AN ANALYSIS OF AVAILABLE FEATURES IN CS-DRMS FOR RECORDING MULTILATERAL LOAN PRODUCTS AND CREDITOR PRACTICES

Transcription

1 Macroeconomic and Financial Management Institute of Eastern and Southern Africa AN ANALYSIS OF AVAILABLE FEATURES IN CS-DRMS FOR RECORDING MULTILATERAL LOAN PRODUCTS AND CREDITOR PRACTICES FELISTER SALIKU KIVISI, MINISTRY OF FINANCE, KENYA TECHNICAL PAPER SUBMITTED IN PARTIAL FULFILMENT OF THE AWARD OF MEFMI FELLOWSHIP January 2011

2 ACKNOWLEDGEMENT I would like to acknowledge the invaluable help accorded to me by my mentor Mr. Macdonald Banda of Commonwealth Secretariat. I also acknowledge my workplace supervisor Mr. Haron Sirima and the Director of Debt Management Department Mr. John Murugu for encouraging me to enlist in the MEFMI Fellows Development Programme, and giving me time off to attend the training sessions. I acknowledge all my colleagues at the Debt Management Department who, in one way or another, have enriched my experience and added to my knowledge as we continually worked on various aspects of debt management and all this has gone a long way in contributing to this work. My sincere gratitude goes to Mr. Simon Odum of DMD who assisted me to format the document. I would also like to acknowledge Mr. Richard Kwaku Ofori-Mante of African Development Bank, who sent me information that I used in this paper. The invaluable information had proved difficult to find. My thanks also go to the MEFMI, Debt Management Programme for guidance and for the chance they gave me to undertake the training and write this paper. Last but not least, I appreciate the support and patience of my family who allowed me to be away from home in the course of the fellowship training and writing of this paper. To all of you I would like to say, Thank you very much and God bless you.

3 TABLE OF CONTENTS ACKNOWLEDGEMENT... i TABLE OF CONTENTS... ii LIST OF FIGURES AND TABLES... v LIST OF ABBREVIATIONS... vi EXECUTIVE SUMMARY... vii CHAPTER Introduction Statement of the problem Objectives of the study Research Questions Hypothesis Literature review... 6 CHAPTER Methodology Significance of the study Scope and limitations of the study Financing Products World Bank - IBRD IBRD Flexible Loan IBRD Deferred Drawdown Option (DDO) DPL-DDO CAT-DDO World Bank-IDA IDA Credits African Development Bank (AfDB) African Development Bank (AfDB) Libor Based Loans AfDF Loan OPEC Fund for International Development (OFID) ii

4 3.6 Conclusion CHAPTER General Creditor Practices of Multilateral Creditors African Development Bank Group Repayment Currencies Billing Application of payments Non business day convention Treatment of Single currency payments Shortfalls Excess payments Arrears and Sanctions policy Prepayment World Bank Billing Arrangements Business day convention Payment Applications Overdue and Sanction Policy Waiver Prepayment policy Conclusion CHAPTER Risk Management Introduction Risks Encountered in Sovereign Debt Management Risk Management Products Risk Management Products of the African Development Bank Risk Management Products of the IBRD Summary Terms of RMP from IBRD Hedging Products African Development Fund IDA iii

5 5.3.5 Bilateral Lenders Commercial lenders Conclusion CHAPTER 6: CS-DRMS Usage in the MEFMI Region Debt and Risk Management in the MEFMI CS-DRMS member states CHAPTER Recording Instruments in CS-DRMS Currency Conversion Interest Swap Currency Swap Recommendation Annex 162 REFERENCES iv

6 LIST OF FIGURES AND TABLES Figure Figure Figure Figure Table Table Table Table Table 6.2 Table 7.1 IBRD conversion path CS-DRMS Instrument Details Screen Interest Swap Arrangement Currency Swap Arrangement Evolution of African Development Bank s Products Summary of Product Characteristics from Multilateral lenders Summary Terms of Risk Management Products from AfDB Summary Terms of Risk Management Products from IBRD Summary of MEFMI CS-DRMS Countries use of RMPs Summary Description of Agreement Types v

7 LIST OF ABBREVIATIONS AfDB AfDF CS-DRMS African Development Bank African Development Fund Commonwealth Secretariat Debt Recording and Management System COM SEC Commonwealth Secretariat IBRD International Bank for Reconstruction and Development IDA MEFMI International Development Association Macro Economic and Financial Management Institute of Eastern and Southern Africa OFID RMCs RMPs SMEs SDR UA OPEC Fund for International Development Regional Member Countries Risk Management Products Small and Medium Enterprises Special Drawing Right Unit of Account vi

8 EXECUTIVE SUMMARY The Commonwealth Secretariat Debt Recording and Management System (CS-DRMS) is designed to provide borrowers with a comprehensive information management system for the effective recording, administration and analysis of their debt portfolio. The CS- DRMS project began in 1983 and to take into account developments in debt management (including creditor practices, new loan products) and user requirements, the scope and features in CS-DRMS has evolved over the years, undergoing a series of enhancements in terms of increased functionality. CS-DRMS is aimed at supporting core debt management functions such as recording, reporting and analysis for wide range of debt instruments. Over the last few years, financial products offered by creditors to sovereign borrowers have significantly changed both in terms of complexity as well structure. As a result, borrower nations are now presented with various types of loan products and financial practices from multilateral and commercial creditors. This study looked at the various loan products and creditor practices offered by major multilateral creditors, assesses how these products are currently being recorded and managed in the MEFMI member states who use the CS-DRMS, and finally recommends how these products and practices can be recorded and managed in CS-DRMS using the existing features or proposed new features. Without a doubt most sovereign borrowers now have substantial internal capacity for active liability management largely through the support of international and regional organizations like MEFMI. This development has seen an increased in demand from borrowers for flexible debt management financial products (i.e. derivatives) to allow borrowers themselves better manage their own portfolios. Technical assistance on managing loan products in the MEFMI region has hugely targeted standard financial products and the need for implementing debt management best practices. Assessing the extent at which MEFMI countries have started using derivatives or the existing potential of using derivatives to manage debt portfolios, will assist MEFMI in designing new technical assistance programmes to support the development of capacity and institutional vii

9 arrangements required for liability management activities in the member states. In so doing, member states will be better prepared both in terms of institutional structures, systems and capacity (skills) to undertake the liability management operations when the need arises. Whilst CS-DRMS has been instrumental in assisting countries better record and manage their debt portfolios, the format and structure of standardizing loan products for the purposes of recording in CS-DRMS has in a way contributed to the fact that CS-DRMS users are somehow detached from the actual financing products and can therefore not use the system to effectively manage these products. Now that there is need for borrowers to undertake active liability management operations in addition to mere recording, the new generation of CS-DRMS should look for ways of reengineering the system to take account of all the features of the new products and functions that are increasingly modifying their products to provide a high degree of flexibility to assist borrowers better manage their loan portfolios. Enhancing CS-DRMS to allow for implementation of liability management operations would have little impact unless it is backed by comprehensive awareness programmes in the member states. Liability management operations are a risky exercise and require a good understanding of the international market. There are a number of risks that any sovereign debt manager should consider and mitigate through active debt management. The risks include market risks, currency risks, exchange rate risks and operational risks. Risk Management products (RMPs) are financial products which allow clients to transform the financial risk characteristics of their obligation under a loan or other instrument without renegotiating or amending terms of the original instrument. These products are technically referred to as derivatives or hedging products. The multilateral institutions have moved to offer the Risk Management Products (RMPs) because there is a belief that over the years, most sovereign borrowers have developed internal capacity (skills) for active liability management. Furthermore, borrowers are now increasingly demanding for debt management financial products in the quest to better manage their portfolios. viii

