used with permission by the publishers, Private Equity Intelligence Ltd. A second key element in our research was a set of structured discussions held by team members with senior managers of a range of funds and facilities identified through the inventory process to provide us with a far more detailed understanding of these entities structure, operations and results than could be gained through desk research alone. The list of those with whom we scheduled discussions was based on the following characteristics: A mix of public and donor supported funds/facilities; public-private funds/facilities; and purely private funds; Geographic diversity; A preponderance of fund/facility managers with well-regarded track records and a minority of start-up fund managers; At least one public/private fund/manager who failed to close and launch a fund, despite backing from an IFI; Representation by both fund/facility managers which combine investment banking with operational management functions as well as those which do not.

An interview instrument to guide the discussions was drafted, commented upon by team members, tested in a few initial discussions, and revised. It was used in the discussions conducted in person by members of the team in Johannesburg, London, New York and Washington, DC by Messrs. Cochran, Kruger and Pellegrini during the months of July to October, 2008. This discussion guidance instrument is attached as Annex 6. A full list of all those with whom we completed discussions in the course of our research is attached as Annex 5.

3.3 The number of infrastructure funds and facilities has risen rapidly on a global basis and has been followed in recent years by growth in funds and facilities operating in SSA The emergence of private finance for infrastructure in the 90s was accompanied by the establishment of several pioneering private infrastructure funds including Emerging Markets Partnership (EMP), the Hastings Fund, Barclays Private Equity and Macquarie. 22 It is notable that one of the earliest funds, EMP, specialized in emerging markets and in Africa. The number of infrastructure funds has grown substantially over recent years and this growth has recently accelerated.

22

Orr, Ryan J. "The rise of infra funds Project Finance International - Global Infrastructure Report 2007, Supplement, June, 2007, pp 2-12.

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A 2007 survey found that at least 72 new funds had been established world-wide during calendar year 2006 and the first three months of 2007 with capital raised or targeted worth a total of $122 billion23. The majority of these funds were focused on United States and European brownfield infrastructure. The average new fund had a target size of about $1.7 billion. The funds focused on emerging markets, including those based in larger countries such as India, tend to be smaller, with far smaller average deal sizes, but correspondingly, larger numbers of anticipated investments per fund and thus greater diversification. This survey found that the limited partners investing in the new infrastructure funds consist primarily of institutional investors including pension funds and insurance companies. Some are treating infrastructure as a new asset class. For others, the emphasis is on rate of return and diversification within their equity, fixed income, and/or alternative asset portfolios. The survey also raised some concern about crowding (too many funds) and the high prices that result, the scarcity of desirable assets and shortage of green-field developers, as well as downward pressure on yields. However, Orr and Kennedy opine, These are likely to be shortterm concerns because long-run demand for infrastructure development is very high. The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI) prepared as part of this study includes information on 262 different funds and/or facilities. The rate of growth of infrastructure funds in emerging markets has accelerated sharply in recent years. While our Inventory has incomplete data on the year of launch, the following table illustrates this pattern of accelerated growth for those funds for which year of launch data was available. Figure: 15: Year by year growth in number of infrastructure funds in emerging markets

Funds only Frequency 1 2 4 9 6 5 5 4 4 3 Percent 1% 1% 3% 7% 4% 4% 4% 3% 3% 2% Cumulative Percent 1% 2% 5% 12% 16% 20% 24% 26% 29% 32%

1986 1990 1992 1994 1995 1996 1997 1998 2000 2001
23

Ryan Orr and Jeremy Kennedy, Research Note Highlights of recent trends in global infrastructure: new players and revised game rules in Transnational Corporations, Vol. 17, No. 1 (April 2008) referring to Global Infrastructure Report 2007, The Growth of Infra funds.

46

2002 2003 2004 2005 2006 2007 2008 Total

6 4 9 8 19 24 23 136

4% 3% 7% 6% 14% 18% 17% 100%

36% 39% 46% 51% 65% 83% 100%

The global financial crisis can be expected to have a sharp effect on future years. Geographic Focus: The EMIFFI contains information on funds and facilities that are mandated to invest (i) globally in both developed and emerging markets, (ii) globally in only emerging markets, (iii) in one or more emerging market regions, and (iv) in only one country. Figure 16: Regional distribution of infrastructure funds and facilities Regional Focus Global MENA Sub-Saharan Africa South Asia East Asia and Pacific CEE Latin America Total Facility 7 0 11 2 2 3 3 28 Fund 46 13 38 56 28 26 26 233 Total 53 13 49 58 30 29 29 261

While a significant number of facilities have been created in other regions, many lack the independence from IFIs, donors, or host governments necessary to qualify them for inclusion in the EMIFFI. A greater number of the facilities which do qualify for inclusion in the EMIFFI focus on Sub-Saharan Africa than on all other emerging market regions combined. This is because many facilities have been established with donor support with the aim of encouraging private infrastructure investment in Sub-Sahara Africa. While the regional distribution of funds is much more even, it is still interesting to note that more funds listed in the EMIFFI focus on Sub-Saharan Africa than on any other region except South Asia.

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3.4

General characteristics of existing infrastructure equity funds in SSA

Infrastructure equity funds in SSA have not been significant financiers of power, roads, and water infrastructure. Rather, they have focused on telecoms. Most financing of power, roads and water infrastructure has come from operating and construction companies. Infrastructure equity funds have thus far focused primarily on telecom investments Equity fund managers throughout the developing world including in Africa have been most successful investing in telecommunications. Telecommunications infrastructure refers to capital facilities such as wireless, broadband, and mobile networks. Most funds define sectors of permitted investments expansively to cover multiple sectors, e.g. telecoms, power and energy, transport, and water. However, fund managers pointed to telecommunications as the sector most likely to yield target returns at the levels desired by their limited partners and other investors. Actual investments in SSA by infrastructure equity funds are in fact mostly in telecommunications. The AIG Africa Infrastructure Fund, for example, was one of the first infrastructure funds in Africa and is highly regarded for its commercial success through investments in telecommunications infrastructure. The telecommunications sector particularly wireless presents projects that are relatively quick to plan, fairly easy to construct, and relatively free of politically inspired controls on tariffs. Equipment components are manufactured outside of the host country and shipped and assembled without heavy reliance on local vendors, contractors, or craft labour. Physical mobile phone facilities are highly standardized with respect to design, equipment, etc. and therefore take far less time to design, develop and construct than most core infrastructure facilities; There is very low risk of government intervention in tariffs as telecom services are not considered to be an essential service Mobile phone enterprises typically begin generating cash flows virtually from the first day so that both equity and debt investors can be paid in far less time than can investors in core infrastructure projects; Shorter tenor debt is more likely to be available in local currency than is longer term debt; Even if the debt is denominated in hard currency, the fact that this debt can be of relatively short duration means that normal currency hedging at reasonable rates is more likely to be available, and in any event, the cash flow generated by mobile phone systems is often so large that international investors believe it will overwhelm currency risks that may threaten flows of dividends and debt service. 3.4.1

Moreover, functions associated with other types of infrastructure projects that tend to cause delay in project implementation such as buying land, relocating existing structures, and getting

48

building permits are significantly reduced in telecom investments. Individuals and businesses are typically willing to pay for telecommunications services and project operators do not have to negotiate or depend upon availability payments or subsidies from host governments in order to achieve project viability. Characteristics like these make it possible to pay back project debt and produce high equity returns at much lower risk within a few years of the project being conceived. 3.4.2 Infrastructure equity funds have played a negligible role in financing of power, transport and water and sanitation in SSA By stark contrast, infrastructure equity funds operating in Africa have not been significant financiers of infrastructure projects in the power, transport and water sectors. These sectors take longer to prepare than telecoms because they are seldom standardized, are more heavily embedded in local institutions, are usually more highly regulated, and almost always require many years of project planning and development, financial structuring, physical construction, and operational ramp-up. They are also more prone to interference in tariff setting by political authorities. Because of the limited role to date in equity fund support to power, roads and water sectors and because of the critical importance of these sectors to development in Africa, the analysis in this report focuses heavily on actions that can be taken to improve prospects for commercial financing of these sectors which we refer to as core infrastructure sectors. Core infrastructure is a term that refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Non-core infrastructure a term that refers to infrastructure that is considered less essential to basic human needs. It generally refers to telecommunications, but could involve a road, gas line or water treatment plant dedicated to a specific industrial operation rather than to providing general service to a population

Only a very few infrastructure equity fund managers with operations in Africa had met with much consistent success in the core infrastructure sectors, in emerging markets. Those few which did succeed in core infrastructure, e.g. Conduit Capital or Actis did so entirely or largely in the power sector.24 The low level of investment by funds and facilities in Africa in the core infrastructure sectors has significance when considering the important development impact of these sectors. Given the importance of the core infrastructure sectors, it suggests that IFI involvement in funds and

24

Monoline financial guarantee insurance companies Ambac, MBIA, and XLCA were exceptions, having concentrated heavily wrapping Greenfield and Brownfield surface and air transportation projects with long-tenor full credit guarantees. They have been able to do this with high returns to capital because the low default probability and loss severity of investment grade rated essential public infrastructure results in low capital charges being assigned to such projects by the rating agencies and regulators.

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facilities should aim at increasing investment in the basic sectors of transportation, water supply and sanitation and power. Hence, in our discussions with fund and facility managers, we focused primarily on their views of the current constraints to investment in core infrastructure, and what they look for when evaluating opportunities to invest in core infrastructure sectors. 3.4.3 Most private equity financing of core infrastructure has come from construction and operating companies rather than from equity funds For the core infrastructure categoriesi.e. electrical power, transportation, and water and sanitationthe principal private investors of equity have not been independently organized infrastructure funds with international financing, but rather construction and operating companies based in the OECD or the emerging market countries themselves. A 2005 survey of projects with private financing in emerging markets by Stephen Ettinger et al25 initially assumed that such projects would be funded by sponsors that mobilized capital globally. In the end, they found that only a small number of PPP projects, (2% by number of firms and 1% by value of investment) had sourced their equity capital from funds with international financial investors. This percentage was dropping in importance over time. The majority of equity was sourced from construction and operating companies. The reason for the dominance of construction and operating companies may have to do with differences in the cost of capital. Private equity funds that are not leveraged at the fund level are likely to have the highest costs of equity capital defined by the return expectations of the limited partners and other contributors of equity. Construction firms, non-regulated power project developers and operators, and transportation concession operating companies have often been able to lower the actual cost of the equity capital which they are expected to contribute to projects through the use of debt raised on a corporate finance basis, e.g. senior or subordinate corporate debt sourced from commercial lenders or bond markets, the proceeds of which are used to make equity investments at the project level. Examples of core infrastructure investors with a history of accessing debt at the corporate level to make equity contributions in emerging market projects included the major water companies such as Thames, Suez and Veolia, transportation concession developer/operators such as Ferrovial/Cintra, Skanska, and Dragados, and numerous power project developers and operators such as AES and CalEnergy. These and other companies that operate in roughly the same way arent included in the Inventory because they havent set up separate infrastructure funds and facilities, but they continue to be important core infrastructure investors in the emerging markets. Equity contributions from such firms must often be locked up for significant periods due to the requirements of the senior secured debt providers or financial guarantors. For example, MBIA and other monolines providing their guarantees of senior debt in the Chilean and Mexican transportation sectors made such requirements mandatory. Such investors may also be able to
25

Stephen Ettinger, Michael Shur, Stephan von Klaudy, Georgina Dellacha, and Shelly Hahn, Developing Country Investors and Operators in Infrastructure, PPIAF Trends and Policy Options, May, 2005

50

tolerate lower equity returns than the private equity funds because the cost of the bank or bond debt they are using to make large parts of those contributions is normally far lower than normal equity return expectations. 3.4.4 Most infrastructure equity funds only rarely use mezzanine financing as part of the funds own capital structure and only opportunistically provide mezzanine financing for project investments Mezzanine capital, in forms such as subordinated or junior debt, convertible debentures, and preferred stock comes with the fundamental characteristic that the obligation to make timely payments of principal and interest on this layer of debt is subordinated to the obligation to make such payments on another class of debt called senior debt. Subordination can apply to principal and/or interest, although the norm and the highest impact is achieved when both principal and interest payments on the mezzanine layer are subordinated. Mezzanine debt is often in turn protected by caveats pertaining to the payment of dividends and stipulating that all junior debt obligations must be met before dividends or capital returns to equity can be considered. In some complex structures more than one layer of mezzanine capital may be used. At the project investment level, the inclusion of mezzanine layers in financing individual transactions can potentially reduce the all-in cost of funds for an individual transaction or for the securitization of several transactions, although the transaction costs of adding additional lenders to the capital structure do tend to be slightly higher. Mezzanine capital can increase chances of economic viability by reducing the amount of equity needed and/or improving the credit quality of the top layer. Equity fund managers indicated that they generally do not employ mezzanine debt as part of the capital structure of a fund because of the relatively high carry costs.

Figure 15:

Mezzanine capital in infrastructure financing structures

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While many equity funds included in the EMFFI inventory are allowed by their mandate to provide mezzanine financing to individual projects that they finance, most only provide mezzanine financing if they see a reasonable chance of equity-like returns on the mezzanine commitment. The use of mezzanine capital is much more common in corporate finance than infrastructure finance. Fund managers indicated that yield considerations are a deterrent to mezzanine finance in infrastructure because the projects tend to have a longer payback period than corporate ventures and the higher yields expected by their equity investors are more difficult to find. At the same time specialized mezzanine debt providers such as Darby that mix equity and borrowed funds to make mezzanine investments in projects at lower cost than funding the mezzanine investment with equity, are few in number especially in Africa. Some senior global project finance bankers that provide senior debt to projects have expressed concern about some structures with mezzanine debt below them in a project capital structure. If

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an event of default occurs and if the mezzanine tranche does not get repaid the principal and interest due, then the mezzanine holder might be able to put the project into bankruptcy causing issues for the senior debt. Anecdotal experience suggests that another reason for limited mezzanine financing in infrastructure may be the requirements imposed by host governments for core infrastructure investment in PPP transaction formats such as concessions. Concession program legal frameworks typically combine with lender requirements to define the permissible characteristics of the equity, e.g. that it be hard equity, paid in at closing or over a specified period during construction, that changes in ownership be approved by the lenders and/or the host governments, and that dividends payments are permitted only after debt service coverage ratios have been achieved. Such constraints are likely to mean that the equity is deeply subordinated to the debt and that less risky (and therefore potentially less expensive) mezzanine debt cannot be substituted for equity, at least not until the transaction is well-seasoned. Project sponsors seek the least expensive debt for the remaining portion of the financing and this will typically be senior debt. However, there are some exceptions. For example, one global infrastructure fund manager whose group will be investing only about 20% of its multi-billion dollar fund in emerging markets indicated that it will be investing an un-specified share of the fund in mezzanine form in lower risk projects and that he was expecting returns in the low teens on such investments. The global credit crisis is likely to make this plan more difficult to carry out as lenders increase their covenant requirements and equity investors require higher returns. 3.5 General characteristics of infrastructure facilities in SSA

While we found 11 facilities that focus in whole or in part on Sub-Saharan Africa, several are quite small such as Acumen Fund and DevCo. Roughly half of the total includes only one or a few SSA countries being targeted. GuarantCo and the Aga Khan Foundation for Economic Development (AKFED) are each of significant size, and are global in scope. They have developed significant Africa expertise and have demonstrated how an ability to mobilize both capital and technical assistance for infrastructure can produce excellent results, with projects such as the Bujagali Hydropower (AKFED and Sithe Energy) and Celtel Tchad (GuarantCo). A few facilities such as ERT I and ERT II, K-Rep banks community water loan program, and Water Partners International Water Credit Initiative in Kenya are dedicated to one country and often just one sector (e.g. small scale renewable energy or water projects) within single countries. One country-specific entity which began life as a privately financed lending facility for municipal infrastructure Infrastructure Corporation of South Africa (Inca)26 has had to change its business plan significantly in the face of legislative changes that brought increased competition for senior general obligation type lending from commercial banks. (See Section 5 below) Similarly, both GuarantCos equity investors and its management have reported having to climb steep learning curves in the context of infrastructure financing opportunities in Africa and have modified their original approach. GuarantCo will now consider taking first-loss risk,
26

Because it mobilizes finance for municipal governments only, it did not fit neatly into the inventorys parameters for either funds or facilities.

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the functional equivalent of the mezzanine financing by lenders and/or equity investors, and full credit risk. It is worth pointing out that while the facilities in SSA have very disparate experiences, they each provide more than financial capital for investment. Each has provided significant amounts of human capital in forms such as willingness to play a pro-active leadership role in the deal development and execution process and/or targeted technical assistance in the project preparation process. Also, each has had to be quite flexible in design and utilization of financial products, willingness to adapt to local circumstances and assessment of shifting market dynamics. This institutional flexibility seems particularly important when the mission of the facility involves the mobilization of local capital, as in the cases of GuarantCo, the K-Rep community water loan program, and Inca. Most of the facilities in Africa are willing to support the development and capitalization of projects of small and medium size, a project scale range in which projects may be more easily realized to the extent that both financial and engineering technology can be kept simple and payback periods kept relatively short. 3.6 National political stability is an investment criterion for both private funds and for private facilities, but managers of private funds and facilities with experience in SSA believe that political risks are manageable Several equity and mezzanine debt investors expressed the belief that the traditional sovereign risks of war, civil strife, expropriation, transfer, and convertibility tend to be manageable in both core and telecommunications infrastructure, without the use of such devices as IFI-provided or commercial political risk insurance. One investor mentioned a power sector investment in Cote dIvoire which survived civil strife unscathed due to quality of management, good record of service delivery under difficult circumstances, and value creation to all parties. Sovereign risk per se did not seem to be a significant concern to Africa fund and facility managers. A number of them pointed out that the perception in the global investor community of Sub-Saharan Africa as an investment destination is still clouded by the perception of Africa as a continent filled with sovereign risk. In fact, one manager of a successful equity fund in Africa expressed that this perception provides his fund with a distinct competitive advantage as it suppresses the competition for good investments he would otherwise face if the low level of sovereign risk were more broadly understood.

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4.

Recommendations for the Design of New Funds and Facilities Intended to Concentrate Investment on Core Infrastructure in SSA

This chapter presents recommendations for supporting infrastructure finance by IFIs or governments, especially recommendations to facilitate the finance of core infrastructure. Except as noted, they can apply with rough equivalence to equity, mezzanine, and other debt funds, or to facilities including guarantee facilities. The recommendations for improving the finance of core infrastructure in Africa are clustered in three themes. The need to aggressively improve the financial environment to encourage private finance of core infrastructure The need to improve institutional capacity and skills related to infrastructure finance The need to adopt different financing strategies for different project types

Figure 16: Major recommendations for improved infrastructure financing in Africa.

THEME 1:

IMPROVE THE FINANCIAL ENVIRONMENT

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The financial environment needs to be improved by making progress in developing the domestic capital market, thereby beginning to improve prospects for domestic currency financing. Other mechanisms that are recommended are government/IFI support to infrastructure funds and facilities with the purpose of extending closing dates, and supporting new debt facilities, guarantee facilities and mezzanine facilities. IFI risk mitigation instruments also can be expanded especially in support of local currency financing. Support to hedging mechanisms to mitigate the risk of foreign exchange financing can be experimented with where forex financing is necessary. Recommendations 4.1 More aggressively develop domestic capital markets

Improved domestic credit markets are needed to provide local currency funds with the longer tenor necessary for sustainable finance of core infrastructure. Governments throughout Africa are devoting substantial effort to a range of initiatives intended to encourage the emergence and growth of capital markets. This often goes hand in hand with the reform of the locally domiciled commercial banking, pension fund and insurance sectors. These efforts should be expanded, for example, by: Supporting further development of legal and regulatory frameworks and the institutional capacity necessary to implement them professionally in the banking, insurance, pension fund and contractual savings sectors; Managing governments own borrowing to establish yield curves where these do not exist as a first step to help establish rational risk-based credit spreads Supporting the development and wide use of financial instruments to match the investment requirements of local buy-side equity and credit market participants including commercial banks and non-bank financial institutions such as deposit-led micro finance institutions, indigenous insurance firms and pension fund managers; Working with and encouraging IFIs to use guarantees, put options, and other techniques to support pioneering transactions to help local equity and debt markets to extend maturities for infrastructure transactions in SSA. Also, to support systems for cost-effective forex hedging. Promoting formal, independent rating systems, including national scale systems for locally denominated debt instruments in which the highest ratings are typically achieved by the locally-denominated Treasury securities of the country. The introduction and increased local utilization of formal, independent national scale rating systems has been used by the World Bank in its support for municipalities in Swaziland and by the Water and Sanitation Program (WSP-Africa) in their support for water utilities. The first step involves a diagnostic or advisory type of shadow rating to identify the key creditworthiness problems facing the

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utility and agree on the internal and external reform agendas necessary to mitigate them, before entering into a formal rating review process as the second step. This two step approach was designed to provide a phased introduction to the rigours of the formal rating process.

Box 1: Credit ratings and sub-national finance in Mexico Legal and regulatory frameworks for sub-national and infrastructure-related borrowing can be altered to require independent credit ratings as a pre-condition to borrowing. In Mexico, the bank regulator required that financial institutions seeking to len It has led to a significant expansion of the municipal debt credit rating market.d to municipalities must link their interest rates to ratings, in effect mandating the immediate emergence of credit spreads in a market which had heretofore been a name lending environment. Two ratings from nationally recognized credit rating agencies are required before making any loans to local governments. The use of credit ratings applied wether the source of borrowing was commercial banks, development banks or the bond market. South Africa has sent a delegation to Mexico to closely study that countrys experience in developing its sub-sovereign infrastructure debt markets and we believe that many other SSA countries can benefit from the Mexican experience as well.

Small countries face greater difficulties in developing domestic credit markets then larger economies because they may lack economies of scale in the number of bond or stock market transactions. The example set by the group of six francophone countries to create a regional bourse in Abidjan should be useful, although the fact that all six countries use the CFA as common currency may limit its direct replicability in other regions. Nevertheless for a variety of reasons recommendations to create regional bourses should be made to blocs of countries already used to coordinating some aspect of public finance policy, such as the Customs Union of Southern Africa (SACU). IFIs have begun to make important contributions to the development of local debt markets through support to help develop legal and regulatory frameworks, capacitybuilding for indigenous financial professionals, provision of equity and debt in new and established indigenous financial institutions, and participation in pioneering transactions that can serve as models for additional transactions of a similar kind. Several fund managers in emphasizing the importance of domestic financial market development, have praised the positive role that the World Bank and other IFIs have played in assisting the development of national legal and regulatory frameworks and the creation and strengthening of market institutions. Fund managers strongly believe that strengthening market institutions and providing risk cover in projects when such institutions are weak, are perhaps the most important roles that IFIs can play. The leadership role of IFIs in developing locally denominated debt or debt guarantee facilities capable of providing relatively long-tenor debt for

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core infrastructure could be important in many SSA countries that havent yet forged the necessary linkages between indigenous sources of capital and essential public infrastructure.

4.2 Support new funds and facilities with the objective of significantly extending investor exit time horizons

Most equity funds have a defined closing date for liquidating investments and returning investors funds ten years from the start date with a possible two-year extension. However, core infrastructure project finance requires debt and equity capital tenor capable of supporting relatively long project design development, construction, and operational ramp-up periods. Twelve to fifteen years is often considered a minimum with twenty to twenty five years sometimes necessary. Many managers of funds felt that extended close dates would be desirable from their point of view and would increase the likelihood of their considering sectors with a longer gestation period. The need for patient capital i.e., capital willing to accept that returns to projects in the core infrastructure sectors of transportation, water and power sectors will be spread over the long life of the asset for core infrastructure arises from a number of basic factors, including: (i) The physical nature of the facilities and the structural characteristics of the core infrastructure sectors, which normally involve: Significant amounts of land, much of which requires either condemnation and acquisition or the negotiation of easement rights with individual owners that can take time to resolve; Lengthy design development processes in order to fit the project to unique system technical configurations arising out of interdependencies with other physical infrastructure systems, for example, a power plant depends upon transmission and distribution capacity; a port needs roads and rails; a water treatment plant requires a distribution network;

(ii) Financial, economic, legal and tax characteristics of the investment including: A pre-existing tariff regime that may need significant reform; Long amortization periods that approximate the planned economic life of the physical assets; Depreciation periods as allowed by country tax codes

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Comparatively volatile demand arising from the facts that business cycles tend to have higher peaks and lower troughs than in developed country markets, and operating entities must be able to ride-out the cash flow consequences of demand volatility; and Currency of debt service, which should match the currency of revenue collection to avoid currency, mismatch risks.

It will be important for sponsors of new funds and facilities to identify fund investors with longer exit time frames. Some international investors e.g. developed country pension funds, insurance companies, sovereign wealth funds, philanthropies have been interested in the higher yields associated with emerging market investments. However, the global financial crisis will increase perceived risks and will affect the readiness of international investors to come forward. Portfolio managers of local contractual savings pools tend to welcome the appearance of wellstructured securities issued by prudently managed public and private entities providing essential public infrastructure services because these instruments can provide both a positive yield spread above similar maturity sovereign securities and enough safety to meet stringent fiduciary guidelines and other relevant regulatory requirements.

BOX 2:

Examples of the role of Pension Funds in Infrastructure Finance

In some cases, organized pressure from the pension fund community has played a key role in developing capital markets. For example, in Mexico, the private pension fund trade association CONSAR advocated successfully for the development of a sub-national and PPP bond market. This market has subsequently flourished with the involvement of pension funds. When the initial PPP debt transactions in the transport sector did not meet the pension funds minimum credit rating requirements imposed by the pension regulators, financial guarantee insurance provided by commercial guarantors MBIA, Ambac and XLCA was used. With the downgrade of these commercial full credit guarantors, the Inter-American Development Bank is reportedly considering assisting the development of a local credit guarantor to take their place. In at least one SSA country, Tanzania, pension funds are seeing few locally denominated debt securities other than Treasury bonds because of that markets underdevelopment. They are nonetheless entering into joint ventures with municipalities to develop and operate bus terminals and at least one mixed public and private use office building because they see this as a relatively safe way to obtain steady rates of return in transportation over the mid- to long-run. In Nigeria, Lagos state government is leading the way both in developing PPPs and issuing subsovereign debt securities appealing to local investors in need of relatively safe, mid- to long-term investments. In both SSA countries, pension funds, life insurance companies, and others with a need for mid- to long-term investment securities should find investing in infrastructure funds and facilities an efficient way to expand their exposure to the sector 59

Longer term fixed rate debt may or may not bear higher interest rates than shorter term fixed rate debt: that component of a transactions annual debt service expense will depend on the shape of the yield curve in the market in which it is raised. However, longer-term debt will always be less expensive with respect to the amortization component of annual debt service expense. Variable rate debt will typically carry lower interest rates than fixed rate debt. However, because transactions using variable rate debt must be structured to withstand the stresses of possible spikes in variable rates, the savings accruing to the borrowing entity through the use of variable rate debt can only be passed along to consumers of the service being provided with substantial lags. Even more importantly, the use of variable rate debt introduces a major element of unpredictability into the borrowers budgets, and this may be unacceptable for both public and regulated private entities of the kind likely to be sponsors and managers of core infrastructure project transactions. The use of full or partial credit guarantee products can substantially reduce the interest rate costs of any debt format particularly in the current environment of unusually wide credit spreads, although some of the interest cost savings will have to be shared with provider of the credit enhancement product. Guarantee facility representatives argued that guarantees can often simultaneously save the borrower as much or more in the amortization component of annual debt service expense through tenor extension as they can in the interest cost component. THEME 2 IMPROVE INSTITUTIONAL CAPACITY

Many of fund managers indicated that their biggest constraint was the lack of a pipeline of bankable projects and, as a result of the poor pipeline, a lack of diversification opportunities. This was often ascribed to two fundamental factors: the quality of the project preparation by the counterparty and the decision-making capacity of the government once the structuring of the project is commenced. Because institutions are underdeveloped and lack systems,proceedures and traditions required for effective management, decision making is often delayed and flawed. Capacity building is needed both at the level of developing individual skills and at the level of developing institutions with the structure, policies and incentives to perform effectively. Recommendations: 4.3 Build skills and develop human capital

Building skills and developing human capital to improve the quality of indigenous project preparation and governmental decision-making will be a long and difficult process requiring the sustained commitment and cooperation of IFIs, donors and host government. It will require developing human capacity in such critical professions as law, accounting, financial analysis, investment banking, financial systems, consulting engineering, and construction project management.

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Traditional technical assistance may in some instances need to be redesigned to provide more capacity building. One fund manager with considerable experience in Africa suggested that promising techniques for improved capacity building can include: The granting by the governments of more bursary awards and internships in fields where skills shortages have reached critical proportion; and Extensive use of retired international and domestic expertise to facilitate operations while fulfilling a mentoring role. This is being used very successfully in South Africa by the DBSA, which has recruited and placed retired practitioners in 140 municipalities. Reform the Institutional Framework Improving institutional performance for infrastrure finance has several dimensions 4.4.1 Reform the legal and regulatory frameworks to improve the business environment for infrastructure finance

4.4

A major factor determining whether investment can be elicited or not and also often determining whether investment is successful or not is the policy, legal and regulatory framework governing business formation, operation and taxation. A simple, clear, and coherent set of policy, legal and regulatory frameworks lowers project development and financing costs as uncertainty is reduced in areas such as (i) profit repatriation, (ii) tax regimes, (iii) regulatory and judicial corruption, and (iv) the effectiveness of investors recourse in the case of problems in the calculation of risk premiums they must charge. In addition, other more general aspects of the business environment must be aligned to facilitate international or local private sector investment rather than constrain and inhibit it. This involves reexamining sector policies and sector structures, legal system issues, regulatory issues, PPP frameworks and fiscal issues. Many fund managers emphasized that legal/regulatory frameworks and tax systems set the conditions for prudent infrastructure finance that attracts skilled private sector managers and investors. Sector policies Critically important policies to encourage core infrastructure investment will include those that clearly set forth a governments approach to development of each core infrastructure sector, its fundamental attitude toward the use of private capital in the financing, construction and operation of infrastructure facilities and the like. In some cases sectors may need to be reorganized to allow private participation. One key to sustainable core infrastructure development is the creation of public, private, or mixed public-private enterprises, which can operate facilities and charge and collect user fee revenues -- and sometimes subsidy flows -- to cover the costs of capital, operations and maintenance. Utility sectors or individual enterprises may need substantial restructuring in order to efficiently and effectively upgrade the quality and quantity of essential public service delivery. This is likely to be particularly warranted in

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instances in which less drastic changes have failed to improve service and/or mobilize new capital for improvements. This can be a two step approach involving first, fully ring-fencing the revenues of and corporatizing a governmentally-owned utility and second, eventually privatizing parts of the system, if circumstances warrant. 27 General legal frameworks Legal framework improvements of particular value to commercial infrastructure finance will include those which: improve the sanctity of contracts and the independence of the courts, strengthen the ability to irrevocably pledge intangible (e.g. financial and legal) assets including ring-fenced revenue streams produced by infrastructure facilities and dedicated taxes and fees, improve honesty and predictability of indigenous enforcement agencies and court systems, and clarify the conditions under which private parties can invest in and operate public infrastructure facilities (part of a PPP framework see below)

The legal and regulatory frameworks for public-private partnerships in Sub-Saharan Africa are generally seen by fund and facility managers as being relatively under-developed and immature. The administration of policy within these frameworks is generally viewed negatively by fund managers and developers. The quality and enforceability of contract law are also very important to project developers and financiers as it applies to all key deal documents such as concession, EPC, off-take, and financial agreements will take the form of contracts and the abrogation of any contract in the deal can threaten the viability of any transaction. PPP frameworks PPP frameworks typically set out the legal conditions for private investment in and operation of infrastructure facilities. Many of fund and facility managers also emphasized that a sensible PPP legal and regulatory framework governing the development, negotiation, and administration of concession and other forms of public private partnership agreements is critically important to attracting high quality international and local firms to provide planning, construction, and operational expertise, as well as external capital. There has been substantial improvement in the quality and number of country PPP frameworks in recent years. Leading examples include countries from all regions, including: Chile, Czech Republic, Hungary, Kenya, Mexico, South Africa, and South Korea.
27

Vivien Foster estimates that at least an additional $3 billion per year can be made available for infrastructure investment in SSA from this activity. See: World Bank Vivien Foster, AFRICA INFRASTRUCTURE COUNTRY DIAGNOSTIC: Overhauling the Engine of Growth: Infrastructure in Africa, draft of September, 2008

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PPP frameworks that permit the selection of project developers, financiers and operators through less than fully competitive bidding processes are favored by private sector fund and facility managers, for a variety of reasons, including timeliness, and the cost of investing in extensive technical feasibility analysis and demand studies before bidding. Private fund and facility managers clearly prefer non-competitive frameworks. However, well prepared projects that are part of a well designed PPP system that provides competitive bidding for the right to be the local private partner can attract considerable competition among potential private partners and can offer the best terms to the public sector. A variety of SSA countries are currently searching for the best way to deal fairly and expeditiously with unsolicited proposals from project developers. For example, Nigerias electric power sector has seen a number of unsolicited proposals for various generation facilities and is working on changes to its legal and regulatory frameworks to be able to address these initiatives in an equitable, transparent manner. Viability Gap Funding in PPPs Ideally, projects should be financially viable and capable of carrying operation and maintenance costs, as well as debt service expenses using dedicated revenue from user fees and charges. In low-income countries, this can be difficult or impossible to achieve. Government financial support is sometimes necessary to make a project viable. Such support should be limited, transparent, affordable, properly accounted for and managed to serve priority objectives. With limited resources, a formal prioritization mechanism with clear criteria is important.. Expected economic benefits should be the dominant interest in prioritization. Many countries have established formal PPP frameworks with specific policies defining Viability gap funding to PPPs when government support is required. Chile, South Korea, and South Africa have well known programs. Viability gap support to PPP projects can be provided in many forms. Common approaches are provision of a capital contribution, a defined ongoing contribution to operations, a minimum revenue guarantee or a guarantee of debt service. Private sector investors usually favor a capital grant as it is not subject to variation depending upon political and financial circumstances and is also not affected by inflationary changes. Bidding for levels of support is an important mechanism when PPP projects are being designed. Good frameworks need to be well administered by host governments in order to result in successful projects. Thus, fund and facility managers emphasized the importance of building the expert capacity of governmental officials ranging from Ministry of Finance staff to utility regulators and dedicated PPP development and administration staffs in order to create an investment environment conducive of private investment, particularly in core infrastructure. The Chilean Ministry of Public Works PPP development and coordination staff was cited as a particularly well respected among emerging market countries and an example of the positive dividends that a governments investment in capacity building can pay.

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Box 3: Unsolicited PPP Project Proposals A recent PPIAF study of standard practices in a wide range of developing countries found that most countries with formal systems for managing unsolicited proposals use similar procedures, in two fundamental phases: The first phase entails the governmental process of project approval, usually entailing several steps, e.g. (i) Submission of a project description by a private proponent to the appropriate national or sub-sovereign government agency, with a greater or lesser amount of detail, depending on the country; (ii) Preliminary response within a stipulated review period, with the responsible government body providing its finding about the proposed projects ability to serve the public interest, fit within a strategic infrastructure plan or meet other public policy objectives; (iii) Formal recognition, if the project concept receives preliminary official acceptance, and an invitation to submit a more detailed proposal within another specified period; and (iv) If the detailed project proposal is also approved, it proceeds directly to the second phase, a modified competitive bidding process. If it is rejected, the proponent may be allowed to submit a modified version which may then be approved and proceed on to modified competitive bidding, or the governmental agency may be able to use the concept in a normal competitive bid after a specified number of years. The second phase involves a competitive bid modified to give the original project proponent an advantage to reward that partys having taken the risk and incurred the cost of developing the concept and obtaining approval by the responsible governmental agency. The Second Phase also serves to market test the project in order to ensure that the public is getting a competitive price for granting a concession or otherwise permitting the project to go forward. Three main bidding methodologies have been used in various countries to achieve this difficult balance of public and private interests: (i) Bonus: Chile and Korea provide a specified bonus to the original proponent; this is usually an additional theoretical value (e.g. 10%) added to the original proponents bid score; (ii) Swiss challenge: used in jurisdictions including Guam, India, Italy, Philippines, and Taiwan this system gives the original proponent the right to match any better offers from competitors; and (iii) Best and final offer: multiple bidding rounds are used to narrow the field of competitors, e.g. to two other third parties, with the original proponent automatically participating in the final round.

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Regulatory system reforms Improvements in regulatory frameworks will usually include those that govern the following: the ability of utilities to set, charge and collect reasonable rates and tariffs for essential services; oversight of construction including compliance with quality standards, environmental and social regulations, etc.; and administration operating agreements between governments and private concessionaires and other transaction participants.

Utility tariff rate regulation directly impacting cost recovery by retail providers and sometimes even wholesale service providers are probably the most immediately important elements of a countrys regulatory environment according to many interviews with fund managers (e.g. Conduit; Latin Power I, II, and III; and Aldwych.). Many fund managers emphasized that the more essential the public service, the more difficult it would be to obtain regulatory approval to charge full cost-recovery rates due to the political pressures to reduce charges. The potable water sub-sector is considered to offer the greatest financial risks particularly in countries or localities where historically water appeared to the consumer to be highly subsidized. The financial risks in Africa associated with sectors such as water were underlined by fund managers who cited factors such as the high incidence of poverty, the increasing unreliability of rainfall, and long traditions of free service and/or theft of services. In the absence of credible tariff regimes that permit full cost recovery, the government will need to provide a subsidy to achieve economic viability. Fiscal reforms Corporate tax policy and taxes on financial instruments also affect private sector appetite for infrastructure investments. Taxes on corporate and public entities participating in infrastructure finance transactions need to be perceived as fair and must also be predictable for the life of the transaction. Taxes on financial instruments used in infrastructure transactions, e.g. stamp taxes, securities transfer fees and the like should be as minimal as possible to encourage the highest possible levels of liquidity in both the primary and secondary securities markets. Taxes on assets transferred to a special purpose entity set up to issue a bond for example may make the use of such facilities impossible. While these principles are important for any capital market, they are crucial in developing capital markets such as those found in most SSA countries. Public revenue mobilization for infrastructure As noted by many, the ability of SSA countries to mobilize public revenue has improved slightly in recent decades: the average tax-to-GDP ratio in sub-Saharan Africa increased from less than 15 percent of GDP in 1980 to more than 18 percent in 2005.28 However, almost all of that growth in this key ratio resulted from taxes on natural resources. Non-resource-related revenue increased by less than 1 percent of GDP over 25 years. Even in resource-rich countries, non28

Sanjeev Gupta and Shamsuddin Tareq, Mobilizing Revenue, in Finance and Development, volume 45, Number 3 September, 2008

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resource-related revenue has essentially been stagnant (Keen and Mansour, 2008). 29 Enhancing the ability of national and sub-national governments to mobilize public tax revenues especially those which can be dedicated to either pay-as-you go or debt financing of core infrastructure is vitally important to the development of local debt markets capable of financing infrastructure. The use of dedicated revenues from user fees to create trust funds which can be used only for specified core infrastructure purposes are one way to keep a steady flow of locally generated resources into the construction, operation and maintenance of related core infrastructure facilities. However, increases in the collection of broader-based taxes are also important to the financing of core infrastructure. Utility fees themselves should generally not be used as the public revenue source of pro-poor subsidies, since they cause allocation distortions. Governments should raise more public revenue from broader-based sources for subsidization purposes. Thus, efforts to improve public resource mobilization should encompass all levies, whether narrowly or broadly based.30 An important element of fiscal policy is the financing of financial support to infrastructure projects with private involvement. This may involve subsidies to beneficiaries and/or support to project entities through guarantees and other credit enhancements, viability gap financing and similar mechanisms. Subsidies and other financial support for infrastructure should be part of a comprehensive rule based policy that is clearly defined for all projects in advance of project identification. Intergovernmental framework reforms Intergovernmental framework reforms that govern sub-national responsibilities and fiscal resources are an important component overall reforms. Improved institutional capacity is also needed at the Sub-national level. A significant number of important core infrastructure projects are the responsibility of sub-national governments e.g. water and sanitation, local toll roads and bridges, local ports, local urbanization projects. Governments need to improve the framework that controls sub-national regulation and subnational debt. This involves improving systems of intergovernmental finance, over-sight of the sub-sovereign sectors, and the regulations governing sub-sovereign borrowing. In many SSA countries emerging from socialist inspired central planning there is very limited local autonomy and therefore very limited local decision making or accountability. The process of promoting further decentralisation and evolution of power should be continued provided that the revenues and ability to generate revenues at sub-sovereign levels accompanies the devolution of power. Some IFIs such as the World Bank and USAID have mounted useful programs helping to develop the sub-sovereign sectors of a number of SSA countries. International support of this
29

Ibid For an excellent discussion of the essential services access and affordability challenges and their relationship to taxation and subsidization issues, see World Bank Vivien Foster, AFRICA INFRASTRUCTURECOUNTRY DIAGNOSTIC: Overhauling the Engine of Growth: Infrastructure in Africa, draft of September, 2008

30

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kind should grow to the extent that central governments in the region can be fully committed partners in the process. 4.4.2 Develop data and information systems permitting more reliable service demand projections and other key analytic activities necessary to develop sound project financing plans. The absence of reliable information is seen by some fund managers as inhibiting the design, appraisal and successful closure of core infrastructure transactions. Information deficiencies cover the entire spectrum from the most basic demographic data to the location of underground utility lines in urban areas to national macro economic data. Lack of data can lead to project failure as a result of optimistic business plans being generated and investors having no way to judge the integrity of the base data and assumptions. The more governments can be encouraged to see data as an important marketing tool for their country the better the quality of base historical data is likely to become. Reliable and comprehensive economic and social data is a crucial foundation of financial risk analysis, pricing and underwriting. This is particularly the case with long term financing of core infrastructure where projections of demand, ability of existing and future consumers to pay cost-recovery rates, and other key risks are critically important to any investors. IFI and donor support for the development and maintenance of high quality social and economic data should be stepped up in those SSA region countries typically the poorest which have substantial deficits in this area.