10 The survey which was undertaken in a number of MEFMI CS-DRMS countries as part of this project clearly showed that most countries have not used the RMPs since most of the countries are classified as IDA only and therefore have limited access to the international market. This means that they mostly borrow from concessional sources. The concessional lenders do not provide any RMPs. This however, does not negate the need to recommend to the CS-DRMS developers to look ahead and improve it to take care of the RMPs. This is so much more since the system is not only used by the MEFMI countries but in 75 sites in 60 countries in the world. The concessional borrowers may also in the future move to different levels and be required to borrow from non-concessional sources where RMPs are an important feature. This is amply demonstrated by Swaziland whose classification has recently been changed from IDA only to a Low middle income country. The study also revealed that Tanzania and Lesotho have undertaken or were approached by creditors/investment banks to undertake liability management operations. Although the use of liability management operations is currently low in the member states, there is every indication that this is a growing demand and thus the need for countries to start putting in place structures for liability management operations. ix

11 CHAPTER Introduction The Commonwealth Secretariat Debt Recording and Management System (CS-DRMS) is designed to provide borrowers with a comprehensive information management system for the effective recording, administration and analysis of their debt portfolio. CS-DRMS Version 1.3 is the latest version of the software. The CS-DRMS project began in The first version of the CS-DRMS software, developed in MS-DOS, was introduced in Sri Lanka in Since then, the software has grown in use to over 75 sites in 60 countries (both Commonwealth and non Commonwealth), helping governments plan and manage their borrowings. The software is available in both English and French. To take into account developments in debt management (including creditor practices, new loan products and user requirements), the scope and features in CS-DRMS has evolved over the years, undergoing a series of enhancements in terms of increased functionality. The technological platform on which the software is offered has also evolved from a DOS version to the current windows based application which was officially launched in October It involved a complete rewrite of the system in client-server architecture under the Windows environment. CS-DRMS is aimed at supporting core debt management functions such as recording, reporting and analysis for wide range of debt instruments. The software adopts a holistic approach to debt management by catering for various types and categories of external and domestic debt instruments. This paper looks at how CS-DRMS is being used to record Risk Management Products of the multilateral organizations in MEFMI member states that use CS-DRMS. This is important especially considering that the system has since been used for recording legacy loans and might be weak on the new products being designed by the creditors. In addition, as the economies of these countries continue to improve, very soon they will be able to access the international market where there are much more sophisticated 1

12 instruments. To be able to analyze the MEFMI member countries engagement with liability management products, a questionnaire was prepared and sent out to the respondents. Out of the eight MEFMI CS-DRMS country members surveyed, only six responded. The six that responded were Kenya, Malawi Mozambique, Lesotho, Swaziland and Tanzania representing a seventy five per cent response rate. The survey revealed that, apart from Mozambique and Swaziland who have relatively low proportion of multilateral debt, the rest of the countries have borrowed heavily from these institutions and it is very likely that this trend will continue. This is an important observation since most of these new financing products with embedded derivatives are from multilateral organizations. The survey also indicated that all the respondents are classified as IDA only but have in their databases instruments from IBRD and AfDB. Swaziland, however, has recently been classified as a low middle income country and no longer qualifies to borrow from the soft window of the World Bank. The instruments in their databases are most probably those that were contracted before the countries were classified as IDA only although that will change overtime. Since all the countries except Swaziland are IDA only countries, it can be safely assumed that most of this multilateral debt is from the soft lending windows of the World Bank and African Development Bank and other organizations such as OPEC and BADEA which do not have inherent embedded options available for risk management apart from prepayment. The following points below summarize the findings from the survey; i. Most of the MEFMI countries are not eligible for non-concessional borrowing and therefore limited in their access to the RMPs through multilateral borrowing; MEFMI countries would only benefit from these products if they are also offered through the concessional borrowing. This is very likely to be the case. 2

13 ii. iii. iv. It is also noted that except Tanzania, which has conducted a currency swap with bilateral lenders, MEFMI countries have not used the Risk Management Products even on the existing loans; Most MEFMI countries have not converted the legacy IBRD or ADB loans that still exists in their portfolio to take advantage of the available risk management products. It should however be mentioned that the benefit would not be much as the products represent a small percentage of the portfolio; Lastly, apart from Mozambique, MEFMI countries demonstrated awareness to the existence of liability management products. The capacity to effectively execute such products is however a different issue all together. Though IMF financing is not the main focus of this paper, the survey revealed that for countries that recorded such IMF financing products in CS-DRMS, the products or facilities are recorded as standard multilateral instruments. They are rather straightforward and pose no challenge in recording and managing the facilities through CS-DRMS. BPM6, however, classifies SDR allocations as external debt and borrowers are required to add these to their external debt stock when reporting to the Quarterly External Debt Statistics initiative. None of the six respondents reported recording of the same. This is therefore one of the areas that the CS-DRMS should provide a solution to enable the users report comprehensively. This paper is divided into seven chapters as follows:- 1. Introduction 2. Methodology 3. Financing Products of Multilateral Creditors 4. General Practices of Multilateral creditors 5. Liability (Risk) Management 6. CS-DRMS Usage in the MEFMI Region 7. Recommendations and Conclusion 3

14 1.2 Statement of the problem Financial products offered by creditors to sovereign borrowers have significantly changed both in terms of complexity as well structure. As a result, borrowers are usually presented with various types of loan products and financial practices from multilateral and commercial creditors. This study aims to look at the various loan products and creditor practices offered by major multilateral creditors, assess how these products are currently being recorded and managed in the MEFMI member states and recommend how these products and practices can be recorded and managed in CS-DRMS using the existing features or proposed new features. The study also aims to assist MEFMI in designing future technical assistance activities aimed at improving capacity to better manage multilateral financing products and derivatives. Information on these products and respective practices is generally available through creditor publications and websites. Through assistance from international and regional institutions (like MEFMI), most sovereign borrowers have developed internal capacity for active debt management. This development has seen an increased demand from borrowers for flexible debt management financial products (i.e. derivatives) to allow borrowers better manage their own portfolios. CS-DRMS can be used to record various types of instruments; it does not have a feature for recording and managing derivatives. Although there are work-around solutions to recording derivatives in CS-DRMS, there is no readymade literature that plainly explains how these products and practices can be recorded. This study will document various products used for undertaking liability management operations and explore their usage in MEFMI member states and how the operations are recorded and maintained in CS-DRMS. 1.3 Objectives of the study Objective of this study is fourfold; 1. Assess and document multilateral loan products (IBRD, IDA, AfDB, AfDF and OFID) in the eight MEFMI countries that use the CS-DRMS. Specifically, the 4

15 study aims to describe which loan products are still being used by the countries taking into account the evolution of such products. These creditors were specifically chosen because of ease of access of information on products offered as well as that these creditors represent a significant portion of MEFMI countries debt portfolio; 2. Study and document creditor practices for IBRD, IDA, AfDB and AfDF. Understanding creditor practices is key to ensuring that the products are being accurately recorded and managed; 3. Document how some of these products are currently being recorded in CS- DRMS; 4. Assess liability management operations being undertaken in MEFMI member states and document how the operations are recorded and managed in CS-DRMS. 1.4 Research Questions The study will attempt to answer the following broad questions. 1. What are the loan products offered by IBRD, IDA, AfDB, AfDF and OFID? How have some of these products evolved over the last few years to meet sovereign borrower s requirements? 2. How are these products recorded in CS-DRMS and what are the gaps/ difficulties experienced by the users when recording these products? 3. What are the creditor practices and general guidelines for OFID, IBRD,IDA,AfDB and AfDF for the following; i) Billing Arrangement ii) Prepayment iii) Business Days computation iv) Revaluation v) Waiver vi) Application of rebates vii) Application of payment viii) Under payment of bills (how do they treat arrears ix) Overpayment of bills (how do they treat the excess payment) 5