4.4.3 Develop a larger, more robust pipeline of bankable core infrastructure projects Infrastructure agencies and project preparation facilities in SSA are not developing a sufficient number of well prepared core infrastructure project opportunities that are of interest to private investors. Private investors are focused on non-core projects such as telecoms partly because of the complex nature of core infrastructure and the lack of well-prepared core infrastructure projects that address issues of risk and return. A number of bilateral and multi-lateral project preparation facilities focused on Africa have been launched in the past decade. However, most of the fund and facility managers interviewed for this study indicated little or no positive experience with project preparation facilities, indicating that dealing with such entities adds unnecessary levels of complication and require more time than if fund managers simply rely on their own and sometimes their co-investors resources to prepare projects. Several fund managers focused on the SSA region indicated concerns that once a project has reached a certain stage of preparation, support is too often curtailed before bankability can be achieved. One equity investor/developer in the power infrastructure sector proposed the creation by IFIs of a revolving fund which could be tapped by potential investors who wanted to complete a larger number of project feasibility studies simultaneously than their own limited budgets would

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permit. The fund could work in a similarly responsive way as the US Trade Development Administration (USTDA), but be free of country content requirements. . India also has a fund along these lines called the India Infrastructure Project Development Fund, a Rs.100 crore Revolving Fund, created with an initial budgetary outlay by the Ministry of Finance, Government of India to quicken the process of development of credible and bankable Public Private Partnership (PPP) projects that can be offered to the private sector.31 To improve the development of project pipelines, Governments should: Develop systems within each sector agency for project selection, screening and prioritization: Building more robust pipelines of economically viable core infrastructure projects in most SSA countries will demand better prioritization within sectors. Sector strategies developed and adopted in conjunction with consortia of donors that have an interest in a particular sector can be helpful. In the end governments need to take their own responsibility for sector strategies and sector investment plansand to ensure that individual projects contribute to a regional or national plan . Clarify the bidding and competition processes: The use of pre-qualification and similar processes to keep competitive bidding of governmentally-initiated PPP projects from being overly cumbersome can quicken the pace of project development and financing without sacrificing the quality of the final outcome. Bidding procedures can be made flexible enough to encourage project-improving suggestions from bidders without sacrificing public integrity. It will be best to adopt reforms of this kind in conjunction with development of comprehensive PPP frameworks that set forth in one coherent package all the rules for private participation in PPPs. (See above) Make Project Preparation Facilities more user friendly for private project sponsors/financiers. A number of investors and project developers emphasized the need for more single source, end-to-end funding of project preparation through the many phases of core infrastructure project development. This is likely to require more financial support for existing and/or new PPFs. The PPIAF publication Infrastructure Project Preparation Facility User Guide for Africa (see below) is a comprehensive catalogue of project preparation facilities serving one or more African country, with detailed information on more than 20 separate entities and step-by-step instructions for tapping these facilities. While there are a number of these facilities they are limited in scope and funding. There is a need for better funded more comprehensive project preparation facilities. Ensure staff has relevant technical qualifications. Take a more focused approach to onthe-job-training and mentoring of staff in project preparation without causing delays; Work with IFIs and bi-laterals to obtain high quality technical assistance. The work of the Municipal Infrastructure Investment Unit (MIIU) in South Africa provides a useful illustration of how this can be done. MIIU was created to offer free advice to local

31

See: Scheme and Guidelines for India Infrastructure Project Development Fund, by Department of Economic Affairs, Ministry of Finance, Government of India. http://www.pppinindia.com/pdf/guideline_scheme_IIPDF.pdf

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authorities on all matters affecting the financing of infrastructure projects undertaken on a joint basis with the private sector. MIIU was staffed with TA financing provided from USAID and achieved good results, with approximately $1 Billion of projects brought to contract stage with a unit expenditure of only $2.3 Million. Use outside financial advisory staff drawn from the investment or merchant banking and financial advisory sectors so that those with experience in actually closing infrastructure financing transactions predominate in the process of structuring new transactions and preparing feasibility studies; Include funding in agency budgets for experienced transaction advisors to assist the government in an advisory fashion following completion of initial feasibility studies Adopt clear processes for annual budgeting of funds for the facility. If significant amounts of money were made available to countries for objective feasibility studies as part of organized PPP programs, this would expand the number of possible project opportunities that private sponsors can evaluate at any one time, potentially accelerating the pipeline Encourage more end-to-end funding of project preparation from the identification to preliminary engineering and sometimes detailed engineering phases of core infrastructure project development; but also support to early stage feasibility studies that could be shopped to potential project sponsors ; Test systems to recover the costs of project preparation by the identification, preparation and structuring of projects which are either (i) successfully sold to private sector developers and operators, or (ii) are successfully financed with public revenues on a payas-you-go basis and/or with the issuance of debt, or (iii) some combination of public and private financing.; Develop strong links to agencies and institutions responsible for utility rate setting, intergovernmental fiscal relations; banking and securities market regulation, etc.; and keeping abreast with and engaging in dialogue about needed reforms. Develop projects in conjunction with explicit PPP frameworks that are well vetted with the investment community and which clarify the role of government and private parties, and which clarifies the types of government support (subsidies, back up guarantees, viability gap financing, and other credit enhancements) which is generally available for infrastructure projects in different sectors and the conditions under which the support is available.

Catalogue of Project Preparation Facilities for Africa Working under a commission from the Consortium for Infrastructure in Africa and with financial support from the PPIAF, a users guide to project preparation facilities in Africa has catalogued twenty three project preparation and other related facilities which have been launched with the

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mission of developing a better flow of bankable infrastructure projects in Africa32. These facilities finance a wide variety of project types both PPP and traditional government projects. Because of the sheer number of different facilities, their varying areas of sector focus, and the different phases of the project preparation process each is permitted to support, any project sponsor or financier seriously interested in utilizing such a resource faces difficult task figuring out how best to proceed and with which facilities. The User Guides table below that shows which facilities support the various phases of the project preparation process suggests the complexity of the challenge facing those seeking to access the facilities.

Figure 17: List of Africa-specific Project Preparation Facilities and the project phases that are covered by a particular facility

Source: PPIAF Infrastructure Project Preparation Facility User Guide for Africa, 2006
32

See Infrastructure Project Preparation Facility User Guide for Africa, PPIAF, 2006 70

The facilities described in the users guide cover six phases of project preparation including: Enabling Environment, Project Definition, Project Feasibility, Project Structuring, Transaction Support, and Post Implementation Monitoring. 4.4.4 New funds and facilities for SSA should adopt proven management principles to increase the probability of success

Key management principles for success in the SSA environment include: Proactive project origination Funds and facilities that approached origination on a more pro active basis had the ability to identify and consider more opportunities than those adopting a reactive origination approach. Several fund managers made the point that deal
origination must be a more active process the less developed the project preparation system in the target country. Particularly in the SSA region, a proactive approach is likely to be

more successful than a reactive approach because it ensures that the fund will be involved in high quality project preparation and financial structuring from an early stage. This should help compensate for the shortcomings many SSA countries exhibit in such areas as human and institutional capacity to develop bankable core infrastructure projects and lack of business support infrastructure. A proactive approach to project origination will be more difficult in countries which have not yet developed frameworks for the swift, fair evaluation and acceptance or rejection of unsolicited proposals for projects in regulated sectors. This issue is discussed further in Chapter 5. A proactive approach to origination will be more expensive than a reactive approach. Because debt funds and facilities are generally going to be operating with much tighter margins than equity facilities, they will find it harder to take a proactive approach, unless they have supplemental sources of revenue to help defray the up-front staff and other costs associated with early involvement in project preparation and transaction structuring. Debt providers may be able to find such supplemental revenue from donors, and/or financial advisory or structuring fees charged to project sponsors, host governments, IFIs, etc. 33 Country knowledge: all the successful funds and facilities had a very deliberate strategy to collect information, study and analyse countries in which they were considering
33

.Project finance units of commercial and investment banks typically charge substantial advisory fees which cover much of their costs of deal origination.. MBIA was able to obtain significant transaction origination synergies from a short-lived consulting subsidiary called Capital Advisors Ltd. When the firms emerging markets infrastructure finance business became better established, it was able to charge enough in structuring fees during the transaction development process to support a large share of its highly proactive infrastructure deal origination efforts. Project finance units of commercial and investment banks typically charge substantial advisory fees which cover much of their costs of deal origination.

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investing. Furthermore a good local partner was considered essential for consideration of investments in a country (See below) Staff background and compensation: The successful funds and facilities all tended to have staff with high incentives drawn from the merchant and commercial banking environment. A critical factor is that all staff have transaction skills and authority to rely and make the use of the services of specialist consultants. Compensation should approximate the remuneration levels of the private sector merchant banking environment. Deal origination and portfolio management combined: Our discussions with fund and facility managers revealed that, in many of the successful funds and facilities, deal origination, deal supervision, and workouts activities are undertaken by the same units usually with participation by local agents. However, some successful funds and facilities divide responsibility for origination and underwriting from monitoring and workout. Those that adopt this division of responsibility typically come from commercial banking backgrounds where this division of responsibility is the norm. Use of well-established, credible local partners For the bulk of investments the conceptualization and definition of a project is a local function whether by an entrepreneur, national government planning agency, international donor, or local community group. In the bulk of cases a local counterparty is virtually a prerequisite to transform the concept into a bankable investment project. The local partner often has a strong political network but weak financial, technical and management capacity and insufficient balance sheet strength to carry out the project on its own. Sometimes former government officials who are retired from active duty play a key role. Experienced equity fund managers report that they favor local partners, especially local operators over better known multinational operators because they believe that in times of difficulty a multinational partner/operator is more likely to decide to exit quickly leaving the fund investors in difficulty. . The quality of project preparation goes hand in hand with the quality of the counterparty. A technically weak, non credible counterparty with limited own resources is not likely to succeed, While a technically and financially strong and highly credible counterparty enhances and immeasurably increases the chances of success. A pro active approach to identifying a local partner is necessary to avoid the risk of teaming up with a weak counterparty or one with a questionable reputation stemming purely from political connections and networks. Managers felt that this point cannot be overstated enough. It is no small effort to determine which local partners, agents, (and sometimes even employees) can be trusted. The consequences of making a poor selection can be high. All the South African funds operating in SSA specifically warned against counterparties engaged in money laundering exercises and equally destructive practices such as bid-rigging, kickbacks, bribery, etc.

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Governance, investment decision-making, and portfolio management practices in conformance with international standards Critical aspects of governance, investment decision-making and portfolio management should conform to internationally-accepted best practice. These standards include: The composition of the board and how stakeholder representatives will be chosen/nominated. It is typical to have a clause in the charter allowing a representative to the board for every 10% invested; The composition of sub-committees like the audit committee, investment/credit committee, human resources committee and management committee; The mandate of the fund which should clearly spell out the geographic focus area, the sector focus area, investment strategies containing the criteria to manage the portfolio (maximum percentage of the fund committed per partner, project, sector, region, rating/credit quality) Appropriate and inappropriate exit strategies; Rigorous arms-length rules ensuring that construction and other bidding will be competitive with no advantages provided to shareholders; Protections for minority shareholders through use of supermajority provisions for such key decisions as executive selection and compensation, incurrence of debt, change of control, appointment of independent auditors, etc. Detail of key management experience and skills; Draft operational budgets; Anticipated capital calls for operational expenses and time of cash flow breakeven (dealing with the so-called J curve); Incentives for key management (performance bonuses, free carries, etc.); and Delegation framework to provide management with discretionary powers.

Investment guidelines that give strong guidance to staff but are flexible enough to permit new opportunities which conform to the basic risk/reward profile originally intended Investment guidelines can play a critical role in the profitability of the fund. Guidelines that are too prescriptive, given the current scarcity of bankable projects, will seriously impede the rate of investment. Ideally they should give strong guidance with a flexible dimension. This is particularly important in an immature fund where healthy diversification can only be attained over a period of time.

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An equity fund investment guideline should typically include the items which are given by way of example in the following table. Figure 18: Example of an Investment Guideline Anticipated return Equity investment Max exposure by area Max exposure per name Prohibited investments Max exposure per sector 28% to 45% 20% to 100% 25% to 50%

25% to 50%

Casinos, Defence Infrastructure, etc. ICT Transport Solid waste Water Sewage

50% 80% Max BBB exposure Per deemed or shadow credit quality 25%

to 20% 50% A

to 10% t0 30% AA

10% to 50% AAA

10% 20%

to

35%

60%

80%

An indicative frame work for investment policy like the one sketched above allows a good deal of discretion but because of the inherent checks and balances guards against exposing the fund to low levels of diversification. In portfolio management the phrase diversification, diversification, and diversification can be compared to the old adage in property: location, location, location. This is also one of the main motivators to place portfolio management responsibility with a dedicated risk manager reporting in the financial cluster. However, fund and facility charters should encourage nimble investment strategies within sound portfolio management guidelines. Overly rigid fund or facility mandates can discourage fund managers from moving to exploit unexpected opportunities likely to emerge in the rapidly changing SSA region. Thus, for example, portfolio management guidelines such as sectoral and geographic limits may need to be open to re-consideration in the light of new opportunities and changed circumstances.

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Control of project entities. Equity fund managers consider the ability to intervene in a project entity the interests of the fund investors to be an important element of investment decision-making. This may involve: seats on the Board of Directors, chairmanship of key committees, e.g. those dealing with personnel, budget and audit; possibly having the Board secretary function because of the crucial nature of the minute-taking and approval process; and or super majority voting on key decisions about all aspects of money management, contracting, and personnel A formal strategy to minimize severity of loss in projects that go sour. A strategy, prepared in advance, to cover worst-case contingencies, including cost of workouts/recovery is standard in well-managed funds. The costs of potential workouts should be considered vis a vis the expected net profit. If the two are to close the project should not be undertaken. One fund manager has consistently turned down municipal projects in Namibia as the size was so small that even one default would have eaten up all profit due to the cost of travel. Adoption of measures to reduce the annual cost of capital The cost of capital is a major contributor to the cost of core infrastructure, because the delivery of most essential public services is capital intensive. Due to the risk and reward expectations of investors, the expected return required by equity investors will normally substantially exceed the cost of mezzanine capital and senior debt, and the costs of mezzanine capital will normally exceed the costs of senior debt. Measures to reduce the cost of capital by re-examining equity vs. debt ratios, using credit enhancements to reduce spreads in senior debt, using mezzanine debt and possibly equity markets, and extending tenor to reduce annual principal amortization burdens, etc. all must be considered. The cost of capital (debt and/or equity) is an important component in determining the full cost recovery price of water, wastewater treatment, transportation and other essential public services. Hence, the annual cost of servicing debt and/or paying dividends is critically important to infrastructure investors, regulators and ratepayers. In many projects, the rule of thumb applied is that the annual expense of capital amortization will be between 25% and 50% of the annual total costs. The global credit crisis appears to be making both debt and equity harder to mobilize at reasonable cost. Whether equity or debt proves to be the more constrained financing element will depend on the specific circumstances of each transaction. Fixed rate, long-dated debt at the lowest possible interest rate is the most useful type of capital for core infrastructure project finance. By contrast, as discussed elsewhere in this report, private equity invested with high return and early exit expectations is likely to be the most expensive capital for core infrastructure project finance. Companies such as construction and operating firms which can access the debt markets on a corporate finance basis in order to be able to raise their project equity investments may be able to tolerate lower returns from those projects for longer periods of time than can those using

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100% hard equity and project finance structures. This can be the case, if the debt used to leverage corporate equity is of relatively low cost and relatively long tenor. In such cases, companies may be able to extract the hard equity portion of their project investment with first-through construction profits and then use dividends in a fairly short period to earn a healthy return, while still servicing the corporate debt taken on by the company to make the initial project equity investment. Use of mezzanine structures may or may not substantially reduce the cost of capital at the project level, depending on the nature and terms of the mezzanine structure used. Mezzanine capital normally yields a rate of return resembling that charged for debt of moderate risk, so it can provide a relatively inexpensive source of capital for start-up funds that use this initial capital base to induce equity investors to invest true equity. Mezzanine funds are generally provided by debt funds or facilities rather than private equity funds. While almost all equity funds are allowed to provide mezzanine financing most only occasionally go up a layer in security if they see a reasonable chance of equitylike returns in the mezzanine tranche.

THEME 3:

DIFFERENT FINANCING STRATEGIES FOR DIFFERENT PROJECT AND COUNTRY CIRCUMSTANCES

As noted in Section 2 of this report, Africa is different from other regions of the world in characteristics that affect infrastructure finance. Africa has a large number of small countries that limit economies of scale, has relatively undeveloped domestic capital markets and has relatively weak institutions. Solutions need to be more tailored to local conditions than is necessary in other regions. This section discusses recommendations that address the unique conditions in Africa. Recommendations: 4.5 Financing solutions should match project scale.

Core infrastructure project needs in Sub-Saharan Africa (as elsewhere around the world) can be visualized as a multi-faceted pyramid (as shown in Figure 19 below), with a small number of regional projects in the upper tier, some large scale projects, quite substantial numbers of medium-sized projects in the middle tier, and very large numbers of very small projects in the foundation tier. The core municipal projects in water and sanitation, power, transport, education, health, etc. are likely to be represented at each size level. As it is comprised of 48 countries of widely varying population size and economic status, each SSA country's pyramid of infrastructure project needs will look different. Small countries are

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likely to need more small- and medium-sized infrastructure facilities, with large- and mega-sized facilities more likely to be most efficiently constructed transnationally. The degree of urbanization will also influence the size composition of infrastructure needs, with more heavily rural countries likely to be requiring more small- and medium-sized infrastructure facilities than more heavily urbanized countries. The challenge for those seeking to develop an infrastructure market finance system for infrastructure is to design ways that sponsors of projects can prudently use market finance to address the needs at each size range and in each basic sector. For large-scale projects of national or transnational scale, multi-national and large domestic commercial banks, investment banks, IFIs, and large international and domestic debt and equity investment funds and facilities are all likely to have the asset bases and expertise to play leading or substantial supporting roles in a projects financing. For small- and medium-scale of local and regional scope, a different mix of institutions is likely to be appropriate, including domestic commercial and investment banks, domestic equity and debt funds and facilities, and pooled lending facilities. Very small and projects of neighborhood and village scale, still another range of institutions can often be the most appropriate, including pooled lending facilities, small and medium sized enterprise equity and debt institutions, and micro-finance institutions. In private and public/private infrastructure finance in SSA -- as in other fully developed and developing regions around the world -- the degree of gearing will be dictated by the senior debt lenders and possibly by such public sector decision-makers as the grantors of concessions and regulators. When senior debt lenders perceive that the financial default risk of a project is relatively low, they will tolerate a higher gearing ratio, e.g. 1:3, than when the perceived default risk is relatively high, when they will demand lower ratios, e.g. 1:1 or 1:2. Default risk is typically associated with such project-specific risks as: country risks, e.g. economic status, macro-economic policy management; broad political risks, e.g. war, expropriation, etc; more narrowly defined political risks, e.g. regulatory failure; construction risk; technology risk; demand risk; and operating risk. The success of those designing and executing each financial transaction in mitigating these risks will influence the gearing ratio of private and public/private infrastructure transactions. One consequence of the current global credit crisis and recession is the demand by most lenders that gearing ratios be lower for all kinds of finance, including for core infrastructure, according to many of those with whom we talked. While some of this push for lower gearing ratios may be a consequence of simple panic by lenders or toughened regulatory requirements with which lenders must comply, much of it arises from the need to revisit key underlying economic assumptions such as projected demand and possibly political assumptions as the threat of labor unrest or other forms of instability rises in some countries trying to cope with local consequences of global recession.