16 x) Application of penalty 4. Have MEFMI member countries embarked on liability management operations (i.e. swaps, conversions, forwards)? If so, what products have been used and how has the operation been implemented in CS-DRMS. Understanding the operations, practices and features of the products offered by creditors is critical for determining and executing liability management operations. The survey will be used to establish how well the member states understand these products. 1.5 Hypothesis The raised awareness of debt management in most countries has put pressure on debt management application providers to move from mere recording applications to management applications that facilitate active use of the system in the day to day activities of a debt management office. To achieve this objective, the application should provide a bridge for users to better understand financial products and creditor practices and assist countries undertake various types of liability management operations. Parallel to providing the required features in CS-DRMS, countries will need to develop the required skills and institutional structures to undertake the liability management operations. 1.6 Literature review Most international creditors have standard templates, practices and guidelines that govern the lending process and terms of financing products designed for sovereign and non sovereign borrowers. Since its maiden launch in 1985, CS-DRMS has constantly been revised and modified to keep in touch with the ever changing creditor practices and products. Throughout this process, CS-DRMS has evolved into a flexible tool designed to record and standardize the various financing products. Standardizing loan products for the purposes of recording in CS-DRMS has in a way contributed to the fact that CS- DRMS users are somehow detached from the actual financing products and can therefore not use the system to effectively manage these products. This is where the question of 6

17 recording or managing comes into the spotlight. There are four guiding principles that should govern the new generation of CS-DRMS; 1. Creditors have a standard set of financing products which they offer; new products may be added and existing products amended or discontinued; 2. Creditors have standard practices that govern the distinctiveness and functions of the various financing products; 3. Creditors have standard practices that administer the terms of the various instruments; 4. Creditors are increasingly modifying their products to provide a high degree of flexibility to assist borrowers better manage their loan portfolios; CS-DRMS is provided with a set of user manuals that describe the system and how it should be used. However, there is no document which compares characteristics of loan products and creditor practices with the features available in CS-DRMS. The Commonwealth Secretariat recently did a study on creditor practices and financing products. For this study, the Commonwealth Secretariat visited the following institutions (i) World Bank (IBRD), (ii) International Development Association (iii) (IDA) International Monetary Fund (IMF), (iv) International America Development Bank (IDB) and (v) Asian Development Bank (ADB). Findings from the study were intended to provide critical inputs into designing a new generation of the CS-DRMS application. The study however did not include the following; 1. The experience from the borrower s perspective; 2. Creditor practices and financial products from African Development Bank and African Development Fund; 3. Liability Management Operations in CS-DRMS user countries and how they are implemented in CS-DRMS. This document focuses on discussing financing products from five major multilateral creditors. The choice of these products is on the understanding that most creditors especially bilateral usually adopt the practices set by the multilateral institutions. It can therefore be assumed that the coverage of the practices and products in this document will apply to both multilateral and bilateral organizations. 7

18 Multilateral institutions continuously review their financing products resulting into new products being designed and the older ones being discontinued. This has been necessitated by recent developments in the international markets as well as the fact that sovereign borrowers are now well versed in managing their debt portfolios. The borrowers themselves are also increasingly demanding for flexible products as well as products denominated in local currencies. The non-concessional window of the multilateral organizations has responded well to these demands. The concessional borrowing has largely remained the same but it is envisaged that it may change in the near future. While the CS-DRMS has been a useful tool in recording and managing debt in standardized formats, it needs to be continually upgraded to take into account the emerging financing products as well as various creditor practices. This paper therefore looks at various financing products and creditor practices of several multilateral institutions and how some of them are managed in CS-DRMS. The paper will recommend a work around way to manage those that are not adequately covered by the current CS-DRMS. The paper will also supplement and extend the paper that Commonwealth Secretariat produced as part of the study which they conducted in collaboration with multilateral institutions. 8

19 CHAPTER Methodology COMSEC recently did a study to understand financial products from the World Bank, Inter-American Development Bank, Asian Development Bank and the International Monetary Fund. This study reviewed the COMSEC document and material from the multilateral organizations and used the same approach to document creditor practices for African Development Bank/Fund and OPEC. In so doing, this paper supplements the Commonwealth Secretariat paper and therefore provides a complete list of multilateral products and creditor practices. In addition, this study gathered information on the use of CS-DRMS and awareness liability management operations from the eight MEFMI member states that use CS- DRMS. Data collected was analyzed as follows; Data collection The non-probability method was used. Enumeration of the whole sample frame was done since there are only eight countries using CS-DRMS in the region. Plans were made to visit the African Development Bank/Fund and OPEC as well as the eight MEFMI countries that use the CS-DRMS, but due to unavoidable reasons it was not possible to visit the institutions. Data collection tools A questionnaire was developed to collect data from the respondents. Since it was not be possible to visit the eight countries, some data were collected during CS-DRMS regional workshops as well as from creditor and borrower s websites. Data analysis This is mainly descriptive in nature and constitutes part of the intended output. 9

20 2.2 Significance of the study The study comes at a time when debt management is shifting from mere recording of debt instruments to active management of portfolios. For countries to actively manage their portfolios and take advantage of the ever increasing liability management products, they will need first to understand the underlying products themselves and also have a debt management system that will assist the countries execute and manage the operations. The study will be useful in the following areas; 1. Although CS-DRMS has been around for a long time, there is no readymade literature on how to record various products in CS-DRMS especially the so called complex instruments from the multilateral institutions. The study will therefore recommend on how best to record such instruments; 2. Commonwealth Secretariat has done a similar study on multilateral creditors apart from AFDB, AFDF and OPEC. This study will supplement the Commonwealth study and assist in the development of CS-DRMS 3. The study will document any liability management operations, if any, being used in the MEFMI region especially in the countries using CS-DRMS. The study will also establish if countries are indeed aware of such options in the financial agreements and explain why they use them or why they do not use the options. Understanding the extent of how liability management operations are used in MEFMI region, will assist MEFMI design capacity building activities to address the issues. 10

21 2.3 Scope and limitations of the study The study was limited to African Development Bank, African Development Fund, The World Bank, OFID and the eight countries that use the CS-DRMS in the MEFMI region 1. The major limitation to the study is that it required visiting all the eight member states to understand their environment and discuss the topics in this paper. Due to exigency of work and budgetary constraints from MEFMI side, the visit to the countries was not possible. This limitation was however mitigated through the use of a survey that was undertaken by sending out a questionnaire to the countries. It was also not possible to visit the multilateral creditors who are subject of this study but their websites and contacts with individuals in these organizations provided considerable amount of information that was used to produce this paper. The paper produced from this study supplements a similar study that was undertaken by Commonwealth which was more creditor focus rather than from the borrower s perspective. 1 Major multilateral institutions provide over 80 percent of the loans to most of the member states. In addition most bilateral and commercial creditors seem to adopt the practices used by these major multilaterals. So although the coverage is limited to the multilateral institutions, the coverage is much wider. 11