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Figure 19:

Financing Structures and project scale

4.6 Initial geographic focus of newly formed funds and facilities should be on a limited number of countries. There are substantial differences among the 48 countries of SSA. A detailed understanding of how the infrastructure systems operate within each country and good relationships with both majority and opposition leaders in each country is essential to making successful investments in core infrastructure. This means that at least the initial geographic focus of new funds and facilities should be on only one or a few countries. 4.7 Where a multi-country fund or facility is established, a strategy is needed for country and sector deal identification.

Once a fund or facility that targets multiple SSA countries becomes operational, the identification and origination of a sufficient number of bankable core infrastructure transactions becomes a critically important priority. This can be a difficult process in any region. In a largely poor region with distinctly different political economies, that process is particularly challenging. A starting point would be to adopt a country differentiated approach. One useful way to begin the task may be to distinguish between countries where a largely reactive approach to deal with

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deal origination will likely be most cost-effective and those where a more proactive plan is warranted. The criteria for selecting countries where a proactive approach is indicated could include: Size Political stability; Vulnerability to regional instability; Economic growth potential; The presence of significant project backlogs; State of regulatory framework and clarity of framework regulating PPPs; Investor-friendliness of tax law regime; Capital market development and likelihood of being able to gear with debt financing; Ability to apply the rule of law especially as it pertains to contract execution; The labour laws; Local skills levels; and Exchange rate history and prospects

By applying a framework as above, the countries identified for active marketing can be provisionally prioritised for the allocation of scarce marketing, project preparation and due diligence resources. Depending on the breadth of the funds or facilitys mandate, the size of its capital base and other factors, priorities can be further refined by sector within single countries or groups of countries, using factors such as: Typical Length and size of required investment; Typical breakeven period (how long for positive cash flow to be achieved); Potential for staged development; Market perceptions and other characteristics that will affect exit strategy;

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 Risk of political interference; Sectoral backlogs, growth and rehabilitation requirements in the different sectors; Ability and influence of the regulator; Typical potential return (if subsidies are involved the predictability and dependability of the subsidies in the specific country); Directness of interface with consumers; Vulnerability of projects in each sector to external shocks i.e. energy cost escalation; Potential to have bulk off-take agreements; Ability to mobilise assistance from project preparation funds; and Potential for risk migration or risk mitigation using credit enhancement instruments. Other considerations that will determine the choice of projects include: Quality of proposal and cost to finalise structure and agreements; The quality of credibility of the demand study including use of probabilistic multivariate stress testing of cash flow projections; The credentials and observable capabilities of the local sponsor(s); The nature of the project (greenfield, brownfield, secondary market acquisition); Equitability of risk allocation; The quality of legal and technical documentation; and Nature and degree of construction risk

4.8 Special consideration should be given to local currency debt and mezzanine facilities in SSA

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Special attention should be given to establishment of facilities that provide debt, subordinated debt or mezzanine capital and /or guarantees of debt in local currency. This is particularly applicable to those facilities focused on single countries or groups of similar countries in a region that would make more use of indigenous pools of long term savings, e.g. domestic pensions funds, military pension funds, insurance companies, etc. for investment in infrastructure. Managers of equity funds in Africa indicated that the lack of longer tenor local debt financing was an important factor that led them to favor telecom projects over investments requiring a longer payback period. Infrastructure debt facilities in Africa should have the objective of mobilizing domestic capital through bond offerings, the proceeds of which could be on-lent to infrastructure projects at rates better than a project entity could achieve on its own. Such debt facilities should have sufficient capitalization and/or credit enhancements to allow high enough credit ratings to attract long term investors such as pension funds and insurance companies. Mezzanine debt performs a credit-enhancing role for senior debt and can be an effective instrument for encouraging banks and other providers of long-term debt to join a project structure. It plays a role similar to that which can be played by a partial credit guarantees. However, as the mezzanine layer is normally paid-in capital, earning a reinvestment return, it can be a less expensive addition to the cost of funds than alternatives such as a full or partial credit guarantee, or direct lending at a spread reflecting sovereign risk on the entire amount. Mezzanine capital can take a variety of forms ranging from preferred stock to convertible debt, and subordinate debt. The best format for mezzanine capital in a given SSA project will depend on such issues as: The level of subordination required; The tax accounting treatment of mezzanine capital in a given country and possibly a given sectors in that country; The legal status of the sponsors and operators of the project; and The security requirements or preferences of the investors. For example, if the sponsor/operator of the project is a governmental or government owned entity where the equity layer has been provided governmental funds, a simple subordinate debt structure may be the most appropriate format. However, if the sponsor/operator is a corporate entity making an equity investment as the bottom layer in a public-private partnership transaction, tax accounting, local market conditions and other considerations may dictate a different format for the mezzanine layer, such as preferred stock or convertible debt. Thus, a key characteristic of a mezzanine fund targeting core infrastructure transactions in Africa will be flexibility with respect to the format to be used and the level of subordination. Pricing is a function of tenor and default risk: the deeper the subordination and the longer the tenor, the more its risk profile approaches that of common equity and this will be reflected in its 81

pricing. Because investors of mezzanine capital are likely to have different risk/reward preferences than either common equity investors or senior debt investors and the risk of nonpayment falls in between the two polar layers, the pricing of mezzanine debt will be in between common equity and senior debt.34 Mezzanine capital layers are normally sized at less than 25% of the total equity if deeply enough subordinated to qualify as quasi equity and very seldom more than 10% of senior debt. Consideration could be given to the establishment of mezzanine funds for groups of countries, such as those West-African countries using the CFA as common currency.

4.9 A format without a fixed end date may be appropriate for new debt facilities and guarantee facilities that concentrate on core infrastructure Infrastructure facilities with no fixed close date may be an appropriate institutional structure for providing long-term debt to infrastructure projects. The on-going operational character of facilities such as revolving loan facilities, bond banks, and guaranty facilities are far better suited to the origination of relatively long-dated lending for infrastructure, than are the set end date structures that are seen in most equity funds. Freed of the need to provide investors with a return of capital by a given close date, entities can concentrate on high-quality portfolio management. They may also have the ability to stretch-out fundamentally sound project financings that are faced with short-term demand shortfalls, thus avoiding some unnecessary project failures. Such entities can concentrate on establishing relationships of service and trust with clients that will lead to repeat business from the same or related sources. Debt facilities can be especially effective where they adopt an approach of being a quasi intermediary that raises funds essentially on demand. The highly regarded FutureGrowth Infrastructure and Development Bond Fund (a facility in the terminology of this paper) in South Africa is an example of the successful application of this principle. Launched in 1995 to invest in both public sector and private debt securities, this award-winning local currency debt facility is now capitalized at R1.6 billion and is invested in a range of diverse projects including transport infrastructure (N3 Toll Road and SA Taxi Securitization), urban renewal projects in central Johannesburg (Jika Properties and the Trust for Urban Housing Finance - TUHF) - and the financing of community buildings. FutureGrowth chief investment officer Andrew Canter has stated that FutueGrowth offered pension fund investors stable and sustainable risk-adjusted longterm returns while at the same time addressing the social and economic needs of South African society. The AA- rated facility is suitable for inclusion in a retirement portfolio as a core socially

34

In some cases such as that of the Development Bank of Southern Africa (DBSA), sovereign governments have provided unfunded mezzanine capital free of charge to their state-owned development banks as callable capital in order to ensure that the development bank achieves the highest possible rating, usually on a par with that of the sovereign governments Treasury bonds. Clearly, this free capital gives a substantial competitive advantage to state-owned development banks over funds and facilities such as INCA, which are being financed and operated along more rigorously commercial lines.

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responsible investment (SRI) allocation or a portion of a bond allocation in a balanced portfolio.35

4.10 Review opportunities for the use of pooling mechanisms to efficiently finance projects of small and medium scale.

Pooled debt funds and facilities can be useful in the local currency financing of small and medium sized core infrastructure projects in a country. There are three reasons why pooled debt facilities have been employed in a number of advanced economies in the world including the USA, Canada, and Europe. 36 First, because the relatively high fixed costs of bond issuance (due diligence, documentation, registration, financial advisor and bond council fees, rating by a rating agency, etc), bond issuance is only feasible for relatively large denominations. Medium and small sized projects may be below the threshold where bond issuance would be feasible. A pooling entity can help in these situations by aggregating the financing needs of several small to medium sized borrowers and creating a single large financing package that justifies a bond issue. With the economy of scale achieved, the lower costs and/or better tenor are passed on to individual members of the pool. Second, a bond pooling entity would go to the market on a regular basis to finance the needs of different groups of clients. The regular rating and due diligence for the same bond pooling entity is more cost effective than it would be for the institutions in a pool that sought ratings individually and infrequently. Third, for rating agencies, the diversification of risks across institutions and perhaps sectors that is inherent in a pool is a positive factor in rating. The most common format for a pooled lending facility is a bond-bank type capital market intermediary which facilitates access by a number of small and medium-sized borrowers to capital markets... The operational design for a countrys pooled lending facility will depend on such factors as: the nature of the local debt markets, the characteristics of the intergovernmental fiscal system and whether fiscal flows to subnational entities can be used as debt collateral where sponsors of small and medium sized
35 36

See Gauteng Business News, 17 November, 2008 For further detail, see e.g.: Fitch Ratings, State Revolving Fund and Municipal Loan Pool Rating Guidelines Nov, 2004

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core infrastructure projects are likely to be sub-national enterprises and governmental authorities, and the source(s) and amount of the funds used to capitalize the fund or facility.

The use of a governmentally operated pooled bond facility model is widespread in the USA, Canada, and the Nordic countries of Europe. Developing country examples of the adoption of the pooled facility model include Tamil Nadu Urban Fund (TNUDF), the Karnataka Infrastructure Fund, and schemes being developed in Columbia, Mexico and the Philippines. Tamil Nadu Urban Fund Pooled Bond Facility The experience of the TNUDF is potentially relevant for a number of SSA countries. A traditional municipal development fund was established in Tamil Nadu State in the 1980s financed from state government resources and a World Bank loan. The Tamil Nadu Urban Fund (TNUDF) was generally well managed and enjoyed a respectable repayment rate. In 1997, a second World Bank project aimed to improve performance further and required a restructuring of the TNUDF by bringing in a private management company. The Industrial Credit and Investment Corporation of India Ltd. (ICICI) owned 21% of share capital of the management company, Infrastructure Development Finance Company (IDFC) owned 15%, and Infrastructure Leasing and Financial Services Ltd. (IL&FS) owned 15%. The government of Tamil Nadu State owns 49%. The state government retained full ownership of the legally separate Tamil Nadu Fund, which had earlier been capitalized. The capital markets in India were rapidly developing at this time. Ahmadabad and several other cities received local scale credit ratings and issued bonds without a sovereign or state level guarantee. A USAID mission subsequently discussed with TNUDF the possibilities of a bond issue secured by a dedicated reserve fund. USAID offered a DCA guarantee as a credit enhancement. In preparation for a credit rating, non-performing loans (NPL) were reduced to about 3%, and a pipeline of 13 water supply projects in small towns were identified whos financing needs would be funded with the proceeds of the TNUDF pooled bond issue. The State government agreed to put money in the dedicated reserve fund, and a domestic bond structure was developed that subsequently achieved an aa local scale credit rating. The bond was issued by a new trust called the Water and Sanitation Pooled Fund (WSPF). The issue was considered a success by the local banks that were the purchasers of the bond. In fact they felt that subsequent issues should be larger. The proceeds of the bond were distributed according to a pre agreed formula to the local government entities that participated in the pool for their water and sanitation projects. The flow of funds is shown below in figure 20.

Box 4: Tamil Nadu Pooled Bond

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Example of a typical local government project loan beneficiary

One example of a project participant in the pooled bond scheme is the township of Valasaravakkam, with a population of 26,260, which has no adequate water supply system, relying on open and bore wells and three above-ground tanks, connected to 11 miles of piping. This system provides an estimated 2 liters of water per person per day. Valasaravakkam is one of eleven local governments that shared in the proceeds of the pooled bond issued by the Tamil Nadu Funds Water and Sanitation Pooled Facility (WSPF.) Without the intermediation of the WSPF, the township could not have borrowed in its own name either from a local bank or from the credit markets.

In principle, it should be possible to use the pooled bond model in African countries where there is a reasonable credit market, say where local bonds could be issued with maturity of 7 to 10 years with the possibility of extension with credit enhancements, and where a local financial intermediary institution with experience in sub-national lending either exists or can be set up with private sector management or equivalent positive incentives for good management. Donor money that could be put in a reserve fund that secured a larger domestic bond would enjoy significant leverage and help reduce country currency mismatches. Figure 20: Flow of Funds: Tamil Nadu Water and Sanitation Pooled Fund (WSPF)

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Tamil Nadu WSPF Flow of Funds

Credit Rating
ULBs

WSPF Trust issues a bond Rated aa on Domestic scale Debt Service Payments

Loan Proceeds used by 13 local governments Monthly Loan Payments to Escrow Account Ninety Days Before Debt Service Payment Date SFC Devolution Intercept, if Necessary *
GoTN replenishes full interest and 50% of principal and USAID replenishes 50% of principal payments made from Bond Service Fund Centennial Group 3

Annual Debt Service Payment Bond Service Fund (Reserve Funds)

GoTN Deficiency Make-up & USAID Guarantee*

ULBs: Urban Local Bodies GoTN: State Government of Tamil Nadu SFC: State Finance Commission WSPF: Water and sanitation Pooled Facility USAID: United States Agency for International Development
Source: Centennial Group Holdings

The Infrastructure Finance Corporation of South Africa (INCA) The Infrastructure Finance Corporation of South Africa (INCA) is an excellent example of African pooled debt facility which played an important role in reviving indigenous commercial debt markets for small- and medium-scale core infrastructure in a rapidly changing intergovernmental finance system. INCA is a subsovereign debt provider and as such have been an important funder of sub-sovereign infrastructure. INCA was launched in 1996 to fill a market gap created by the political and financial uncertainty caused by the political democratization of South Africa. The traditional providers of capital to local authorities, such as commercial banks and contractual savings institutions such as pension funds and life insurance companies, had little understanding of the changes caused by the amalgamation of previously racially segregated local authorities no longer enjoying implicit sovereign State guarantees and curtailed all direct lending. A new financial intermediary was needed to marshal the specialized expertise necessary

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to originate new lending to localities, underwrite these loans with rigorous credit standards, and manage the resulting portfolio to prevent or mitigate defaults in a rapidly and continuously changing financial and political environment. INCA was therefore set up as a commercial entity offering market related rates of return to its investors which were prominent South African banks and contractual savings institutions, black and women empowerment organizations, and prominent development finance institutions. INCAs bonds were listed on the South African Bond Exchange and rated as double AA- (local currency scale) by Fitch in 1996, permitting it to raise funds initially by issuing bonds first in the domestic capital market and later in the international capital market. This Rating was based on INCAs proposed level of capitalization, systems of surveillance and remediation, reserve investment policies, and other critical business plan elements. INCA negotiated with FITCH to rate the organizations credit underwriting and surveillance process, including the system for assigning initial and on-going internal credit ratings for underlying loans to municipalities. . The credit rating of each underlying loan to a municipality determined the maximum permissible exposure as a percentage of capital as well as the amount of capital that had to be reserved against each loans possible default. Fitchs agreement with INCA to audit this system on a monthly basis helped to get the bond issue rated AA-. In the very beginning there was no subordinated debt although provision was made for it and the first subordinated debt was only issued when necessary to augment capital after about a year and then topped up when the Sanlam portfolio (R1.5billion) was purchased. Another critical consideration in Fitchs initial bond rating of INCA was the quality of the shareholders. INCA commenced lending to municipalities early in 1997. The company was an integrated commercial entity with shareholders and management responsible for all aspects of INCAs operations, and passive bond-holders who had no influence on the investment activities of the company. The company was effectively also in direct competition with the state owned Development Bank of Southern Africa (DBSA). It was able to succeed in this competition due initially to a highly sophisticated credit assessment process allowing average response times of about 3 weeks, strict single risk credit exposure limits and other credit review, approval and monitoring mechanisms which were in place from the moment INCA opened its doors and began reviewing applications. INCAs staff has varied around an average of thirty professionals. Its portfolio grew rapidly: by 2004, it had a sub-sovereign debt portfolio of a $1 billion, with defaults contained at less than 0.1% of that amount. Another key to INCAs early success was a relatively aggressive capital structure in which primary equity was held at between 6% and 8%. The substantial use of deeply subordinated mezzanine debt improved the credit quality and lowered the financing cost of the senior bonded indebtedness. Profits for shareholders in this period were retained at an average of 22% and the company made a substantial contribution to the financing of municipal infrastructure. INCA faced substantial new competition from the commercial banks with their acceptance in 2004 of the Financial Charter, a voluntary agreement between the South African government and

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the South African private sector financial institutions in which the latter agreed to a points system based on such factors as direct investment in previously disadvantaged areas. Direct lending to municipalities proved to be a good way for these institutions to earn such points. Principally for this reason, Incas portfolio has diminished in size since the introduction of the Financial Charter and long term loans have been replaced with shorter term factoring and asset financing transactions.

Box 5 INCA Distressed Bond Company The use of a Partial Credit Guarantee to facilitate the remediation of distressed municipal credits and restore investor confidence in the sub-sovereign sector Soon after Apartheid ended and the Government made clear that no explicit or implicit sovereign guarantees were associated with outstanding sub-sovereign debt, a window of opportunity opened for better informed investors such as INCA to purchase distressed or perceived distressed sub-sovereign debt at a discount. To protect its own credit rating as it participated in this down-market segment of the sub-sovereign sector, INCA created and capitalized a separate entity in 1999 (eventually named The INCA Distressed Bond Company.) The company was formed with INCA holding 20% as equity, 50% commercial debt from a commercial bank supported by a credit guarantee provided by the Development Credit Authority (DCA) program of USAID, and a further 30% senior debt provided by INCA. By creating the company, INCA was also, in effect, protecting its own source of funding as large scale defaults anywhere in the South African municipal debt markets would also have affected Incas pricing and access to the domestic capital markets. This structure allowed this company to pursue its special mission of acquiring actually or perceived distressed debt, rehabilitating each underlying credit by working with the issuer to correct problems causing the credit impairment, and selling the securities at a profit (or holding them and enjoying the substantial spread of their high effective yield over the companys cost of funds) without negatively affecting the credit rating of INCA. Although no formal credit rating for the INCA Distressed Bond Company was deemed necessary by any of the parties, FITCH took account of the facts that the distressed securities were 70% collateralized with cash or cashequivalents and that they were acquired at a deep discount and Fitch permitted INCA to carry its senior debt credit exposure to the company with an internal rating of double AA, one notch higher than INCAs own public rating of double AA-. The use of the DCA credit guarantee not only made it possible for INCA to launch this initiative, but it also played a major role in

We believe that the r INCA e v informing the design and launch of other countryexperience can be of significant value in e specific pooled lending funds particularly in SSA nations with intergovernmental finance n systems which permit borrowing by sub-national enterprises and/or local authorities. t
i n g t h e s u b

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5.

Recommendations for IFIs in Supporting Specific Funds and Facilities

This section of the report contains recommendations for IFIs when they consider supporting the development of infrastructure funds or facilities in SSA..

5.1 Participate in infrastructure equity funds with the objective of extending the closing date of the funds and facilities. (See recommendation 4.2)

The equity of private investors with relatively short time horizons can be extended in several ways without jeopardizing the long term capital needs of the underlying investments. One very traditional way is for the founding equity investors to divest themselves of their original stakes through public sales (IPOs) or private placements to new investors seeking the more sedate risk/reward profile of a proven operating asset after the project has successfully concluded construction and ramped up operations. Another way to extend the time horizon of equity funds and their project investments is to match the needs of the funding source to the stage of the project lifecycle. For example, while construction companies are often most willing to provide equity capital for the construction phase, institutional investors with multi-generational strategies, e.g. pension funds, life insurance companies, sovereign funds, family offices, etc. are often interested in owning operating assets for multiple decades. In SSA, we have found at least two new infrastructure fund managers who have either completed raising funds with longer exit time horizons than the typical norm of ten years or are currently still in the midst of raising their capital. The South African Public Investment Commission has helped launch a new fund with a fifteen-year exit time. The use of convertible equity, preferred stock, and other mezzanine techniques may appeal to patient capital investors such as pension funds and insurance companies, and prove to be another way of extending the average life of financing structures for core infrastructure. ( See below) A final way to extend time horizons of equity investments may be to use an open or evergreen format, similar to Egis and Ideal. JP Morgan is also known to have an equity facility structure with this format. If the IFI community were to engage in an equity fund with the objective of moving the closing time horizon to 15 or 20 years as a condition of participation, would that induce private sources of equity to participate for a longer time period? It would seem that they could use their role as anchor investor in new fund structures to extend fund tenor.37 Based on out discussions with
37

Chowdhury, Abu, Orr, Ryan, Settel, Daniel. Multilaterals and Infrastructure Funds: A New Era The Journal of Structured Finance, Winter 2009.

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fund managers, we believe that the involvement of IFIs would push sponsors of new equity funds to identify more fund investors with longer exit timeframes, e.g. international and/or indigenous pension funds and insurance companies, sovereign wealth funds based in both emerging markets and the developed world, philanthropies using either normal or program-related investments, and wealthy individuals. 5.2 Expand use of partial risk and partial credit guarantees, put options, liquidity facilities and other techniques in support of locally denominated, longer tenor debt and equity.

Proactive risk mitigation to encourage long dated investments at the project investment level [and the fund/facility level] is a specific opportunity for IFIs and will be even more important during and following the financial crisis38. For entities that are leveraged at the fund/facility corporate level (most likely debt or mezzanine entities) the use of partial financial guarantees for international or local debt not only serves as a comprehensive risk mitigation instrument, but it can send an important psychological message of confidence to the market. For example, in the case of INCA, the successful closing of a senior bank loan of US$49.2 million benefiting from a USAID DCA 100% guarantee made it possible to raise substantially more in bonded indebtedness than would otherwise have been possible.39 Such international vote of confidence can play a major part in opening up reluctant debt markets. In some cases where pension funds are relatively new and comply with very stringent guidelines that incorporate minimum ratings, the use of international guarantees can be a decisive factor in granting infrastructure investors access to the domestic debt market Use of third party risk mitigation to magnify the impact of reform Traditionally defined sovereign risks including war, civil strife, transfer and convertibility tend to be regarded as manageable in most cases. However, with core infrastructure, the risk of government not honoring regulatory and contractual commitments is seen by many fund managers focused on SSA as a challenge, and an area where IFI or commercial risk mitigation can play an important role. The current global credit market turmoil may also increase the demand for more traditional political risk insurance to cover risks of expropriation, creeping expropriation, transfer and convertibility. The existing mechanisms available from IFIs and commercial sources are usually thought by fund managers focusing on SSA countries to be sufficient, (although we did hear some complaints that conditions are sometimes too stringent or too rigid to accommodate African modes of doing business.)
38

As discussed in section 4 unenhanced debt with longer final maturities should normally have lower annual debt service than shorter maturity debt. Fixed rate debt with longer maturities may or may not produce higher annual interest costs: that will depend on the shape of the yield curve and other factors in the market being accessed to raise the capital. Risk mitigation products can and should both extend tenors and lower interest costs.
39

When this transaction was concluded in approximately 1999, the DCA program was permitted to guarantee 100% of a loan or bond issue. That authority has since been curtailed by Congress, first to a maximum of 80% and more recently to a maximum of 50% of the principal amount of the debt in question.

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Moreover, IFI or commercial mitigation of specific political risks which can threaten infrastructure project finance viability, e.g. the risk of governmental failure to honor cost recovery principles in rate setting and collections is seen as a tool which should help attract more investment for core infrastructure. This type of coverage should be very useful whether the financing is denominated in local or foreign currency. In addition, providing liquidity support to put-options giving the project investor an ability to exit the project at predetermined milestones can effectively extend a financings tenor to approach the assets economic life. This is an existing World Bank Group product that has already been used to significant advantage. Expand availability and use of locally denominated capital by scaling up cost effective forex hedging products The best way to reduce the forex risk in core infrastructure investment is to develop local capital markets for debt and equity so that much or all of the investment can be made in local currency at reasonable rates of interest and with mid- to long-dated final maturities. The development of local capital markets to the point where they can regularly provide significant amounts of capital for core infrastructure will take years or decades in many of the SSA countries. Foreign exchange (forex) risk can be a significant deterrent for foreign investors in any region and was mentioned repeatedly as a potential problem for core infrastructure financing by many of the fund managers focusing on Africa. Several emphasized that the longer the tenor of the potential investment, the more powerful a deterrent forex risk is likely to be. This can be especially critical issue in the core infrastructure sectors where tenors must be long enough to approach the economic lives of the facilities being financed in order to keep the annual debt service costs affordable to maintain inter-generational equity. The Currency Exchange (TCX) describes itself as a special purpose fund providing currency and exchange rate risk management products to TCXs investors active in emerging markets, in order to catalyze the development of long-term finance in local currency in developing countries.40 TCX focuses on currencies and maturities that are not covered by regular market providers. During its first three years of its existence, TCX is limited to transacting solely with its investors. Third parties are instructed to approach TCXs investors if they would like to obtain local currency products. The current roster of 20 TCX investors is dominated by European multilateral and bi-lateral IFIs and ECAs, but also includes the Inter-American Development Bank, ABN-Amro, a global commercial bank active in emerging market infrastructure, and OikoCredit, a for-profit development finance entity founded by the World Council of Churches.

40

According to its Overview, dated October, 2008 TCX is a Netherlands-domiciled, tax-exempt public limited liability company (naamlozevennootschap), a semi-open ended investment fund, with an indefinite term but with redemption provisions (subject to limitations)TCXs Supervisory Board consists of 5 members appointed on the basis of a binding nomination submitted by the Shareholders.

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Box 6

The Currency Exchange Fund (TCX)

TCX provides three hedging products: (i) FX swaps and forwards (deliverable and non-deliverable); (ii) Cross currency and interest rate swaps (deliverable and non-deliverable) and (iii) Forward Rate Agreements (FRAs) TCX provides its products for currencies for all OECD DAC 2006 countries. It offers hedging of these currencies into any tradable currency. TCX has no maturity limit. TCX aims not to compete in cases of transaction requests that can readily be provided by regular market participants. TCX offers its products based on approved liquid market benchmarks (NDF or domestic) and may offer interest rate maturities up to 50% longer than the longest observable liquid local benchmark. TCX is developing alternatives to be applied in countries without sufficiently liquid or transparent benchmarks but cannot provide quotes in these cases yet. Typical Deal Description: An international provider of long-term financing (such as TCX investors) approves a 15 year loan for the construction of a power plant in Zambia. Given that electricity revenue is typically charged in Zambian Kwacha (ZMK), the financing of the project in USD results in a currency mismatch as the cost of debt is now dependent on the value of the Zambian Kwacha over the life of the loan. The international lender thus wishes to denominate the loan in Kwacha, thereby eliminating this risk and thus reducing its credit risk. In order to hedge the associated market risk with a local currency loan, the lender enters into an offshore non-deliverable currency swap with TCX. This allows the lender to earn a guaranteed USD denominated return whilst the borrower receives local competitively priced Zambian Kwacha. By providing hedging services, TCX facilitates the creation of a local currency business line for its international investors and in this manner achieves its mission. The graphic below provides a graphical depiction of a typical offshore transaction:

TCX's first swap transaction was executed in January 2008 and reported in October 200841 that it was beating targets with a comfortable margin. As of mid-October 2008, the volume of primary investments reached US$ 247m, spread over 13 currencies. The secondary trading portfolio grew to US$ 520m spread over 16 currencies. TCX also reported a strong transaction pipeline and expectations of good near-term portfolio growth. Few of the fund managers we interviewed were familiar with this mechanism, despite TCX managements expressed interest in facilitating core infrastructure investment in Africa, including its poorest countries. Due to its small size, TCX has relatively low single risk limits and other constraints which make its use less likely in medium or large-scale core infrastructure investments. So better marketing of TCXs services to core infrastructure investment funds should probably be accompanied by a concerted effort to scale up its capitalization to levels permitting significantly higher commitments to individual projects.

41

Ibid

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Developing liquidity support tools to help address foreign exchange shocks: Another approach is the use of liquidity support provided by an IFI to cushion the shocks of major exchange rate movements. Although this concept has been applied at least once in South America by the US OPIC with its Foreign Exchange Liquidity Facility in the Tiete financing and seems likely to be applied again Central America by the multi-lateral Central American Bank for Economic Integration (CABEI), we are not aware of any successful attempts to replicate this type of mechanism in the SSA region.42

5.3 Adopt a policy of seeking to maximize the leverage of IFIs own funds when setting up funds or facilities IFIs should seek multiplier effects i.e. they should ask how the IFI can invest its limited capital to catalyze the greatest amount of secondary and tertiary investment by other players and thus maximize its positive impact. This is often called leverage. For purposes of this report, leverage obtained by a financier can be considered to be the ratio of the total project capital mobilized to the amount invested (or set aside as a capital charge or reserve) by the financier. The concept of leverage applies both to the investors balance sheet at the fund/facility level, and to the capital structure of individual projects. At the project level for example, offering a political risk insurance policy stamps the IFIs international seal of approval on the project and makes it easier for the project company to raise senior debt. Thus, it is more effective for the IFI to offer a political risk insurance policy than to offer a direct loan, because the political risk insurance policy requires a much smaller reserve on the IFIs balance sheet than the direct loan. Therefore the IFI can influence a greater number of projects in a positive way by selling political risk insurance policies than by selling direct loans that use up the IFIs balance sheet in a very inefficient way. At the fund/facility level, a loan by an IFI to a domestic debt facility for example that simply onlent the proceeds of the IFI loan on a one to one basis to sub-projects would achieve no leverage. However, a standby loan liquidity facility to support a debt issue on the commercial markets by the domestic lending facility would achieve leverage. An equity investment in an equity fund, debt facility or guarantee facility would similarly achieve leverage. High leverage ratios are achieved by guarantors, which use rigorous capital charge models with conservative assumptions of default probability and severity of ultimate losses in default. We understand that the DCA program of USAID achieves ratios of 35:1 - 50:1 leverage using the capital reserving model imposed on all US government guarantee programs by the US Office of Management and Budget. To the extent that new guarantee facilities are created to facilitate the debt financing of core infrastructure, we recommend that they be mandated to use a capital

42

Robert Sheppard for Infrastructure Finance Experts Group, see: http://www.globalclearinghouse.org/InfraDev/assets%5C10/documents/Sheppard%20%20Proposal%20FX%20Liquidity%20Facilities%20(2004).doc

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charging or reserving system based on evidence-based default probabilities and severity of loss estimates. Debt funds or facilities can be founded with seed capital and then leverage up at the fund level. Emerging Africa Infrastructure Fund (EAIF) is a good example. EAIFs capital structure currently has $100 million of equity supplied by PIDG members, $85 million of sub debt supplied by DBSA, FMO and DEG, and $600 million of senior debt raised at the very narrow spread of 150 basis points over LIBOR in the capital markets. So at the fund level, EAIF is leveraged at almost 7:1. We recommend that any new funds created to serve the SSA core infrastructure finance market use similar leveraging strategies at the fund level in order to reduce the cost of capital ultimately lent to public or private project sponsors. Nick Rouse, the Managing Director of EAIFs fund manager Frontier Markets Fund Managers, reckons that at the project level, every $1 of EAIFs involvement in a debt or mixed debt and equity project financing attracts roughly $6 more. So he believes that his debt funds equity investors are achieving 36:1 leverage, which is roughly comparable to what they would achieve were they to invest equity capital in a financial guarantor. The Asian Development Bank has estimated that for every dollar invested by the Asian Development Bank in private equity investment vehicles, another $8.08 in equity capital has been mobilized, plus additional debt financing on top of thatso the IFIs can and do play a very important effect in catalyzing new investment.43 How does the use of mezzanine capital effect the cost of funds for EAIF and its borrowers? According to Mr. Rouse, at the fund level, the cost of capital raised in mezzanine form is significantly less than the equity return expectations of equity investors. At the project level, mezzanine capital provided by EAIF is significantly less costly than the equity return expectations of the project equity investors. The extent to which a project sponsor can substitute mezzanine capital for hard equity in a given instance will be determined by the senior lenders (who are concerned about maintaining specified debt service coverage ratios) and sometimes by the grantors of the concession agreement on which the financing is based. Equity capital funds operating in the emerging markets are not themselves typically leveraged at the fund level but they do leverage with ratios in the 2:1 to 4:1 range at the project level. The use of leverage at the fund/facility level is mostly seen in debt and mezzanine funds and is useful primarily to the extent that it results in less expensive capital provided to projects. However, the trade-off of having too much leverage is that the overall entity becomes less resilient to business cycle pressures and interest rate volatility, as we have learned from the demise of Babcock and Brown and MBIA. For IFIs, higher leverage of private funds in a transaction may also be an indication that the financing strategy embodied in a program or transaction is more sustainable than a traditional transaction. Thats because the participation of private financiers will often mean that the IFI is supporting market mechanisms. The downside is that when private capital subsititutes for IFI capital, the sost will ususlly be higher. In general, sustainability should be the primary objective.
43

Chowdhury, Abu, Orr, Ryan, Settel, Daniel. Multilaterals and Infrastructure Funds: A New Era The Journal of Structured Finance, Winter 2009.

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Sometimes the amount of leverage which can be introduced can be dictated by historical tradition. The World Bank uses capital charges for the application of partial credit and partial risk guarantees that are not related to the probability of default by the borrower and severity of loss in the event of default. IFIs such as the World Bank which are not currently using probabilisticallybased capital charging systems akin to those developed by commercial banks, monoline financial guarantors, and a few IFIs such as the USAID Development Credit Authority program could increase the developmental impact of their capital reserves substantially by a change in policy. 5.4 Support mezzanine finance either directly in projects or through new facilities that offer mezzanine finance Mezzanine finance is a niche product, but it is an instrument that should be considered when the opportunity arises. 5.4.1 Provision of mezzanine finance at the project investment level

The use of IFI funds to directly provide mezzanine financing at the project level can be useful in certain circumstances to achieve objectives in specific infrastructure transactions including: Enhancement of the senior layer(s) in the financing structure, possibly lowering the cost of that component of the financing and of the transaction as a whole; Increased leverage for the IFI making the investment; and Diversification of the investor base as the yield/return and other features of the mezzanine tranche is likely to be most attractive to investors whose preferences are somewhere in between the risk/reward sweet-spots of traditional equity and debt investors.

As it is normally intended to mitigate the default risk of senior debt, the tenor of mezzanine debt is normally matched to the tenure of specific series of senior debt and often a series of mezzanine debt issues with sequential subordination is used to achieve the most precise tenor matching possible. Pension funds can play a greater role at the project investment level and may be given comfort by the participation of an IFI. Pension funds are typically permitted to make some share of their fixed income investments in lesser-rated securities. Even if they are not so permitted under the terms of their country regulatory frameworks, they may prefer to make investments from their regulatorily permitted equity buckets into lower-yielding but safer mezzanine layers of a given investment. An IFI risk mitigation product may provide the level of safety needed. It is important to emphasize that risk management standards of pension funds need to be maintained. It is up to project sponsors to demonstrate that they meet the high investment standards required by pension

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funds. Pension funds should not lower risk management standards to finance infrastructure projects. There are a few SSA countries, e.g. South Africa, Nigeria and Ghana with sufficiently large and well-developed local capital markets to support mezzanine funds restricted to investing solely within their own national borders. Mezzanine investors may also be granted one or more seats on the governing board of project entities. This allows them to closely monitor the performance of their investments and play an active role in management of the enterprise, if necessary. If an IFI is the mezzanine investor, an active governance role in the projects receiving support provides an opportunity to assist with the introduction of good corporate governance and other key policies. In SSA countries with poorly developed local capital markets, mezzanine capital initially denominated in foreign capital may still prove to be of value in optimizing financing structures for core infrastructure in certain circumstances. If at all possible, such capital should be converted into local currency. Mezzanine capital is an extremely flexible instrument. An important advantage is that this type of debt can be structured to vary in amount in order to meet minimum capital adequacy covenants or credit rating requirements, without incurring the longer-term impact of having rights issues to raise additional capital. In summary, mezzanine capital can be used flexibly by IFIs to meet their own objectives while optimizing the capital structures of projects. 5.4.2 Provision of mezzanine finance at the fund/facility level

IFI provision of mezzanine support to funds and facilities at the level of the capital structure of the fund/facility can also be important. OPIC has catalyzed the development of a significant number of single- and multi-sector equity funds using preferred stock a form of mezzanine capital - as its method of investment in the funds. The Inter-American Development Bank has also supported mezzanine funds. It has provided loans to several funds established by Darby Overseas that make Mezzanine investments in infrastructure projects. The IDB loans leverage the equity capital investments from Darbys limited partners. Darby has found significant numbers of local investors including pension funds and insurance companies in large, middle income developing countries such as Brazil and Mexico willing to invest in country-specific, locally-denominated funds and used for mezzanine investments for infrastructure and other purposes. INCAs experience with the use of mezzanine capital is instructive. In INCAs case, the initial mezzanine layer was provided by PROPARCO as convertible debt, at relatively high cost reflecting its deep degree of subordination to the senior debt. In the second round of raising

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mezzanine debt several other IFIs offered INCA direct junior debt denominated in either foreign or local currency, but the IFIs pricing included such high premiums for sovereign risk that INCA was able to tap the South African short- to mid-term commercial debt markets at roughly 200 basis points under the rates offered by those IFIs. This illustrates the importance of pricing and structure in designing IFI interventions. For development institutions a mezzanine fund offers an opportunity to sponsor more projects with a wide diversification and a high level of gearing with a predetermined exit,44 typically a thorny issue for both IFIs and foreign investors when they are acting as common equity investors. 5.5 Support debt facilities and pooled finance facilities

A significant goal for new infrastructure debt facilities including pooled finance facilities (See section 5.5 above) targeting core infrastructure finance in the SSA region should be the provision of debt with tenors approaching the projected useful lives of the facilities being constructed, in order to achieve the lowest possible annual cost of financing and the lowest possible cost of funds as a component of tariffs charged to customers as well as more abstract objectives such as intergenerational equity. Both debt facilities and pooled finance facilities should be designed to tap domestic capital markets, preferably through issuance of bonds in order to attract the widest range of investors including long term investors. A debt facility would normally issue a bond on a corporate finance basis, whereas a pooled facility would issue a bond secured by the specific project entities who benefited from the proceeds of the bond issue. IFIs could use the same range of instruments to support both debt facilites and pooled finance facilities since the key objective in both cases is to extend the tenor of resources available for onlending to infrastructure projects. Three ways that an IFI could help extend the tenor of debt are i) through the use of a credit guarantee of late maturities of a domestic borrowing, ii) through support of a stand-by liquidity facility designed to step in if initial lenders with shorter time horizons, (e.g. local commercial banks who purchased bonds issued by a debt facility) were given a put options and feel the need to terminate their obligation (even if the debt is performing well45) and iii) providing a partial guarantee (deficiency make-up) of a debt service reserve fund that supports a bond issue.

44

The US Overseas Private Investment Corporation (OPIC) is not permitted by the terms of its Congressional charter to make common stock equity investments, so it typically uses a deeply subordinated mezzanine instrument such as preferred stock with a low specified rate of return and a 10 year maximum maturity as seed capital for private funds for infrastructure and other purposes in SSA and through-out the developing world. 45 The liquidity facility would re-market the debt to institutions willing to take the credit risk of satisfactorily performing (seasoned) debt for at least another defined period of time e.g. until final maturity. We believe that the fundamental aspects of this structure could be used in a wide variety of SSA settings where local commercial financial institutions are ether uncomfortable with taking -- or not permitted by their prudential regulators to take the mid- to long-term tenor risks which accompany core infrastructure debt financing. Annex 3 is a description of the recently approved Philippine Water Revolving Fund) facility which uses a liquidity facility.)

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An IFI could also support debt and pooled finance facilities by making an equity investment in the start up capital. In the case of a debt facility, the IFI could also make a loan to the facility that would be designed to be used to leverage capital by co-financing from other domestic sources and the extend tenor of other sources. 5.6 Support the public sector with significant additional funding of project preparation and associated technical assistance. Section 4 discusses the need for a larger, more robust pipeline of bankable projects. IFIs like the World Bank can play an important role in the design of facilities for project preparation and can support such facilities through loans or IDA credits 5.7 Ensure that IFI participation does not crowd out the private sector

Private fund managers are sensitive to the possibility that IFI participation may lead to the IFI to use its concessional funding to take over a project that they have worked to develop. Several have cited examples where this has happened. Private investors believe that this is particularly a concern in an environment where there are so few good projects. IFI participation through minority investments, loans or guarantees of funds and facilities that involve private investors is one way to mitigate this risk. Guidelines that restrict IFI funding of individual infrastructure project investments where private investment is feasible, to a minority share, or that involve other forms of leverage for the IFI investment are others. IFI support should be judged by the extent that the support supports pioneering projects that bring in new actors and new instruments and which can lead to a deepening of the domestic capital markets.