22 CHAPTER Financing Products This chapter will briefly document and analyze the various financing products offered by the five major multilateral institutions in the MEFMI region. The chapter will also, where necessary, briefly describe the evolution of products from some of the creditors in order to show the trend in which creditors are moving to meet their own requirements as well as those borrowers. 3.2 World Bank - IBRD The International Bank for Reconstruction and Development (IBRD) was established in 1944 as the original institution of the World Bank group. It is structured like a cooperative that is owned and operated for the benefit of its members. Its membership is made of one hundred and eighty six (186) countries. Its stated objective is to reduce poverty in middle income and credit-worthy poorer countries by promoting sustainable development through loans, guarantees, risk management products, analytical and advisory services. IBRD s market presence and strong financial policies provide a solid foundation for offering clients a broad menu of financing options at highly competitive market-based terms. It raises most of its funds on the world s financial markets, becoming one of the most established borrowers since issuing its first bond in The IBRD offers various financing options to its borrowers. It offers loans, contingent financing and catastrophe risk management products. The new loan and hedging products being introduced are a natural extension of a client-driven product design process that started in 1993 with the introduction of single currency loans and was followed by the offer of currency choice on currency pool loans extended to borrowers from 1996 to Since 1996, IBRD borrowers have selected single currency loan terms for over 95 percent of their IBRD loan commitments. Borrowers also converted $67 billion equivalent (58 percent) of their currency pool loans to single currency terms under the conversion offer that concluded July 1, From 2008, IBRD currently offers one loan product called IBRD Flexible Loan. However, since not all legacy loans were converted, countries are still holding and maintaining legacy loans although this is at smaller scale. 12

23 The diagram below illustrates the conversion routes to the IBRD loan products from Currency Pooled Loans which was the only IBRD financing product in Figure 3.1.1: IBRD Conversion Path 1996 Currency Pooled Loans Undisbursed Portion Disbursed Portion Conversion ( ) Conversion Fixed Rate Single Currency Loan (FSCL) LIBOR Base Variable Spread Loans (VSL) Single Currency Pooled Loans (SCP) Name Change Maybe be transformed through amendment to loan agreement Full conversion to the single currency in Fixed Spread Loans (FSL) May be transformed through amendment to loan agreement Fixed Rate Single Currency Loans (SCL) 2008 IBRD Flexible Loan (IFL) Below are some of the changes from IBRD lending; 1. On February 12, 2008 the World Bank introduced the IBRD Flexible Loan. 2. On August 5, 2009, the Bank increased the contractual lending spread from 0.30% to 0.50% affecting all new loans for which the invitation to negotiate issued on or after July 23, 2009, and those for which the invitation to negotiate was issued before July 23, 2009 but which have not been approved by November 30, On June 22, 2010 the Bank introduced an annual maturity premium of 0.10% for average remaining maturities greater than 12 to 15 years, and 0.20% for average remaining maturities greater than 15 to 18 years for all loans approved after June 30,

24 3.2.1 IBRD Flexible Loan One of the distinct characteristics of the flexible loan is the flexible repayment terms. The flexible loan allows borrowers to customize loan terms. The borrowers are able to customize grace period, repayment period and amortization profiles to meet budget requirements or project objectives. The final maturity can be up to 30 years including grace period. However, the weighted average maturity may not exceed 18 years. The borrowers have a choice of two types of repayment schedules; commitment-linked Repayment schedule where the loan repayment schedule is set at the beginning when the loan is negotiated. Principal repayments are calculated as a share of the total loan amount outstanding. Disbursement-linked Repayment schedule is linked to actual disbursements. Each semester s group of disbursements is similar to a tranche with its own repayment terms (i.e. grace period, final maturity, and repayment pattern), which must be the same for all tranches within the loan. Cost of Borrowing Pricing of the loan is also done in a manner to assist the borrower. With the flexible loan, IBRD s Triple A rating is translated into cost savings to all its borrowers. The flexible loan offers pricing predictability and transparency by using standard benchmarks. The Lending rate consists of a variable base rate plus a spread. The Flexible Loan interest rate in major currencies is reset semiannually based on six month Libor plus a variable or fixed spread. This consists of IBRD s average of cost margin on related funding relative to Libor, plus IBRD s contractual spread of 0.50%. The spread is recalculated on January 1 and July 1 if each year. The borrower may also opt for a Fixed for the life of the loan spread. This consists of IBRD s projected funding cost margin relative to Libor, plus IBRD s contractual spread of 0.50%, a risk premium and a basis swap adjustment for non-us$ loans. A Front End Fee (FEF) of 0.25% of the loan amount is charged at the beginning of the project and can be financed out of the proceeds of the loan. Loan Currencies Loan commitments are offered in most major currencies like EUR, JPY, and US$. Other currencies may be available if IBRD can fund itself sufficiently in the market. Borrowers 14

25 may contract loans in more than one currency. Disbursements may take place in any currency, as requested by the borrower. Currencies are acquired by IBRD and passed on to the client at market terms. The loan obligation however remains in the currency of commitment. Currency of repayment is the same as currency of commitment. The loan principal, interest and any other fees must be repaid in the currencies of commitment. However, currency conversion options and swaps are available on all flexible loans IBRD Deferred Drawdown Option (DDO) The IBRD Deferred Drawdown Option or DDO - is a committed line of credit with similar pricing and the same built-in risk management features and flexibility as the IBRD Flexible Loan. With this option, the borrowers gain the flexibility to rapidly fund financing requirements due to an unexpected shortfall in resources. Under this option, there are two categories of financing: DDO for Development policy loans (DPL-DDO) and DDO for catastrophe Risk. (CAT-DDO) DPL-DDO The Development Policy Loan Deferred Drawdown Option (DPL DDO) provides the borrower with the flexibility to rapidly fund its financing requirements following a shortfall in resources due to adverse economic events such as downturns in economic growth or unfavorable changes in commodity prices or terms of trade. All IBRD borrowers are eligible for this product upon meeting pre-approval criteria. Under the DPL DDO, the borrower may defer disbursement of a DPL for up to three years, renewable for an additional three years. Disbursements Up to the full loan amount is available for disbursement at any time within three years from loan signing. The drawdown period may be renewed. Cost of Borrowing The Lending rate consists of a variable base rate plus a spread. The DPL-DDO Loan interest rate in major currencies is reset semiannually based on six month Libor plus a 15

26 variable or fixed spread. The spread used is the prevailing spread for regular IBRD loans at the time of each drawdown. A front end fee (FEF) of 0.75% of the loan amount is due within sixty (60) days of effectiveness date is charged and may be financed out of the proceeds of loan. A renewal fee of 0.55 of the undisbursed balance is charged when renewal is requested by the borrower. Currencies Just like the regular IBRD loans, commitments are offered in most major currencies like EUR, JPY, and US$. Other currencies may be available if IBRD can fund itself sufficiently in the market. Borrowers may contract loans in more than one currency. Disbursements may take place in any currency, as requested by the borrower. Currencies are acquired by IBRD and passed on to the client at market terms. The loan obligation however remains in the currency of commitment. Currency of repayment is the same as currency of commitment. The loan principal, interest and any other fees must be repaid in the currencies of commitment. However, currency conversion options are available CAT-DDO The objective of the Catastrophe Risk DDO (CAT- DDO) is three fold. 1. To enable the borrower access an immediate source of funding to respond rapidly in the aftermath of a natural disaster; 2. To enhance/develop capacity of borrowers to manage catastrophe risk and 3. To safeguard on-going development programs. Disbursements Up to the full loan amount is available for disbursement at any time within three years from loan signing. The drawdown period may be renewed up to a maximum of four extensions. Cost of Borrowing The Lending rate consists of a variable base rate plus a spread. The CAT DDO Loan interest rate in major currencies is reset semiannually based on six month Libor plus a 16

27 variable or fixed spread. The spread used is the prevailing spread for regular IBRD loans at the time of each drawdown. A front end fee (FEF) of 0.5% of the loan amount is due within sixty (60) days of effectiveness date is charged and may be financed out of the proceeds of loan. A renewal fee of 0.25 of the undisbursed balance is charged when renewal is requested by the borrower. Currencies Just like the regular IBRD loans, commitments are offered in most major currencies like EUR, JPY, and US$. Other currencies may be available if IBRD can fund itself sufficiently in the market. Borrowers may contract loans in more than one currency. Disbursements may take place in any currency, as requested by the borrower. Currencies are acquired by IBRD and passed on to the client at market terms. The loan obligation however remains in the currency of commitment. Currency of repayment is the same as currency of commitment. The loan principal, interest and any other fees must be repaid in the currencies of commitment. However, currency conversion options are available. Other features The CAT DDO size is limited to a maximum of 0.25% of GDP of the borrower or the equivalent of US$ 500 million, whichever is smaller. CAT DDO also has a revolving feature in that the amounts repaid by the borrower are available for drawdown, provided that the closing date has not expired. 3.2 World Bank-IDA The International Development Association (IDA) is the part of the World Bank that helps the world s poorest countries. Established in 1960, IDA aims to reduce poverty by providing interest-free credits and grants for programs that boost economic growth, reduce inequalities and improve people s living conditions in the World s poorest countries. These are countries that cannot afford to borrow from the IBRD. IDA complements the World Bank s other lending arm, the IBRD, which serves middleincome countries with capital investment and advisory services. The IDA's funds are 17

28 obtained from three main sources: members' subscriptions; periodic "replenishments" provided by richer members and certain special contributions; and transfer of income from the IBRD and repayments on IDA credits. IDA lends money known as credits. IDA's credits are highly concessional with a grant element of about 85% IDA Credits IDA extends funds in form of credits, at zero interest rate, to the poorest developing countries. All development credits are made to or guaranteed by member governments or to the member government of a territory of a member. Eligibility for IDA development credits is based on a country s per capita income and its lack of financial ability to borrow from IBRD. Currencies IDA credits are denominated in Special Drawing Rights (SDRs) 2. The amounts disbursed, service and commitment charges, and repayments are also calculated in SDRs. Principal payments and charges are made in the currency (US Dollars, Pounds Sterling, or Euros) specified in the Credit Agreement, in an amount equivalent to the SDRs required under the Credit Agreement. Repayment terms IDA credits approved through June 30, 1987, have a final maturity of fifty (50) years. Credits approved after that date have three different final maturities and repayment schedules. All IDA credits have a ten year grace period. 2 The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries' official reserves. Its value is based on a basket of four key international currencies, consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-value of the SDR is posted daily on the IMF's website. It is calculated as the sum of specific amounts of the four currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market. 18

29 IDA only countries For IDA-only countries or countries classified as least developed by the United Nations, credits are repayable over 40 years, with principal payment at the rate of 2 percent for the credit amount per year from 11 th to the 20 th year and 4 percent per year thereafter. Most of MEFMI member countries fall under this category although a number of countries are on the path to upgrade to concessional borrowing. Other IDA-eligible countries Credits are repayable over 35 years, with repayments of 2.5 percent of the credit amount per year from the 11 th to the 20 th year, and 5 percent per year afterwards. For credits approved after 30 th June 2002, for IDA-eligible countries with a GNI per capita that has been above operational cut off for IDA eligibility for more than two consecutive years, credits are repayable over 20 years, with principal repayment at the rate of 10 per cent per year from the 11 th to the 20 th year. Cost of Borrowing There is no interest charged on IDA development credits, however, a service charge of 0.75 percent is levied on principal amounts withdrawn and outstanding. A commitment charge is also levied at rates set by the Association. The rate ranges from zero to half of a percent of undisbursed balance of the credit. IDA Management reviews its financial position on an annual basis and proposes, for the Board s approval, a specific rate for that year. Borrowers are notified at the beginning of each fiscal year of the rate applicable for that year. The current rate, for the 2009 financial year was set at zero. The commitment charge begins to accrue 60 days after the Credit Agreement is signed. 3.3 African Development Bank (AfDB) The African Development Bank is the flagship or parent institution of the African Development Bank Group. The group was established to help development efforts on the continent. The African Development Bank was established on August 4, 1963 in Khartoum, Sudan, by the then 23 newly independent African countries; as well as two 19

30 concessionary windows - the African Development Fund (ADF), established on November 29, 1972, by the African Development Bank and 13 non-african countries, and the Nigeria Trust Fund (NTF), set up in 1976 by the Federal Government of Nigeria. The inaugural meeting of the Board of Governors of the Bank was held from November 4-7, 1964, in Lagos, Nigeria, and the headquarters was opened in Abidjan, Côte d Ivoire, in March Its operations commenced on July 1, Since early 2003, the Group operates from its Temporary Relocation Agency (TRA) in Tunis, Tunisia. Membership of the AfDB Group, as at the end of December 2007, includes 53 independent African countries and 24 non-african countries. Time Table 3.1 Evolution of the African Development Bank s Products Characteristics Pre-1990 Only fixed rate loans offered by the Bank. Lending rate consisted of a base rate plus 50 basis points lending spread fixed for the entire life of the loan Multicurrency pool based variable rate loan. Lending rate based on the average funding cost of qualified pool of borrowings. The rate is obtained by adding a fixed lending spread of 50 basis points to the average cost of the pool of qualified borrowings 9determined twice a year) 1997 Replacement of multi currency variable rate product with single currency products with alternative interest rate bases (variable, floating and fixed). Conversion of multicurrency variable loans to the terms of the new single currency variable loan. Single currency Libor based loans and fixed rate loans 2002 Risk management products introduced, only available to the Bank s clients and on existing loans i) Interest rate swaps ii) Cross currency swaps iii) Commodity/index swaps iv) Interest rate caps and collars 2004 Guarantees introduced for borrowers who wanted to access funds from third party lenders, including capital markets 2005 Single lending product known as the Fixed spread Loan with a simple pricing based on a fixed spread of 40 basis points over Libor and no other charges 2008 Introduction of a 20 basis points waiver on the lending spread, bringing the pricing for sovereign and non sovereign borrowers to Libor plus 20 basis points. Waiver applicable to all new sovereign guaranteed loans approved by the board. 20

31 2009 Revision of loan pricing passing full cost passed to the clients. Maintenance of lending margin at 40 bps. Temporary suspension of interest rate waiver of 20 bps. Maintenance of zero front-end and commitment fee policy. Temporary suspension of fixed spread loan products for new sovereign and sovereign guarantees commitments. Reintroduction of a variable spread loan for sovereign and sovereign guaranteed commitments More Equity and quasi equity products recent Local currency loans products Syndications and parallel and A/B structures African Development Bank (AfDB) Libor Based Loans These are Sovereign guarantee Loans made to a Regional member country of the African Development Bank or if it is supported by the full faith and credit of the member country in whose territory the borrower is domiciled. This facility is also extended to multinational institutions that are guaranteed by a member country or by member countries in whose territory the borrower shall execute the project. Currencies AfDB loans are approved in UA 3. The loans are extended in one or several currencies approved as lending currencies. Currently, the approved currencies are US$, EURO, JPY and ZAR. The bank may also consider lending in other currencies in which it can fund itself efficiently and for which there is sufficient demand. Disbursements, principal and all loan charges are denominated in the loan currency chosen by the borrower. Disbursements and grace period Disbursements are subject to fulfillment of disbursement conditions and are made in tranches over an agreed period. They are denominated in the selected currencies and are contingent on the fulfillment of the conditions specified in the loan agreements. Grace period starts from the date of signature of the loan agreement. Grace periods are 3 UA is the Unit of Account. The value of the Unit of Account is defined as gramme of fine gold. The Unit of Account has been valued as equivalent to 1 SDR. 21