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Annex 1

List of Funds and Facilities in Inventory

Fund/Facility Name 3i India Infrastructure Fund 7L Capital Partners Emerging Europe L.P. ABN Amro Infrastructure Capital Equity Fund Abraaj Infrastructure and Growth Capital Fund ACEE III ACEE IV Actis Infrastructure Fund Actis South East Asia Infrastructure Fund Acumen Fund Africa Catalyst Fund Africa Finance Corporation (AFC) Africa Growth Fund Africa Healthcare Fund Africa Opportunity Fund (AOF) Africa Telecommunications, Media and Technology Fund African Infrastructure Fund African Millenium Fund AfricInvest II AG Angra Infrastructure Fund Aga Khan Foundation Agribusiness Partners International AIG African Infrastructure Fund AIG Brunswick Millennium Fund AIG Emerging Europe Infrastructure Fund (Europe I) AIG Indian Sectoral Equity AIG-GE Capital - LAIF Alcazar Capital India Fund Alcazar Capital Partners Fund I

Fund (F) / Facility (FA) F F F F F F F F FA F F F F F F F F F F FA F F F F F F F F

Name of Management Entity Partnership of 3i and India Infrastructure Finance Company Limited 7L Capital Partners (EE) Ltd Fortis Investments Abraaj Capital and co-sponsored by Deutsche Bank and Ithmaar Bank Advent International Advent International CDC Capital Partners/ Actis CDC Capital Partners/ Actis Acumen Fund Africa Finance Corporation Seven Seas Capital Management and Indigo Venture Partners Pty Africa Opportunity Partners East Africa Capital Partners Africa Infrastructure Investment Managers (JV b/w Macguire Bank and Old Mutual Asset Managers of South Africa Alliance Capital AfricInvest Capital Partners AG Angra The Aga Khan Development Network Agribusiness Management Company, LLC. AIG AIG Investments AIG Investments, ABN-AMRO and Edison Capital Infrastructure Leasing & Financial Services Limited, AIG Emerging Markets Partnership

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Aldwych International Allco SIF AllianceBernstein High Income Fund (formerly Emerging Market Debt Fund) AMBAC AmKozen Asia Fund AMPCI - Infrastructure Fund of India Fund/Facility Name ArcLight Energy Partners Fund 1 Asia Development Partners II, L.P. Asia Development Partners, L.P. Asia Equity Infrastructure Fund Asian Giants Infrastructure Fund Asian Infrastructure Fund Atherstone India Invest Atlantic Coast Regional Fund Aureos East Africa Fund (AEAF) Aureos Southern Africa Fund (ASAF) Aureos West Africa Fund (AWAF) AXA Iinfrastructure Fund of Funds Axis Infrastructure Fund I Babcock and Brown Asia Infrastructure Fund Babcock and Brown European Infrastructure Fund Babcock and Brown Turkey Infrastructure Fund Baer Capital Infrastructure and Real Estate Bancroft Eastern Europe Fund Baring India Private Equity Fund II Baring Mexico Private Equity Fund II Baring Vostok Private Equity Fund III Biotechnology Venture Fund (BVF) Bioventures Fund Brazilian Infrastructure Investment Fund (BIIF) Bunyah GCC Infrastructure Fund Capital Alliance Property Investment Capital Innovations GDG Infrastructure FoF Capital International Private Equity Fund I (CIPEF I) Capital International Private Equity Fund II (CIPEF II) Capital International Private Equity Fund III (CIPEF III) Capital International Private Equity Fund IV (CIPEF IV) Capital International Private Equity Fund V (CIPEF V) Capital North Africa Private Equity Fund

F F F
FA

Aldwych Investment Group Allco Equity Partners Management AllianceBernstein Global High Income Fund, Inc Kozen and AmInvestment Bank AMP Capital Investors (Australia) Name of Management Entity ArcLight Olympus Capital Holdings Olympus Capital Holdings CDP Capital -Private Equity Group AMP Capital Investors Peregrine Investment Holdings of Hongkong Atherstone India Infrastructure Fund Advanced Finance & Investment Group Aureos Aureos Aureos AXA Private Equity Axis Private Equity Babcock & Brown Infrastructure Babcock & Brown Infrastructure Babcock & Brown Infrastructure Baer Capital Partners Bancroft Baring India Private Equity Partners Baring Private Equity Partners Baring Vostok Capital Partners Limited APIDC Venture Capital Biotech Venture Partners (Pty) Ltd ABN AMRO Real SA, Sao Paulo, IADB Instrata Capital African Capital Alliance Capital Innovations Capital International, Inc. Capital International, Inc. Capital International, Inc. Capital International, Inc. Capital International, Inc. Capital Invest

F F Fund (F) / Facility (FA) F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F

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Carlyle Infrastructure Partners CDP Korean Telecom and Infrastructure Fund Central Africa Growth Sicar (ECP) Challenger Mitsui Emerging Markets Infrastructure Fund Chilean Transmission Fund Fund/Facility Name China AME Energy Fund Citi Infrastructure Partners ClearWater Capital Investments II, LP Climate Change Investment I SA SICAR (CCI). CLSA Pacific Transport COMESA Infrastructure Fund ContourGlobal Currency Exchange Fund (TCX) Darby - BBVA Latin America Private Equity Fund, LP Darby - Brazil Mezzanine Fund, LP Darby - Converging Europe Mezzanine Fund Darby - Latin American Mezzanine Fund Darby - Latin American Mezzanine Fund II Darby - Mexico Infrastructure Fund Darby - Overseas Asia Mezzanine Funds I Darby - Overseas Asia Mezzanine Funds II Darby - ProbanCo Fund II Decorum Sanlam Infrastructure Fund DevCo DIF Infrastructure Fund II Draper International India Dynamo Puma II E+Co ECP Africa Fund II, PCC ECP Africa Fund III, PCC ECP MENA Fund I Egis Investment Partners Emerging Africa Infrastructure Fund, Infraco Management Services and GuarantCo Emerging Europe Fund Emerging Markets Liquid Investment Portfolio/ Ashmore Investment Management Energy for Rural Transformation Phase I Energy for Rural Transformation Phase II

F F F F F Fund (F) / Facility (FA) F F F F F F F F F F F F F F F F F F FA F F F FA F F F F FA F F FA FA

The Carlyle Group Korea Infrastructure Fund Management Emerging Capital Partners (ECP) Challenger Financial Services Group Brookfield Asset Manangemet Name of Management Entity Arch Financial Product Citigroup Infrastructure Investors Clear Water Capital Partners 3C Consulting CLSA Capital Partners To be administered by a Committee of ministers of participating countries ContourGlobal LLC TCX Investment Management Company Darby Oveseas Darby Overseas Investments Darby Overseas Investments/ the private equity arm of Franklin Templeton Investmetns Darby Overseas Investments Darby Overseas Investments Darby Overseas Investments Darby Overseas Investments Darby Overseas Investments Darby Overseas Investments Sanlam DIF Draper International LLC (Venture capital firm) Dynamo Administrao de Recursos Ltda Emerging Capital Partners Emerging Capital Partners Emerging Capital Partners (ECP) Egis Projects, developer and operator of infrastructure projects in France Frontier Markets Fund Managers/ GuarantCo Europe Capital Ashmore Investment Management

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Ethos Fund V EU Africa Infrastructure Partnership Trust Fund Evolution One Fund FE Global Clean Energy Services Fund IV Fund/Facility Name FINDETER (Financiera de Desarrollo Territorial) First NIS Regional Fund

F F F F Fund (F) / Facility (FA) FA F

Ethos Private Equity EIB Evolution One LP/ Inspired Evolution Investment Management GEM Management IV Corp., an affiliate of FE Clean Energy Group, Inc. Name of Management Entity Financiera de Desarrollo Territorial Baring International Investment Management Limited Established by Benin, Burkina Faso, Burundi, Central African Republic, Cted'Ivoire, Gabon, Mali, Mauritius, Niger, Rwanda, Senegal, Chad, Togo Fortis Futuregrowth Asset Management (Futuregrowth) GCC Energy Fund Managers GCC Energy Fund Managers GLG Golbal Environment Fund Global Infrastructure Partners The World Bank GMR Group

Fond de Solidarit Africain (fsa) / African Solidarity Fund Fortis Clean Energy Capital Fund Futuregrowth Infrastructure & Development Bond Fund GCC Energy Fund GCC Energy Fund II GLG Emerging Market Fund Global Environment Emerging Markets Fund I Global Infrastructure Partners Global partnership for Output-Based Aid (GPOBA) GMR Infrastructure Goldman Sachs Infrastructure Partners I Goldman Sachs Infrastructure Partners II GP Capital Partners III Great Circle Fund, LP Greylock Africa Opportunity Fund I GuarantCo. Gulf One Infrastructure Fund I H21 Infrastructure I Hambrecht & Quist Korea Growth and Recovery Fund Hambrecht & Quist Philippine Ventures (H&Q P - III) Hambrecht & Quist Philippine Ventures (H&Q PVII) HBG Infrastructure Helios Sub-Saharan Africa Fund Henderson India Infrastructure Fund Henderson Infrastructure Fund III HSBC Infrastructure Fund Management

F F F F F F F FA F F F F F F FA F F F F F F F F F F

GP Investimentos Great Circle Capital Greylock Capital Management Standard Infrastructure Fund Managers Gulf One H&Q Korea, the South Korean arm of private equity fund H&Q Asia Pacific HP&AQ Hambrecht & Quist Philippines, Inc., a subsidiary of H&Q Asia Pacific HBG Holdings Helios Investment Partners Henderson Equity Parner Henderson Equity Parner HSBC Infrastructure Company Limited

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IDB Infrastructure IDFC Private Equity Fund II IDFC Private Equity Fund III IFC InfraVentures IL&FS Trikona Infrastructure India Development Fund Fund/Facility Name India Direct Fund India Infrastructure Financing Initiative India Private Equity Fund II India Private Equity Fund III India Project Development Fund India Project Development Fund II Indo-China Capital, Sustainable Infrastructure Fund Industrial Promotion Services (IPS) InfraCo Asia (previously known as the Asian Private Infrastructure Financing Facility (AsPIFF) InfraCo Management Services InfraCo Sub-Sahara Infrastructure Fund Infrastructure Leasing and Financial Services (IL & FS) Intermarket Asset Allocation Fund Islamic Asia Infrastructure Fund Israel Infrastructure Fund Israel Infrastructure Fund II JP Chase India Infrastructure Fund JSPE Fund I Kagiso Infrastructure Empowerment Fund (KIEF) KB Asset Management Infrastructure Fund Kotak Infrastructure Fund Kula Fund Kula Fund II Land Transport Innovation Fund Latin America Enterprise Capital Fund Latin American Private Equity Fund I (LAPEF I) Latin American Private Equity Fund II (LAPEF II) Latin American Private Equity Fund III (LAPEF III) Latin Power I fund Latin Power II fund Latin Power III fund

F F F F F F Fund (F) / Facility (FA) F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F

IDB InfraFund/ EMP Global IDFC Private Equity IDFC Private Equity IFC Trikona Capital IDFC Private Equity Name of Management Entity International Equity Partners (Manager) and IDEA and HDFC (advisors) IDFC Private Equity IDFC Private Equity IDFC Private Equity IL & FS Investment Managers IL & FS Investment Managers Indochina Capital Corporation IPS, infrastructure and industrial development arm of AKFED InfraCo, a donor-funded infrastructure development company InfraCo, a donor-funded infrastructure development company InfraCo Management Services, Ltd. Infrastructure Leasing and Financial Services (IL & FS) Intermarket Asset Allocation Fund Asian Development Bank Israel Infrastructure Fund Israel Infrastructure Fund JP Morgan Infrastructure Kagiso Trust Investments (KTI) and African Infrastructure Investment Managers (AIIM) KB Asset Management Kotak Private Equity Group Aureos Capital (Brisbane of Australia) Aureos Capital (Brisbane of Australia) Latin America Enterprise Fund II, L.P Advent International Advent International Advent International Conduit Capital Partners, LLC Conduit Capital Partners, LLC Conduit Capital Partners, LLC

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Leverage India Fund (LIF) LGUGC Macquarie Global Infrastructure Fund Macquarie Global Infrastructure Fund II Macquarie Global Infrastructure Fund III Fund/Facility Name

F FA F F F Fund (F) / Facility (FA)

ILFS Investment Managers Limited LGUGC Macquarie Funds Management Group Macquarie Funds Management Group Macquarie Funds Management Group Name of Management Entity Macquarie Shinhan Infrastructure Asset Management Co.,Ltd., a joint venture between the Macquarie Group and the Shinhan Financial Group Macquarie Shinhan Infrastructure Asset Management Co.,Ltd.,. JV of Renaissance Capital and Macquarie Funds Management Group Tuninvest Finance Group Srei Venture Capital Dubai International Capital Meridiam Infrastructure Merrill Lynch

Macquarie Korea Infrastructure Fund

Macquarie Korea Opportunities Fund Macquarie Renaissance Infrastructure Fund Maghreb Invest MBIA Medium and Small Infrastructure Fund MENA Infrastructure Fund Meridiam Infrastructure Fund Merrill Lynch Infrastructure Mexican Sustainable Resources Fund Middle East & Asia Capital Partners Clean Energy Fund II Milestone India Build-Out Fund I Millenium Development Goal fund Millennium Global Africa Opportunities Fund Millennium Private Equity Infrastructure Fund Modern Africa Growth and Investment Fund Morgan Stanley Infrastructure partners Moroccan Infrastructure Fund (ECP) New Century Capital Partners, L.P. Newbridge Andean Partners, L.P. NIS Restructuring Facility Northstar Equity Partners Old Lane India Specific Fund Paladin Realty Community Infrastructure Finance Paladin Realty Latin America Investors II, L.P. Pan Africa Infrastructure Development Fund (PAIDF)

F F F
FA

F F F F
FA

F F F F F Fa F F F F F F F F F F

OPIC Milestone C apital Advisors P vt L td Millennium Asset Management Ltd. Millennium Private Equity BPEP MA Ltd Morgan Stanley Infrastructure Emerging Capital Partners NHC Advisors TPG, Acon Investments, L.L.C., and Blum Capital Partners, L.P Baring Vostok Capital Partners Limited (BVCP), Northstar Pacific Partners Old Lane Management Paladin Realty Partners, LLC Paladin Realty Partners, LLC

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Pan Africa Infrastructure Fund Pan Asia Project Development Fund Peepul Capital Fund Peepul Capital Fund II Fund/Facility Name

F F F F Fund (F) / Facility (FA) FA FA F F F F F F F F F F F F F F F F F F F F F F F F F

PAIDF IL & FS Investment Managers Peepful Capital LLC

Name of Management Entity ProInversion (Perus Private Investment Promotion Agency)/Ministry of Finance of Peru, IBRD

Peru Investment Guarantee Facility Philippine Water Revolving Fund (PWRF) PME Africa Infrastructure Opportunities plc Poland Partners, L.P. Prescient-Fieldstone Pan Africa Infrastructure Fund Q India Private Equity Fund Quadriga Capital Russia Private Equity Fund II L.P. Red Fort India Infrastructure Fund Reliance Energy India Power Fund Riverstone Holdings LLC RREEF Pan-European Infrastructure Fund Russia Partners II, LP Russia Partners, LP RWB Special Market Fonds Infrastructure India Saffron Infrastructure Fund Sage Bhartiya Infrastructure Fund Samara Capital Partners Fund I Limited Santander Infrastructure Fund I Saratoga Asia Fund Saratoga Asia Fund II SBCVC Fund II SCI Asia Infrastructure Growth Fund SEAF - Asian Funds SEAF - Central and Eastern European Funds SEAF - Latin American Funds SNS REAAL Waterfonds South Africa Infrastracture Fund (SAIF)

Innova Capital, OPIC Prescient-Fieldstone Investment Management (Pty) Ltd Quantum Equity Advisors Quadriga Capital Russia Red Fort Capital Advisors Reliance Capital Asset Management Ltd. Riverstone Holdings LLC (Subsidiary of The Carlyle Group) RREEF Infrastructure (Deutsche Banks Asset Management division) Russia Partners Management LLC (Subsidiary of Siguler Guff & Company, LLC) Russia Partners Management LLC (Subsidiary of Siguler Guff & Company, LLC) RWB PrivateCapital Emissionshaus AG Saffron Asset Advisors Future Capital Partners Samara Capital Partners Ltd Santander Private Equity Saratoga Emas Saratoga Emas Softbank Venture Capital Standard Chartered/ IL&FS Small Enterprise Assistance Funds Small Enterprise Assistance Funds Small Enterprise Assistance Funds SNS Asset Management/ SNS Real Africa Infrastructure Investment Managers (JV b/w Macguire Bank and Old Mutual Asset Managers of South Africa HIS, a joint venture between MMA, a real estate and clean energy finance company, and affiliates of Howard Eurocape

South Africa Work Force Housing Fund

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South America Private Equity Growth Fund South Asia Clean Energy Fund South Asian Regional Apex (Sara) Fund Fund/Facility Name South East Asian Strategic Assets Fund (SEASAF) Southeast Europe Equity Fund I Southeast Europe Equity Fund II Southern Cross Standard Africa Development Fund Standard Chartered and IL&FS Asia Infrastructure Growth Fund Tamil Nadu Urban Fund TATA Infrastructure Fund Technical Assistance Facility (TAF) The ADIC-UBS Infrastructure Investment Fund The Moroccan Infrastructure Fund Transport Infrastructure Investment Company Troika Infrastructure Fund UBS International Infrastructure Fund Urjankur Fund UTI India Fund UTI Infrastructure Fund Vietnam Growth Investment Fund VF2 VinaCapital Vietnam Infrastructure Fund Vision Global Investment India Infrastructure Fund WaterCredit Initiative West Africa Growth Sicar (ECP) XLCA ZM Africa Investment Fund ZonesCorp Infrastructure Fund

F F F Fund (F) / Facility (FA) F F F F F F F F FA F F F F F F F F F F F FA F

FA

Baring Private Equity (Subsidiary of ING Group) since 2007; before it was managed by Westsphere Group GEF Management Corporation ILFS Investment Managers Limited Name of Management Entity South East Asian Strategic Assets (General Partner) Limited, CIMB Standard Strategic Asset Advisors Sdn Bhd George Soros of Soros Private Funds Management (SPFM) Bedminster Capital Management Southern Cross Standard Bank Standard Chartered Private Quity Tata Realty and Infrastructure PMU & TAF Technical Advisor Abu Dhabi Investment Company (ADIC) and Union Bank of Switzerland (UBS) Emerging Capital Partners (ECP) Transport Infrastructure Investment Company Troika Capital Partners UBS Infrastructure Asset Management IL & FS Investment Managers UTI International UTI International VietFund Management Vietnam Capital Vision Global Investments WaterPartners International, US-based NGO Emerging Capital Partners (ECP) Zephyr Management L.P Macquarie Funds Management

F F

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Annex 2

Characteristics of funds and facilities from inventory

The global rise in infrastructure funds and facilities: The emergence of private finance for infrastructure in the 90s was accompanied by the establishment of several pioneering private infrastructure funds including Emerging Markets Partnership (EMP), the Hastings Fund, Barclays Private Equity and Macquarie.46 It is notable that one of the earliest funds, EMP, specialized in emerging markets and in Africa. The number of infrastructure funds has grown substantially over recent years and this growth has recently accelerated. A 2007 survey found that at least 72 new funds had been established world wide during calendar year 2006 and the first three months of 2007 with capital raised or targeted worth a total of $122 billion47. The majority of these funds were focused on United States and European brownfield infrastructure. The average new fund had a target size of about $1.7 billion. The relatively few funds focused on emerging markets, including those based in larger countries such as India, tend to be smaller, with far smaller average deal sizes, but correspondingly, larger numbers of anticipated investments per fund and thus greater diversification. This survey found that the limited partners investing in the new infrastructure funds consist primarily of institutional investors including pension funds and insurance companies. Some are treating infrastructure as a new asset class. For others, the emphasis is on rate of return and diversification within their fixed income and alternative asset portfolios. The survey also raised some concern about crowding (too many funds) and the high prices that result, the scarcity of desirable assets and shortage of greenfield developers, as well as downward pressure on yields. However, Orr and Kennedy opine that these are likely to be short-term concerns because long-run demand for infrastructure development is very high. They also point out that the expected rates of return for these funds are largely dependent on financial structuring and the persistence of historically low interest rates. For example, as numerous 2008 press accounts have noted, funds sponsored by Macquarie and Babcock and Brown have shown stellar returns in substantial part through the low cost leveraging of projects, with the use of new debt proceeds to pay dividends. Rates of return earned in this fashion are clearly not sustainable according to market participants; the recent fall of Babcock and Browns listed share price from over $30 per share to less than $1 is the perhaps the most spectacular example of the market view.

46 47

Orr, Ryan J. "The rise of infra funds." Project Finance International - Global Infrastructure Report 2007, Supplement, June, 2007, pp 2-12.

Ryan Orr and Jeremy Kennedy, Research Note Highlights of recent trends in global infrastructure: new players and revised game rules in Transnational Corporations, Vol. 17, No. 1 (April 2008) referring to Global Infrastructure Report 2007, The Growth of Infra funds.

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Recent growth in the number of funds and facilities in emerging markets: The proliferation of independent funds and facilities intending to invest in infrastructure in emerging markets has accelerated since the first funds were established in the late1990s, with extraordinary growth occurring in the last few years. The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI) now includes information on 262 different funds and/or facilities. The rate of growth of infrastructure funds in emerging markets has accelerated sharply in recent years. While our Inventory has incomplete data on the year of launch, the following table illustrates this pattern of accelerated growth:

Funds only Frequency 1 2 4 9 6 5 5 4 4 3 6 4 9 8 19 24 23 136 Percent 1% 1% 3% 7% 4% 4% 4% 3% 3% 2% 4% 3% 7% 6% 14% 18% 17% 100% Cumulative Percent 1% 2% 5% 12% 16% 20% 24% 26% 29% 32% 36% 39% 46% 51% 65% 83% 100%

1986 1990 1992 1994 1995 1996 1997 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 Total

At least 79 of these entities are new enough so as still to be raising capital. A significant number of entities were categorized as unidentified because we couldnt determine their status. Also, several proposals for new funds or facilities were identified, the launch of which has not yet been formally announced: Fund / Facility Facility Fund Total Closed 7 111 118 Raising 3 76 79 Unidentified 18 47 65 Total 28 234 262

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Size: The EMIFFIs data on fund size is somewhat fragmentary, but is useful, as it illustrates wide variation. The currency denomination of overwhelming choice for the funds and facilities capital is the US dollar over the Euro, by a factor of ten times: Funds and facilities N Mean Range Size of fund / facility (USD, mn) 103 515 3 6,500 Size of fund / facility (EUR, mn) 10 572 22 2,000 Wide variation in size characterizes both funds and facilities: Funds Size of fund (USD, mn) Size of fund (EUR, mn) Facilities Size of facility (USD, mn) N Mean Range 4 6,500 88 531 22 2,000 10 572 15 418 3 1,700

Equity or Debt: Equity funds heavily outnumber debt funds in the inventory, and here too the amount of variation is significant: Equity funds Size of the fund (USD, mn) Size of the fund (EUR, mn) Debt funds Size of the fund (USD, mn) N 25 3 N 11 Mean 507 873 Mean 912 Median 200 598 Median 360 Range 4 - 6,500 22 - 2,000 Range 3 - 6,500

Only 6 debt funds which are specialized to provide mezzanine debt were identified in the EMIFFI. These funds are typically $180 mn value, with relatively small variation in size: Mezzanine N Mean Median Range Size of the fund (USD, mn) 5 183.2 190 140 - 236 Size of the fund (EUR, mn) 1 598 598 598 An even smaller number invest in projects using both debt and equity: Debt and Equity N Mean Median Range Size of the fund (USD, mn) 5 1481.8 200 100 - 6,500 Geographic Focus: The EMIFFI contains information on funds and facilities that are mandated to invest (i) globally in both developed and emerging markets, (ii) globally in only emerging markets, (iii) in one or more emerging market regions, and (iv) in only one country: Regional Focus Global MENA Sub-Saharan Africa South Asia Facility 7 0 11 2 Fund 46 13 38 56 Total 53 13 49 58

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East Asia and Pacific CEE Latin America Total

2 3 3 28

28 26 26 233

30 29 29 261

A greater number of facilities listed in the EMIFFI focus on Sub-Saharan Africa than all other emerging market regions combined. While the regional distribution of funds is much more even, it is still interesting to note that more funds listed in the EMIFFI focus on Sub-Saharan Africa than on any other region except South Asia. The size distribution of funds for which we could find target size information for each region is roughly similar: Regional Focus Global MENA Sub-Saharan Africa South Asia East Asia and Pacific CEE Latin America Total N 20 3 20 22 10 13 15 103 Mean 1,252 317 339 275 233 377 464 515 Range 4 6,500 150 500 3 1,500 16 1,200 6 1,080 64 2,100 100 2,800 3 6,500

Most funds in the EMIFFI are dedicated solely to emerging markets. Few invest in both developed and emerging markets: Targeting emerging markets Emerging country 198 Mixed 29 Total 227

The overwhelming majority of the funds have a regional or global focus rather than a single country focus: Fund / Facility Scope Single country Regional Global Total Facility 2 21 5 28 Fund 59 129 44 232 Total 61 150 49 260

However, we found a relatively high number of country-specific funds and facilities all of recent origin. We have also heard from several fund managers that they intend to launch additional funds of this kind particularly in the BRIC countries. This trend suggests that in years to come the country-specific category may continue to grow at a disproportionate pace. One explanation for this trend is that where the

111

local capital market is reasonably developed Infrastructure funds have been able to raise capital in domestic currency from wealthy individuals, pension funds, insurance companies and other domestic investment companies. If a fund is also able to find a strong local partner, a single country strategy can be quite reasonable. We were also interested in seeing whether funds and facilities which are still raising capital are targeting larger sizes than the funds and facilities already closed. We found very substantial variation by region on this measure. The mean size of funds being raised which include either MENA and/or Sub-Saharan Africa among their regional targets is actually lower than the mean size of the funds already closed. The opposite is the case for the global funds and those which include each of the other regions as targets, with the most spectacular increase in sizes being targeted occurring in Central and Eastern Europe: Closed funds (Million, USD) Region Global MENA Sub-Saharan Africa South Asia East Asia and Pacific CEE Latin America Total N 5 2 8 10 12 6 5 Mean 977 1,150 467 256 197 339 275 Planned total amount Range

4,884 149 - 2500 2,300 300 - 2000 3,735 21 - 2000 2,561 32 - 1000 2,369 16 - 600 2,037 100 - 1000 1,375 125 - 500 19,261

Raising funds (Million, USD) Region Global MENA Sub-Saharan Africa South Asia East Asia and Pacific CEE Latin America Total N 13 6 9 23 8 3 4 Mean 1,004 329 410 757 516 2,020 358 Planned total amount 13,050 1,975 3,690 17,418 4,124 6,060 1,430 47,747 Range 150 - 3500 175 - 500 100 - 1000 15 - 5000 50 - 1250 1000 - 3560 200 - 730

Project Type : Core vs. Non-Core, Project Stage: Relatively few funds or facilities in the EMIFFI disclose that that are targeting just one infrastructure sector, such as power or water, while the vast majority seek investments in more than one sector:

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Scope of infrastructure sectors targeted One industry Multiple industries Total This holds true for both funds and facilities: Scope of infrastructure sectors targeted One industry Multiple industries Total

Fund and Facilities 21 134 155

Percent

14% 86% 100%

Fund 20 125 145

Facility 1 9 10

Total 21 134 155

We were also interested in knowing whether the funds and facilities listed in the EMIFFI are legally permitted to invest in the core infrastructure categories of Power, Transport and Water, the non-core infrastructure categories like Telecoms, mine-related, and other dedicated industrial infrastructure etc., or both. For those 137 funds and facilities giving a clear indication from available disclosure information, we found that the largest number were permitted to invest in core infrastructure, followed by those that were permitted to invest in non-core sectors, with many permitted to invest in both: Industry target Fund Facility Total Core sectors 111 5 116 Non-core sectors 82 5 87 Core and non-core sectors 56 4 60 The EMIFFI contains only limited information on the project stage targeted by the funds and facilities (i.e. Greenfield, Brownfield, Secondary48) Relatively few funds target secondary market transactions. Our discussions with fund managers suggest that this may be because emerging markets are still developing new infrastructure assets and do not yet have a base of assets at a level of economic maturity to create extensive opportunities for existing asset sales: Project Investment Stages of Funds and Facilities Greenfield investment Brownfield investment Secondary stage 38 32 18

48

Greenfield projects develop entirely new facilities, Brownfield projects develop major improvements to existing facilities; and Secondary Projects represent the acquisition of existing facilities without significant additional expenditure for major improvements.

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Public Involvement in Capitalization: It is also interesting to note how many funds and facilities which disclosed enough information for us to know currently include as investors such public sources as multilaterals, bi-laterals, and governments of the emerging market target country. Almost half of the funds and about 85% of the facilities have some form of public participation in their capitalization: Presence of public investors Fund Facility Total Present 70 11 81 Not present 71 2 73 Total 141 13 154

Among the public source, multi-laterals have led the way in helping capitalize funds which include infrastructure in their sectoral mandates, while bi-laterals have been playing a substantial secondary role. As might be expected, emerging market governments themselves have thus far been playing a more modest role: Type of Public Source Fund Facility Total Multi-lateral organizations 45 8 53 Bilateral organizations 28 4 32 EM Governmental entities 6 3 9 Total number that have information on 70 11 81 public investors among shareholders

Fund Investor Exit Time Horizons and IRR Expectations: The EMIFFI includes only a little information on the exit expectations of fund investors, a key parameter because fund-level expectations drive fund managers investment time horizons at the individual project level. This topic is discussed more extensively in Sections 2 and 3 below, based on information derived from interviews with fund and facility managers. The EMIFFI data on this issue is summarized in the following Table.: Characteristic of funds/facilities Planned life of the fund/facility (yrs) Target Project IRR (%) Actual Project IRR (%) N 19 15 10 Mean 10 21 24 Median 10 20 25 Range 5 25 yrs 16 - 35% 8.5 - 59%

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Annex 3 Philippine Water Revolving Fund -- Description of the MDFO Stand-by Credit Line49

The MDFO SCF-LGUWSS is a credit window available for LGU water supply and sanitation projects availing of financing from the PWRF Program. The PWRF was designed as a co-financing facility targeting creditworthy WSPs. The basic financial structure of the PWRF is shown in Figure 1. Figure 1: PWRF Financial Structure
DBP/ MDFO
provides Stand-By Credit Line to cover liquidity risk of PFIs

USAID/DCA
co-guarantees LGUGC

LGUGC
provides partial credit risk guarantee of PFI loan

GRP
provides sovereign guarantee for JBIC Loan

The Stand-by credit line will be used to refinance the PFI loan if it decides not to extend the tenor beyond the original seven-years.

PFIs
Co-lends through PWRF/DBP to Water Service Providers

JBIC
lends to DBP

PWRF Special (Revolving) Account

for re-lending, stand-by credit line or additional credit enhancement

DBP administers Philippine Water Revolving Fund PWRF Lending Window

Sinking Fund
receives reserve fund surplus to repay JBIC after 10-year grace period

DBP collects repayment and distributes to the PFI, DBP general ,fund, JBIC and PWRF-SA
credit enhancement and lending reflows

Creditworthy Water Service Providers

Credit enhancers Lenders Borrowers

PWRF combines JBIC funds lent to the Development Bank of the Philippines (DBP), and funds from the Private Financing Institutions (PFIs). The co-financing arrangement is a means to initiate PFI participation in WSS lending, which heretofore has been largely provided by government financing institutions and other government agencies. 50
49 50

Author: Philippines Water Revolving Fund (PWRF) Support Program, a USAID supported project
The crux of the PWRFs design is the leveraging of ODA (JBIC) with private sector resources. The basic financing structure is a co-lending arrangement between DBP using JBIC funds from the EDP Loan and private financing institutions, i.e., commercial banks, using their own sources of funds. The targeted borrowers are creditworthy water service providers, consisting of water districts, LGUs and private service providers. The co-lending arrangement will be on a per transaction basis. DBP as the administrator will act as the main loan originator and lead arranger. Another critical feature is the ring-fencing of the reflows from the DBP/JBIC loan during the grace period, to build a special account that could provide liquidity cover to PFIs, as well as use for new loans or credit

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Under the PWRF program, PFIs shall be allowed to co-finance DBP-JBICs loans to LGU for WSS projects. PFIs can finance a minimum of 25% of the funding requirements of the LGU, while the DBP/JBIC funds shall take the remainder. DBP shall lend to the LGU on payment terms of up to 15 20 years while the PFIs shall lend based on its preferred terms. However, in order to make the debt service lower, PFIs shall be required to amortize its loan according to the longer re-payment terms of the DBP loan, e.g., 15-20 years. At the end of its preferred payment term, the PFI will have an option to extend or to receive a balloon payment equivalent to the outstanding amount of its loan after the last principal payment at the end of the preferred term. Allternatively, PFIs can provide 100% financing at commercial terms. Should there be a mismatch in the PFIs offer and the LGUs tenor requirement, the PFI shall have the option to tap MDFO stand-by credit line similar to the arrangement described above. For illustrative purposes, an example is herein provided. Assume that the PFI has agreed to extend x pesos amount of loan to an LGU with a 7 years re-payment term. Assume further that DBP, using JBIC funds, will co-finance the project, extending a loan amount of z pesos to the LGU but with a longer n years term (thus having a yearly principal amortization amount of z/n pesos per year). In order to make debt servicing more affordable, the PFI loan shall not be amortized in 7 years but in the same term as the DBP loan (n years), thus having an annual principal payment amortization of (x/n) pesos per year. However, after the last principal payment of x/n pesos at the seventh year, the PFI shall have an option to extend or to cause the release

enhance future bond issues. Section 2 of the DBP PWRF OPG describes in detail the financing arrangement, including the sub-modalities of the basic structure. The Fund will be established as a special lending program within DBP.

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of a balloon payment from the MDFO SCF-LGUWSS an amount equivalent to: Balloon Payment = {x ( 7/n ) x } pesos51

Where: x is the original amount of the PFI loan to the LGU in pesos n is the term of the DBP loan in years Balloon Payment is the outstanding loan in pesos after the payment of the last principal amortization at the call option date
Box 1. SCLF Balloon Payment: Example Assume a 50:50 co financing arrangement between DBP and PFI wherein both agree to extend Php100 million loan to the LGU. The DBP loan tenor is 15 years while the PFI loan is 7 years with both loans having a grace period of three years. Under PWRF, the PFI shall amortize the loan according to the DBP term, such that the yearly principal payment by the LGU to the PFI shall be Php8.33 million (Php100 million 12 years).After the last principal payment at the 7th year, the PFI shall be entitled to a balloon payment from MDFO equivalent to Php66.67 million (Php100m (4/12) Php100m), or the outstanding amount of the PFI loan.

The MDFOs standby loan to the LGU is equal to the balloon payment at the end of the PFI loan. The standby loan agreement shall be executed at the same date as the PFI and DBP loans to the LGU. In consideration of its commitment, MDFO shall charge a standby loan commitment fee, which shall form part of PFIs lending rate to the LGU.

51

If the PFI and DBP loans have grace periods in years of g1 and g2 respectively, the annual principal amortization of the PFI loan shall be x/(n-g2) pesos. At the end of seven years, the PFI shall be entitled to a balloon payment option amounting to: Balloon Payment = x - ( 7 - g1) x ( n g2)

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Annex 4 MFI K-Rep Bank in Kenya loans to small water enterprises

The following excerpts from a USAID project description52 provide useful detail on the K-Rep Banks lending program for small water enterprises in Kenya

Background

Water Sector Water supply is delivered under several institutional arrangements: the Ministry of Water Resources Management and Development (MWRMD), the National Water Conservation and Pipeline Corporation (NWCPC), and various local authority arrangements. Of the 201 urban centers in Kenya, only 99 had water supply systems managed by the MWRMD or NWCPC in 2003.53 Of the remaining urban centers, 10 rely on local authority/community management, and 109 do not have access to a piped water system. From a 2000 survey, only 50% and 56% of households in Mombasa and Kakamega respectively have access to a piped water system. This ratio is 71% for households in Nairobi. The emerging picture is a large amount of Kenyans rely on water supply from independent providers and un-piped sources. Independent providers of water fill a market niche that is vital to the survival of Kenyans, but their service is overall inferior to a piped water system service due to a number of reasons. Independent providers are not regulated by a water service board and so their quality of water is usually very poor. A New York Times article from June 16, 2006 attributes this characteristic of independent water providers to a major Cholera epidemic in Angola: The Bengo River passes north of here, its waters dark with grit, its banks strewn with garbage. Two dozen roaring pumping stations suck in 1.3 million gallons from the river each day, filling 450 tanker trucks that in turn supply 10,000 vendors across Luanda's endless slums. The vendors then fill the jerry cans and washtubs of the city's slum dwellers, who buy the water to drink and bathe in. This is one reason, health experts here say, that Luanda's slums are now the center of one of the worst cholera epidemics to strike Africa in nearly a decade In addition to low-quality water, independent water providers also charge higher costs than water provided through pipes. From a study of urban areas in Kenya, the median price of un-piped households is $2.59 per cubic meter while the median price for piped households is only $1.80. Also time-cost is not associated in this price. Households with a piped connection spend an average of 5.3 minutes per day collecting water while households who do not have a connection in their yard or house spend on average 37.4 to 54.7 minutes per day

52

USAID MFI K-Rep Bank in Kenya loans to small water enterprises by Allen Fleming, Katherine Naughton, et al undated project summary document
53

Gulyani, Sumila., Debabrata Talukdar, and Mukami Kariuki. Water for the Urban Poor: Water Markets, Household Demand, and Service Preferences in Kenya. World Bank, Water Supply and Sanitation Sector Board. 2005.

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collecting water depending on their water supply source.54 Both the high price and high time-cost of collecting water demonstrate the significance of having some type of piped water supply. Most importantly, it is the poor who overwhelmingly depend on non-piped sources of water. From the same study cited above, 51% of the people that use alternative sources for water supply such as vendors and surface water are poor, and only 4.5% of the households that rely on an in-house connection are classified as poor. One of the main reasons for this discrepancy is that formal utilities do not recognize residents that do not have legal land tenure. Since the time of this survey, several policy changes have occurred and the vital role of smalls-service providers has emerged. One of the key legislations that altered the sector is the Water Act of 2002. The act decentralized water provision and opened the door for new approaches for peri-urban and rural service delivery by increasing the autonomy of rural water supply providers and small-scale water providers. Under the act, water service providers can enter into contracts with water services boards and be subject to regulation by the water services regulatory board. These small-scale water providers are able to serve slum communities and rural areas because they are not bound by the same regulations as the formal utilities. In addition, because they are small-scale, they can cost efficiently serve rural communities. Project Overview Leveraging off of the Water Act of 2002 and surveys of Kenyan water supply from 2000, several international development organizations developed innovative pilot projects to determine the best way to strengthen smallscale water providers. USAID is proposing to utilize a guarantee to support one of these pilot projects, strengthening and financing community-managed small water enterprises. The project is currently being implemented in 21 communities with the intent to scale up to 55 communities. The project was created and currently shaped by three multi-donor trust funds. The Water and Sanitation Program (WSP) developed and is currently managing the project. The Global Partnership on Output-Based Aid (GPOBA) is supporting the communities by providing an output-based grant. The Public-Private Infrastructure Advisory Facility (PPIAF) provided initial feasibility studies and provides on-going technical support. In addition, USAID is committed to get involved in the project through a credit guarantee that would enable the project to scale up to 55 communities. Since USAIDs expressed commitment, the European Union (EU) has made a verbal commitment to contribute funding in order to scale up the technical assistance part of the project to 55 communities. Timeline of Major Developments Survey demonstrates abundant use of non-utility water and high cost of water to poor Kenya Water Act is passed, decentralizing water supply regulations WSP studies the market for finance and TA to small-scale water providers PPIAF financed a study on the capacity needs of community-managed water providers and financing models GPOBA contributes funds for technical assistance to develop the project and output-based grants for the communities Two loans are disbursed under the project, but additional loans are halted due to collateral requirements; USAID verbally commits to provide guarantee EU verbally commits to contribute funds and scale project up to 55 communities

2000 2002 2003 2005 2006 2007 2008

54

Gulyani, Sumila, et al. 2005

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Below are the key institutions involved in the project and their relation to the project. The water enterprises are regulated by Athi Water Services Board (AWSB), which is a regional water service board. The water enterprises will sign a Service Provision Agreement (SPA) with AWSB. The SPA will specify performance standards and tariff structures per each community-managed water enterprise. In addition, AWSB will also chair a project procurement committee to oversee and support procurement decisions made by the water enterprise. WSP is providing technical assistance to K-Rep Bank, the community-managed small water enterprises, and develop business development services enterprises. These arrangements are displayed in the figure, Institutional Arrangement, below.