32 dependent on the projects and the time required for their implementation but should not exceed 5 years. In exceptional cases, grace periods longer than 5 years may be considered provided they are properly justified. Repayments Repayments are made in equal installments after the expiration of the grace period. Other repayment terms such as annuities, bullet payment and step up or step down amortization may be considered if the borrower satisfactorily justifies the need for them. Payments are made semi-annually on the dates specified by the bank. Regarding debt service and security, the Bank loans must rank pari passu with other senior loans of the borrower 4. Cost of Borrowing The applicable rate of interest for the Bank loans is made up of two components, namely; the base rate plus a lending margin or spread. Interest rates on the Bank loans are expressed as nominal rates. Interest and other charges are computed on the actual number of days elapsed and a 365 day year. The Bank offers three principal structures for the base lending rate, namely floating base rate, fixed base rate and variable base rate. Floating base rate is determined for each loan currency. It refers to the 6 month reference rates Libor (US$ LIBOR, JPY LIBOR, Euribor (EUR) and JIBAR (ZAR) which is reset semi-annually. The reset dates are 1 February and 1 August and is applicable for the six months period following the reset date. Variable base rate: Determined for each loan currency using the Bank s average cost of funding of a designated pool of borrowings as the reference rate this is adjusted semiannually on January 1 and July1. Unlike the floating base rate, the variable rate adjusts very slowly to changes in the market. 4 Policy of the bank, in making loans to, or with the guarantee of, its member states not to seek special security from the member state concerned. The borrower also should ensure that no other external debt has priority over its loan or guarantee obligation in allocation, realization or distribution of foreign exchange held under the control or for the benefit of such member state. 22

33 Fixed base rate remains fixed for the life of the loan. It is calculated as the swap market rate corresponding to the principal amortization schedule of a particular tranche of a loan. Every tranche therefore has its own fixed rate but the Bank gives the borrowers the option to consolidate multiple tranches into a single equivalent structure when disbursements are complete. Funding margin refers to the Bank s cost of borrowing relative to Libor. It resets semiannually on January 1 and July 1 Lending margin is a rate premium added to the borrower s chosen base rate to determine the total lending rate. It is determined by the Bank and remains unchanged throughout the life of the loan. Currently it is 40 basis points. 3.4 African Development Fund (AfDF) Established in 1972, the African Development Fund (ADF) became operational in It is administrated by the African Development Bank and comprises State Participants (donor countries) and recipient countries. Its main objective is to reduce poverty in Regional Member Countries (RMCs) by providing loans and grants. The ADF contributes to the promotion of economic and social development in 38 least developed African countries by providing concessional funding for projects and programs, as well as technical assistance for studies and capacity-building activities AfDF Loan The AfDF loans are modeled on the IDA credits. They are meant for the countries that cannot access financing from the hard terms window of the Bank group. AfDF is the soft window of the Bank group. Just like the IDA, eligible countries get financing without paying interest. Only a service charge of 0.75% is charged. Currencies The loan is denominated in Unit of Account (UA). Borrowers can select disbursement currency. Currencies available include EUR, US$, JPY & GBP (currencies of SDR 23

34 basket. Choice of currency is done at loan signature. The loan however remains denominated in Unit of Account. Repayment is in currency disbursed Disbursement and grace period Disbursements are subject to fulfillment of disbursement conditions and are made in over an agreed period. They are denominated in the selected currencies and are contingent on the fulfillment of the conditions specified in the loan agreements. Grace period starts from the date of signature of the loan agreement. AfDF loans have a Grace Period up to 10 years. Repayments Project loans have a 50-year repayment period, including a 10-year grace period. The borrower pays 1% of the principal per annum from the 11th to 20th year, and 3% of the principal per annum from the 21st to 50th year. Payments are made twice annually on the dates defined in the loan agreement. Cost of Borrowing No interest is charged on ADF loans; however, loans carry a service charge of 0.75 percent per annum on outstanding balances, and a commitment fee of 0.50 percent per annum on undisbursed amount accruing 120 days after loan signature; 3.5 OPEC Fund for International Development (OFID) The OPEC Fund for International Development (OFID) is a multilateral development finance institution established in 1976 by the Member States of the Organization of the Petroleum Exporting Countries (OPEC).The primary aim of OFID is to contribute to the social and economic development of low-income countries. By the end of July 2009, OFID had committed a cumulative US$11.07 billion in development financing to121 countries in Africa, Asia and the Pacific, Latin America, the Caribbean and Europe. OFID cooperates closely with a number of Arab/Islamic institutions in delivering its developmental assistance. 24

35 This group includes:- The Abu Dhabi Fund for Development, The Arab Bank for Economic Development in Africa, The Arab Fund for Economic and Social Development, The Islamic Development Bank, The Kuwait Fund for Arab Economic Development and The Saudi Fund for Development. Collectively these institutions have provided over US$90 billion in development financing. OFID finances development projects in both the Public and Private Sectors. It funds: The Public Sector through loans to governments that contribute mainly to improving infrastructure and social services. The principal sectors covered are transportation, agriculture, education, health, water, sanitation and energy supply. The Private Sector by providing lines of credit to Small and Medium Enterprises (SMEs) through financial intermediaries and by financing real economy projects in a wide range of sectors. Trade to meet the trade financing needs of institutions in partner countries, including banks, private enterprises, governments and parastatals. Grants to provide assistance to social and humanitarian projects and programs. Disbursements After the Loan Agreement has been declared effective, and unless the Borrower and OFID Management shall otherwise agree, the Loan is disbursed from time to time to meet Eligible Expenditure in accordance. Applications for withdrawal of the Loan proceeds must be prepared in conformity with the Disbursement Procedures. 25

36 Repayments Immediately following the end of the Grace period, the borrower is expected to repay the principal of the loan. Principal is usually repaid in the currency of the loan or any other freely convertible currency acceptable to OFID management. Principal is repaid in thirty (30) equal semiannual payments after a five (5) years grace period. Cost of borrowing OFID loans attract interest at the rate of one and one half per cent (1.5%) per annum on the principal amount of the loan withdrawn and outstanding. The borrower also pays a service charge at the rate of one per cent (1%) per annum on the principal amount of loan withdrawn and outstanding. Interest and service charges are paid semi-annually into the OFID account. 3.6 Conclusion The analysis of the various products clearly shows that there is some commonality between products offered by the various creditors. There is also a clear trend of creditors moving towards variable rate products (market determined cost of borrowing) than fixed rate lending especially through the non-concessional borrowing. 26

37 CHAPTER General Creditor Practices of Multilateral Creditors This chapter describes and analyzes the various creditor practices that have an impact on the financial aspect of the financial products offered by the creditors. In addition to recording the details, terms and transactions of financial products, CS-DRMS also models the various creditor practices in order to facilitate reconciliation between the borrower and the creditor s accounts. It is therefore important that the borrower clearly understands these practices. This chapter will describe creditor practices of African Development Bank and the World Bank 4.2 African Development Bank Group Repayment Currencies In their session of June 1989, the Board of Directors of the Bank Group approved the introduction of the system of billing in currencies of disbursements for all loans granted to borrowing member countries. Under the previous billing system which was based solely in Unit of Account, disbursements made in different currencies were first converted into UA and then debited to the loan account, which was expressed in UA. As a result, loans were disbursed in certain currencies whereas repayments were often settled in different currencies. There was, therefore, no direct relationship between the currencies of disbursements and those of repayment. This created a mismatch in both institutions. The system of billing in currencies by equating currencies repaid with those disbursed was meant to eliminate the major deficiency and inherent risks to the bank group of the UA billing. For the borrowers, the system of billing in currencies has removed the uncertainty faced in determining, in specific currencies, their liabilities to the Bank Group. Recognizing that some borrowers may not have access to the numerous currencies billed and payable, the Bank acts as an agent of the borrower to obtain the currencies required. The Bank provides the option to settle the bills in one of the four convertible currencies i.e. US$, EUR, JPY and GBP. The Bank upon receipt of funds in the selected currency and acting as an agent of the borrower, purchases the actual currencies required 27

38 to settle the debt obligations. Irrespective of the date of conversion, the borrower s account is credited on the date the Bank receives the funds. In determining the amount payable under single currency payment option, the Bank, after calculating the amount payable in each currency, makes an estimate of the equivalent of each currency in the four option currencies (US$, EUR, JPY, and GBP). This is done using exchange rates which reflect recent market trends. The rates used for conversion include a margin of between 5 and 10 percent to cover currency fluctuations which may occur between the billing and settlement dates Billing Bills show the debt obligation payable on a specific due date and are based on loan account balances three months before the payment due date. Bills are produced about two months before the due date and are sent to borrowers about six weeks before the payment due date Application of payments In accordance with the General Conditions Applicable to loan and Guarantee Agreements, all payments are applied against the appropriate invoice in the following order: commitment charge, statutory commission (if applicable), interest/service charge and principal Non business day convention The Bank group uses the forward business day convention. If the due date falls on a non working day for the receiving bank, although interest and other charges will continue to accrue on the outstanding loan balance, no additional costs or penalties are imposed on the borrower provided payment is received on the first working day thereafter. Non business days are defined as all holiday days including Saturdays and Sundays. 28

39 4.2.5 Treatment of Single currency payments When a borrower exercises the single currency option, the payment is first applied against amounts billed in the currency of payment. Any remaining funds are used to purchase the other currencies billed on behalf of the borrower. Any surplus or shortfalls arising out of such transactions are always for the borrower s account. Upon completion of the currency purchases, amounts purchased are applied against the bills as though payment has been received directly from the borrower in the actual currencies payable. However, for loan accounting purposes, the value date is the original date the single currency payment was received. The borrower is notified immediately the results of the currency purchases and whether there has arisen any shortfalls or surpluses Shortfalls A shortfall is considered to have occurred where i) a borrower pays using the single currency option but due to exchange rate fluctuations the single currency payment is not sufficient to purchase all currencies payable or ii) the unpaid amount is less than UA 25,000. Shortfalls are added to the next claim for the same loan and the borrower advised accordingly. However, as the amount is due, the shortfall continues to be reported as arrears and where that amount is due on principal, will continue to attract applicable charges Excess payments Excess payments arise when a borrower makes an excess payment in error or when the exchange rates move in favour of the borrower. When this happens, one of the following actions may be taken: i. An excess on one loan may be applied to cover a shortfall/ arrears on another loan to the same borrower. ii. The excess may be held on the borrower s suspense account and applied against the next claim or to other obligations of the borrower to the Bank Group. Where the excess is applied against the next claim, the funds are wherever possible applied against principal. iii. The excess may be refunded to the borrower. 29

40 4.2.8 Arrears and Sanctions policy A loan is considered to be in arrears if payment due is not received on the due date of the bill. The bank however allows a thirty (30) day period before sanctions are imposed. Sanctions are imposed by prohibiting signature of previously approved loans and guarantee agreements, suspending disbursements and withholding Board presentation of new loans. An overdue is not considered for the purposes of sanctions under the following circumstances: The total amount of arrears is less than UA 25,000. The borrower is still however required to make immediate payment. The borrower opted for a single currency payment to settle amounts due in various currencies and has made payment in accordance with the amount indicated in the bill. As a result of exchange rate movements, the payment requested by the Bank and made by the borrower is not sufficient to purchase all currencies payable. The borrower is requested to make payment of the shortfall Prepayment Borrowers can prepay their loans in full or in part subject to payment of all interests and giving the Bank 45 calendar days notice. In the event of early repayment, the Bank may charge a prepayment premium that reflects the Bank s cost of redeploying the pre-paid funds. The premium is based on current market interest rates, loan interest rate and repayment structure of the remaining term of the loan. 4.3 World Bank Billing Arrangements Each IBRD loan and IDA credit is billed twice yearly, on dates specified in the loan or Credit Agreement. The billing statements are prepared as of two months before the semiannual payment due date. IBRD and IDA bills reflect four months of actual accrued charges and two months estimated charges. Billing for IBRD Loans is based on balances and exchange rate values available at the billing cutoff date, charges are estimated for the two months period. The borrower s 30

41 obligation is recomputed on the payment due date. The difference between the billed amount and that which is calculated on the due date is carried forward to the next billing date on a no-interest bearing basis. It is known as deferred balance. If the deferred amounts are not settled at the time of the next billing, the deferred principal component will be subject to additional charges. If the due date obligation is less than the amount billed, the resulting excess is carried forward as a credit for application on the next bill and payment due date. While, all IDA development credits are billed in United States Dollars, pound sterling, or Euros. The borrower may change the currency of repayment by giving appropriate advance notice to IDA. Any shortage of remittance due to exchange rates conversion is treated as overdue. Upon receipt, the borrower s payment is translated at the exchange rate on the value date of receipt into the currency of commitment (either US$ or SDR). Shortfalls or surpluses which may arise due to exchange rate changes or to transactions on individual credits between the billing and due dates, are carried forward for settlement or application on the next payment due date Business day convention Debt service payments are requested on the 1 st and 15 th of the month, except when the payment date falls on a bank holiday. The payment is then requested for the next banking day Payment Applications IBRD debt service receipts are applied in the following order: i. Overdue amounts ii. Deferred amounts and iii. Current receivables. Within these categories, the order of application is as follows; i. Interest on overdue principal ii. Commitment fees iii. Interest 31

42 iv. Transaction fees and v. Principal IDA debt service receipts are applied in the following order: i. Overdue amounts ii. Balances carried forward and iii. Current receivables Within these categories, the order of application is as follows: i. Principal ii. Service charges on overdue principal and iii. Service charges. The major difference between IDA and IBRD is that if there is any shortfall in the payment by the creditor, the shortfall will be applied on the principal for IBRD while for IDA, the shortfall will be applied on the Service Charges. This difference has significant implications when calculating penalty on arrears Overdue and Sanction Policy When a borrower fails to service its loans or credits on the due date, the World Bank has the option of suspending disbursements immediately on all loans and credits to the borrower. The Bank s current practice is to follow a graduated approach, using reminders, incentives and sanctions. Reminders are sent to defaulting borrowers on the 5 th, 30 th, and 35 th day after the due date. On the next business day after the 45 th day, a warning of suspension notice is sent to the member country and all borrowers therein, informing them that the suspension of disbursements will take effect on the 60 th day. A portion of interest payments on IBRD loans may be waived as an incentive for timely payment. Other progressive sanctions imposed include withholding Board presentation of new loans and guarantees, delaying signature of previously approved loans and guarantee agreements, and suspending disbursements Waiver After the annual review of IBRD s net income, the World Bank may waive a portion of the loan charges applicable in a fiscal year. A waiver of charges applies to all IBRD s 32