Institutional Arrangement
GPOBA fund K-Rep Bank

OBA Subsidy

WSP

TA

Loan

50% Guarantee

USAID
Repayment

Community-Managed Small Water Enterprises

Service Provision Agreement

Athi Water Services Board

The other institutions, GPOBA, K-Rep Bank, and USAID, are primarily involved in the financial structure. As displayed above, K-Rep will make loans to individual community-managed small water enterprises which are guaranteed 50% by USAID. GPOBA will supply a subsidy to cover partial repayment of the loans. The involvement of each financial partner is tailored to the need of the financing; GPOBA will mitigate repayment risk and USAID will enable K-Rep to reduce collateral requirements. The figure below, Average Project Characteristics, explains the financing arrangement for an average project. The average underlying project cost is $100,000, but $20,000 is covered by the community through inkind or cash contributions. The actual loan disbursed by K-Rep will be $80,000 on average. The full amount of the loan will be disbursed up-front and will have a grace period until measurement of the output-based aid (OBA) indicators. In year two or earlier, GPOBA will measure the indicators. There will be two main outputs measured: (1) change in service coverage which will primarily be measured by the number of new water connections and (2) change in revenue collected which will primarily be measured by the change in total revenue collected. The indicators will be derived project by project and stem from baseline reports conducted by PricewaterhouseCoopers in conjunction with Tertiary Consulting Engineers Ltd. The baseline report will also be used to establish the output indicator that GPOBA uses to determine whether or not to make the grant. An independent project audit consultant will verify measurements of the outputs. If the output indicators are met, GPOBA will disburse a grant equivalent to 50% of the loan value. This grant will go directly to

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repayment of the loan and cannot be confiscated by the community. This subsidy provides incentives for the community to effectively and timely implement their water infrastructure construction plans. Because the subsidy is tied to the success of the project according to the outputs, it is not a guaranteed repayment stream from the perspective of K-Rep Bank; the subsidy primarily acts as a benefit to the community.

Average Project Characteristics:

$100,000 Total Investment
$80,000 loan $10,000 in-kind contribution by community $10,000 up-front cash contribution by community
OBA Indicators Measured OBA $40,000 Grant for debt service if indicators met

USAID 50% Guarantee

$80,000 Outstanding Loan Disbursement (Year 0) Year 2

$40,000 Outstanding Year 3.5

$20,000 Outstanding Loan Repaid (Year 5)

At this point in the life of the loan according to the figure above, the GPOBA indicators have been measured. If the indicators are met, then the remaining balance of the loan on average will be $40,000 and if the indicators are not met, then the remaining balance of the loan will be $80,000. The figure above displays the case if the indicators are met, but in both cases, the remaining loan repayment is straight-lined. If the loan is not fully repaid at the end of its term, USAID will go through its normal procedures and pay a claim of 50% of the defaulted principal balance. USAIDs guarantee is applied to every project and is not affected by GPOBA indicators. Because the guarantee is effective under all circumstances, K-Rep Bank can use the guarantee to reduce collateral requirements, an action that is vital to the success of the project. Development Rationale and Objective Because many poor households do not have land tenure, they are not serviceable by formal utilities. This factor leads to insufficient water supply to poor households. With the passing of the Water Act of 2002, communitymanaged small water enterprises are able to formally supply water to rural and unrecognized land settlements. This key piece of the Water Act will in principle enable millions of people to access safe drinking water in their homes or at the very least within their community. In order to optimize this piece of the act though, community-managed water enterprises need financing to establish or expand water supply infrastructure. While the majority of small and medium-sized enterprises (SMEs) in Kenya do not have sufficient collateral to access financing, water SMEs are worse off. Water SMEs main assets are pipes and pumps used to carry water from its source to households. With the exception of pumps, these assets lie underground. Because it is not cost-effective or feasible sometimes for a bank to collect these assets, financial institutions value water enterprises assets at a small fraction of their nominal value or value them at 0%. The USAID guarantee will enable K-Rep Bank to reduce collateral requirements and make loans to small water enterprises. Ultimately, this financing will lead to an increased number of households accessing potable water and the strengthening of community-managed small water enterprises. Financial Intermediary K-Rep Bank Limited K-Rep Bank is a licensed commercial bank that specializes in microfinance products and services. The bank has been operational for more than five years. More than 50% of the banks portfolio is in microfinance.

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Maintaining its focus on clients that lack formal sector access to financial services, K-Rep foresees increased opportunity in community-based lending. K-Rep Bank was identified by WSP as a market innovator in Kenya. K-Rep negotiated and signed an MSED loan portfolio guarantee agreement with USAID in September 2002 with a maximum authorized amount of $800,000. In 2005, K-Rep signed an additional guarantee for lending to SMEs under the DCA. This guarantee had a clause stipulating that 50% of the total facility benefit womenowned enterprises. Neither of these guarantees focused on small water enterprises. Borrowers Due to the Water Act of 2002, the government of Kenya is decentralizing its water supply operations with a focus on developing small service providers. These service providers can be broken down into three main categories: community-based small service providers, private small service providers, and households as selfservice providers. Borrowers under this guarantee will mainly constitute community-based small service providers. The clear majority of the community-based providers were founded and grown through community generated investments. Most of the households in these communities have a low income and so they cannot generate large pools of money to make substantial capital investments. The result is marginal investments that do not lead to significant improvements in water supply. Since these community-managed enterprises are longstanding in the community and its officials are usually democratically appointed or elected, the water enterprises are entrenched in the community. By enabling the community-managed water enterprise to access financing, they will be able to make improvements that will benefit the greater good of the community. The community-managed small water enterprises under the guarantee must be formally recognized by law and regulated by a water service board. Qualifying Borrowers according to the legal agreement will be defined as any group legally recognized to provide water. In Kenya this would constitute a group holding a duly signed service provision agreement (or other such legislation as may be applicable) with the relevant water services board. Complementary Technical Assistance The project has three layers of technical assistance all of which are provided through WSP: (1) a partnership with a local Kenyan Bank, K-Rep Bank, to develop their capability and capacity for financing communitylevel water infrastructure projects, (2) technical assistance to community-managed small water enterprises via a project implementation consultant; and (3) the development of a business development services (BDS) sector that can sustainably support small water enterprises. (1) WSP continues to have an on-going relationship with K-Rep Bank in order to provide updates on projects and assist in loan appraisal. WSP worked with K-Rep to understand how to better valuate assets and the unique cash-flows of water enterprises. (2) A project information consultant will be available for each water project as well. This consultant will provide construction project management services and support to management efficiency-linked improvements during operational phases. The consultant will provide support to mobilize the community for technical, financial input, and business planning assist in procuring and supervising contracts, and commissioning post-construction and warranty. The consultant will also be available for the post-implementation phase to ensure that the enterprise is running efficiently and that the enterprise attains long-term sustainability. (3) The BDS services are the main intervention to address long-term sustainability of the enterprises. WSP is working to develop a commercial BDS sector specifically supporting small water enterprises. The BDS enterprises will provide a variety of support: a. Financial services such as accounting, bookkeeping, and audits b. Ongoing training including technical and managerial aspects of water enterprises

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c. d. e. f.

Technical services: audits to assess system performance, investments and maintenance Strategic planning: technical and financial input to prepare system business plans Community support such as governance audits and arbitration Regulation and monitoring by ensuring compliance with legislation.

Market Imperfection Financing for water infrastructure is one of the scarcest types of financing. Water is traditionally seen as a social good and not as an economic good. This concept of water as a social good that should be provided free is one major market imperfection that needs be addressed and is outside the scope of a credit guarantee. The guarantee will help to strengthen small water enterprises which treat water as economic good, but the market imperfection that the guarantee will address is much more specific. The biggest market imperfection facing community-managed small water enterprises is a lack of credit available for financing capital investments. The reason for this lack of financing is multi-faceted, but generally stems from a lack of understanding water supply enterprises. Community managed water enterprises have assets that are also difficult to collect such as pipes buried five feet under the ground. In addition, project finance for water needs medium to long-term loans, and these are almost completely absent in the Kenyan context. Specifically related tot his project, there is a niche imperfection. WSP is working with K-Rep bank to better evaluate project finance loans and teach how water enterprises are operated. WSP is also working with GPOBA to make the project more bankable. Despite all this, one specific imperfection remains that K-Rep will not address: a lack of traditional collateral. Because water enterprises do not have traditional collateral and K-Rep maintains strict and extensive collateral requirements, water enterprises cannot access credit. Additionality This guarantee will address a significant imperfection in the Kenyan market which is to overcome risk aversion to lend to community managed water enterprises. The guarantee will provide an incentive for K-Rep to extend credit to these enterprises. Specifically, the guarantee enables K-Rep bank to substitute nontraditional collateral with the guarantee. Because it is difficult to collect on the assets held by the community enterprises, the guarantee will enable the communities to meet collateral requirements of K-Rep. The guarantee will enable financing for over 50 communities with the capacity to improve drinking water supply of over 200,000 Kenyans.

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Annex 5 List of persons interviewed INTERVIEWS COMPLETED AS OF 10/25/08

Name and Title 1. 2. 3. 4. David Wilton, Manager, New Business, Private Equity and Investment Funds John Simon, Executive Vice President OPIC Koonal Gandhi, Investment Funds Officer, Investment Funds Department Oliver Fratzscher, Gemloc Program Manager, Capital Markets Department Adrian Becher, Principal Investment Officer, Infrastructure Dept. Peter Tropper, Senior Investment Officer, Asia IFC 7. 8. Bharat Parashar, Managing Director Alain Ebobisse, Principal Investment Officer, Infrastructure Department and Task Manager Thomas Gibian, CEO EMP-Daiwa Capital Asia InfraVentures (IFC) ECP Private Equity IADB Darby Overseas Darby Overseas Darby Overseas 8.5.08 8.5.08 8.5.08 8.4.08 In-person 8.5.08 In-person In-person In-person By phone 8.4.08 In person 8.5.08 In-person 7.8.08 OPIC 7.8.08 World Bank Group 7.9.08 IFC 7.8.08 In-person In-person In-person In-person Organization Date 7.8.08 IFC 7.8.08 In-person In-person In-person or phone

5. 6.

9.

10. Natasha Richardson, Portfolio Management Officer, Structured and Corporate Finance Department 11. Richard Frank, CEO 12. Jonathon Haddon, General Counsel 13. David Hudson, Head of Global Infrastructure

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INTERVIEWS COMPLETED TO DATE (Continued) Name and Title 14. Franklyn Minerva, Managing Director, Global Public Finance 15. Eyob Easwaran, Managing Director-16. Everett Santos, Former Managing Director, Latin America Infrastructure Fund 17. Declan Duff, Former Vice President, Investment Operations 18. Vincent Goaurne, Director, Corporate Sub-Sovereign Finance Program 19. Andre Steyn, Manager for South Africa, AIG African Infrastructure Funds I and II Organization Date 7.31.08 MBIA Conduit Capital Partners EMP Global 7.30.08 In-person 7.31.08 By phone 8.9.08 IFC 8.9.08 IFC AIG and Emerging Markets Partnership Organization: African Infrastructure Investment Managers Pan-Africa Infrastructure Fund Savage Holdings UK Parliament Frontier Markets Fund Managers Aldwych Mizuho Bank Corp. 8.9.08 In-person By phone In-person By phone In-person or phone

20. Andrew Johnston CEO S A Infrastruture Fund, Africa Infrastruture Fund, Kasigo Investment Fund

8.23.08

In-Person

21. Souleymane Keita, Chief Investment Officer

9.1.08

In-person

22. Frank Savage, Former CEO, Africa Millennium Fund 23. Susan Kramer, Member of Parliament 24. Nick Rouse, Managing Director, GuarantCo and Emerging Africa Infrastructure Fund 25. Helen Tarnoy, Commercial Director and Deputy Managing Director 26. Paul Jennings, Managing Director, Sovereign Risk

9.3.08 9.8.08 9.8.08 9.9.08 9.9.08

In-Person In-Person In-Person In Person In-Person

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INTERVIEWS COMPLETED TO DATE (Continued) 27. Philip Sullivan, Managing Director and Chief Risk Officer for International Credit 28. Deborah Zurkow, Managing Director, Global Infrastructure Finance 29. Peter Roberts, Private Sector Infrastructure Policy Advisor 30. Richard Avery, Investment Officer 31. Mark OHare, Founder and Managing Director 32. Richard Stus, Research Analyst for Infrastructure 33. Anthony Way, Senior Policy Manager, Global Funds and Development Finance Institutions Department 34. Lindsay Forbes, Director, Corporate Equity 35. John Hodges, Project Manager 36. Regis Damour, Former CEO, Egis MBIA Insurance Corp. MBIA Insurance DfID InfraCo Private Equity Intelligence Private Equity Intelligence DfID EBRD PIDG AECOM Enterprises/ Meridium DEPFA Bank Global Environment Fund IADB PIDG World Bank Morgan Stanley 9.10.08 9.10.08 9.11.08 9.12.08 9.12.08 9.12.08 9.12.08 9.13.08 9.14.08 9.18.08 In-Person In-Person In-Person In-Person In-Person In-Person In-Person In-Person By Phone In-Person

37. Michael Freed, Senior Advisor, Credit Enhancement 38. Scott McLeod, Managing Director

9.18.08 9.19.08

In-Person In-Person

39. Javier Molina, Task Manager, Central American Infrastructure Fund 40. Dianne Rudo, Managing Director, Rudo International 41. Luis Guasch, Task Manager, Peru Infrastructure Guarantee Fund 42. Sadek Wahba, Senior Managing Director, Morgan Stanley Infrastructure Partners

9.19.08 9.19.08 9.19.08 9.22.08

In-Person In-Person In-Person In-Person

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INTERVIEWS COMPLETED TO DATE (Continued) 43. Pascal Raess, Section des Institutions Financires Internationales, 44. Odo Habek, Managing Partner, Michael Kenwood Capital 45. Joost Zuidberg, Managing Director 46. Justin Schwartz 47. Iain Menzies, Senior Infrastructure Specialist 48. Suman Babar, Former Head of Infrastructure Financial Guarantee Operations 49. Gad Cohen, Managing Director, Sub-Saharan Africa Infrastructure Fund 50. Andrew Cantor, Director, Future Growth Swiss Agency for Development and Cooperation MK Master Investments Ltd. TCX Investment Management Co. Sythe Energy/ Blackstone LLC World Bank World Bank InfraCo Futuregrowth Development and Bond Fund, Futuregrowth Development Equity Fund Mercer Consulting CMDC Development Company CMDC Development Company 10.13.08 10.13.08 9.25.08 In-Person

9.25.08 9.30.08 9.30.08 10.1.08 10.3.08 10.10.08

In-Person By phone By phone By phone By phone In-Person In-Person

51. Rob Treich, Managing Director 52. David Stevens, CEO

By phone By phone

53. David White, President

10.13.98

By phone

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Annex 6

Interview Template

Interviewee: Interviewer:

Organization: Date: / /08 In-person___ or phone___

1. Which infrastructure fund(s) or facility(ies) targeted at emerging market countries do you Manage? e.g.: In what form does your fund/facility invest/commit capital (e.g. equity, debt, full or partial risk guaranty, full or partial credit guaranty)? If the form of support is debt or guaranty, is it denominated in international or local currency? What country(ies) and what infrastructure sector(s) are included in this funds/facilitys mandate? Are youcontemplating any changes in these fundamental parameters in the foreseeable future?

2. Sources of capital and investor expectations, e.g. What is(are) the source(s) of capital for your fund/facility and what rate of return are the investors expecting? Is this considered by the investors to be a risk-adjusted market rate of return or a concessional rate of return? Has(have) the originally-expected rate(s) of return been achieved to date? What other measures are the investors using to evaluate the performance of each fund/facility?

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3. Is your fund/facility aiming to invest/lend capital at risk-adjusted market cost or at concessional rates? If yourfund/facility is providing debt, what is the longest final maturity provided thus far? What is the average final maturity on debt lent so far?

4. Please generally describe your funds/facilitys record of originating or participating substantially in infrastructure financings to date, e.g.: What percentage of each funds or facilitys capital has now been committed? How long did it take (or do you reasonably project it to take) to fully commit 100% of each funds or facilitys capital? What factors most influenced your funds or facilitys rate of commitment?

5. Please describe the management and decision-making structure of your fund/facility, e.g.: Is management in-house or out-sourced? What advantages or disadvantages do you see in those contrasting models?

How was management recruited? Are there written job descriptions for key management positions?

How are capital commitment decisions made, e.g.: is there any separation between the transaction origination and capital commitment/underwriting staffs and decision-makers? Is there a committee process? Are there written capital commitment/underwriting guidelines?

Who is responsible for surveillance, remediation and, if necessary, workout of the transaction portfolio? Are there written surveillance and remediation procedures?

6. What role(s) do formal credit ratings play in the structuring and underwriting of your funds/facilitys individual transactions?

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7. Please generally describe the performance of your funds or facilitys portfolio of closed transactions; e.g. return on equity, rates of delinquency and default on debt or guaranties.

8. What infrastructure finance transactions best typify your funds or facilitys accomplishments to date? Can you provide documentation about each of these exemplary transactions?

9. Does each fund/facility have a formal or informal relationship with one or more project preparation facility, and if so, what is the nature of that relationship? How has that relationship contributed to each funds/facilitys ability to originate or substantially participate in infrastructure finance transactions?

10. What are the key challenges to the use of your fund/facility in infrastructure finance transactions? Consistency of the funds/facilitys charter with actual demand? Statistical treatment in OECD Development Assistance Committee Official Development Assistance statistics? Risk assessment/underwriting guidelines and portfolio management perspective of the fund/facility ? Treatment in the financial statements of the funds/facilities investors? Of the target borrower/equity recipient? Of the host country? Relations with Paris Club or the IMF, particularly regarding sub-sovereign lending? Acceptance/understanding by the funds/facilitys staff working as originators, transactors, risk underwriters, or surveillance officers on specific transactions? By the staff of the target borrower/equity recipient? By key host country official, e.g. in MOF, Central Bank, Securities Regulator, or Bank Regulator? Others?

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11. Does your fund/facility attempt to leverage additional international of domestic public or private capital into specific transactions? If so, is the fund/facility required to do this on only a pari-passu basis or is it permitted to take junior credit priority (e.g. first-loss) or equity positions? Does your fund have target leverage ratios?

12. Who are your funds/facilitys competitors in their markets? Who is doing best? Why?

13. If your fund/facility is not currently involved in Africa, was Africa considered? If a given fund or facility is now considering involvement in Africa, what countries are being considered and why? What are the preconditions of success?

14. What criteria do you use to assess the success of fund/facility which you manage?

15. Do you think any of the following factors account for either the success or underperformance of the fund/facility, and if so, has each factor you select been a major or minor factor: a. The relevance of the quality of demand study conducted for setting up the fund/facility. ___ YES ___ NO / ___ Major ___ Minor The adequacy of the design/structure of the selected facilities in meeting its objectives, such as choice of financing or risk mitigation instruments, tenors, pricing etc. ___ YES ___ NO / ___ Major ___ Minor The impact of country or region specific circumstances, such as available local savings, size of the potential market, the adequacy of the policy and legal environment for private investment/ public private partnerships, etc. ___ YES ___ NO / ___ Major ___ Minor The quality of infrastructure project preparation capacity ___ YES ___ NO / ___ Major ___ Minor Implementation issues: set-up times, approval processes and procurement procedures, ability to respect time schedules etc. ___ YES ___ NO / ___ Major ___ Minor Technical issues: impact of the source of funding, fund size, type of financing instrument and access to investor base.

b.

c.

d. e.

f.

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___ YES ___ NO / ___ Major ___ Minor g. Adequacy of fund/facility strategy to identify projects, to support/trigger private investment and the fund/facilitys relative contribution to financing private infrastructure (particularly if there are peer comparisons that can be made), including issues such as cost effectiveness. h. ___ YES ___ NO / ___ Major ___ Minor i. Other success or underperformance factors not included above which you have identified?

16. What key positive and negative lessons have been learned from the development, launch and operation of each fund/facility? Whether or not your fund is involved in Africa, what lessons can be drawn for African countries and for new funds/facilities designed specifically for Africa? 17. What roles can and should the IFIs -- especially the World Bank Group play in the successful operation of infrastructure funds/facilities? How do these roles differ by region, country, sector?

FINALLY: WHAT OTHER QUESTION(S) SHOULD WE HAVE ASKED IN THIS INTERVIEW?

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Information needed on specific transaction examples cited to illustrate each funds/facilitys performance:

1. Detailed explanation of transaction, 2. Institutional, legal, policy framework necessary to permit the transactions structure. 3. Risks borne by various parties including lenders risks involved in each facility and risk mitigation measures 4. Effect of the facilities on development effectiveness and improved delivery of services.

5. Lessons learned, both positive and negative from each transaction.

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