43 loans except Special Development Policy Loans (SDPLs). The three types of waivers are (a) commitment charge waiver, (b) interest charges waiver and (c) front- end fee waiver. The borrowers are notified at the beginning of each fiscal of the waiver rate applicable for that year. The partial waivers apply to all payment due dates that commence within the fiscal year for which the waivers are approved Prepayment policy Borrowers have a right to prepay in advance of maturity, as of a date acceptable to the World Bank ;( a) all of the outstanding principal of the loan; or (b) all of the principal of any one or more maturities of the loan. For IBRD loans, prepayment premium is determined by the specific type of loan (Fixed spread loans, variable spread loans, fixed currency single currency loans and currency pool loans; only applicable to the legacy loans). Currently, for IDA credits there is no prepayment premium charged on prepayment. 4.4 Conclusion The table below summarizes the characteristics of the products offered by the different creditors. 33

44 Table Summary of Product characteristics from Multilateral lenders. Practice IDA IBRD ADB ADF OPEC Billing Procedure i.e. Bill Cut-Off date 2 months 2 months 2 months 2 months 2 months Payment on nonbusiness days Forward move convention Forward move convention Forward move convention Forward move convention Forward move convention Arrears Amortisation Not Applicable Fixed Equal commitment linked payment 0.5% penalty on arrears with a payment window of 30 days Commitment Linked; disbursement Linked Yes Commitment Linked; disbursemen t Linked Not Applicable Fixed Equal commitment linked payment Not Applicable Fixed Equal commitment linked payment Interest convention day 30 over 360 Actual over 360 (Variable rate); 30 over 360 for fixed rate Actual over 360 (Variable rate); 30 over 360 for fixed rate 30 over 360 for fixed rate 30 over 360 Derivatives Instruments (Embedded Options) Not Available Available Available Not Available Not Available Lending Terms Fixed Rate LIBOR based Rates LIBOR based Rates Fixed Rate Fixed Rate 34

45 5.1 Risk Management CHAPTER Introduction Risk management refers to the policies, procedures and practices involved in identification, analysis, assessment, control and avoidance, minimization, or elimination of unacceptable risks. The ultimate goal of any risk manager is to establish a position in the market in an attempt to offset exposure to price changes or fluctuations in some opposite position with the goal of minimizing one's exposure to unwanted risk. There are many specific financial vehicles to accomplish this, including insurance policies, forward contracts, swaps, options, many types of over-the-counter and derivative products, and perhaps most popularly, futures contracts. Risk management is therefore an important exercise that current debt managers ought to undertake to ensure that their portfolios contain prudent risks. It should be noted that there are no internationally set out benchmarks for the acceptable risks and every sovereign borrower ought to set these out in its debt strategy after carrying out a cost/risk analysis. This chapter will look at liability management products also known as Risk Management Products (RMPs) offered by two multilateral institutions; World Bank and African Development Bank as derivative products. 5.2 Risks Encountered in Sovereign Debt Management There are a number of risks that any sovereign debt manager should consider and mitigate against through active debt management and prudent risk management operations. Market Risk Refers to the risks associated with changes in market prices, such as interest rates, Exchange rates and commodity prices. This affects the cost of the government s debt servicing. Changes in interest rates would affect debt servicing costs both for foreign currency and domestic currency debt. Floating rate debt causes uncertainty in the 35

46 portfolio as the borrower cannot predict which direction the rates may move. For domestic short term debt, the issuer may also face uncertainty in debt servicing costs on new issues when fixed rate debt is to be refinanced. The risk that debt will have to be rolled over at an unusually high cost or, in extreme cases, cannot be rolled over at all is called rollover risk. Rollover risk is limited to the risk that debt might have to be rolled over at higher interest rates, including changes in spreads. Excessive concentration in very long-term, fixed rate debt however, is not the panacea. It may also pose a risk as future financing requirements are uncertain. Currency risks Debt denominated in or indexed to foreign currencies also adds volatility to debt servicing costs as measured in domestic currency owing to exchange rate movements. Any movement in the price of the various currencies therefore affects planning and budgeting for debt service. A borrower may therefore need to look at the currency mix in the debt portfolio and find ways of hedging against the most volatile currencies and especially those that have an upward trend against the domestic currency. Operational Risk This includes a range of different types of risks, including transaction errors in the various stages of executing and recording transactions. This is attributable to human nature and such mistakes may lead to wrong decisions being made or financial losses. It also includes inadequacies or failures in internal controls, or in systems and services. Reputation risk; legal risk; security breaches; or natural disasters that affect business activity are also classified as operational risks. The CS-DRMS as a debt management system has minimized this by offering the users a computerized system that minimizes manual errors that would otherwise have been made. 5.3 Risk Management Products Risk Management products (RMPs) are financial products which allow clients to transform the financial risk characteristics of their obligation under a loan or other instrument without renegotiating or amending terms of the original instrument. These 36

47 products are technically referred to as derivatives or hedging products. The multilateral institutions have moved to offer the RMPs because there is a belief that over the years, most sovereign borrowers have developed internal capacity for active liability management. Furthermore, borrowers are now increasingly demanding for debt management financial products in the quest to better manage their portfolios. The two terms often used interchangeably to refer to risk management products are Derivatives and Embedded Options Derivatives Derivatives is a collective name for futures, options and other securities whose characteristics and values depend on the performance of something else. They offer an effective means of managing risk. However, derivatives also carry risks and if not used properly may lead to increased volatility and result in substantial losses. Embedded Options As the term denotes, an embedded option is an option that is part of another instrument. It does not trade by itself but affects the underlying instrument. These are risk management products inbuilt in the original loan terms which the borrower can make use of during the life of the loan Risk Management Products of the African Development Bank The Bank offers RMPs to its clients in order to enable them to hedge their exposure to market risks including interest rate, currency exchange and commodity price risks. The RMPs are available to clients at the time of loan signature and at any time during the life of the loan. However, the legacy pooled and non pooled loans are not eligible for the offer. The Bank offers the products only in respect of obligations outstanding or new Bank loans in whole or in part. Clients under sanctions are not eligible for the RMPs. The Bank does not offer RMPs for the purpose of enabling the client to manage its obligations to a third party. Any client with an existing or new Bank loan will be eligible for a RMP. Multiple RMPs may be obtained for the same loan and at different period. However, the terms of the new request must be compatible with the existing hedge. Most borrowers, in 37

48 the MEFMI region still have the legacy loans which they continue to service as per the terms negotiated at signature and have not or taken the opportunity of converting the liabilities to the new product. For those countries that have converted or contracted the new products, the Bank offers the following RMPs or a combination thereof: Interest rate swaps, Currency swaps, Commodity/index swaps, Interest rate caps and collars. Interest rate swap An exchange of cash flows between two parties in this case the Bank and its client, in which floating rate obligations in a particular currency are transformed into a fixed rate obligation in that same currency or vice versa. Interest rates may be fixed (or unfixed) at the client s option for as long as the interest swap markets provide, subject to the final maturity of the loan. Currency swap An exchange of cash flows denominated in different currencies. The cash flows are based on agreed-upon exchange rates and may or may not include the exchange of principal. The swap is only available for the disbursed portion of a loan and for as long as the currency swap markets provide subject of the loan. Commodity/index swaps An exchange of cash flows, where one of the cash flows is based on the price of a particular commodity/index or a basket of commodities, while the other cash flow is based on an interest rate. The Bank s clients may convert the disbursed portion of a loan from an interest rate reference to a commodity price reference and vice versa for as long as the commodity swaps markets provide, subject to the final maturity of the loan. Interest rate cap An interest rate cap limits the maximum interest rate on a floating rate loan regardless of the future level of the market reference rate. The floating rate client who purchases the interest rate cap can enjoy lower interest rate costs while market rates are above the specified maximum rate for the duration of the cap. 38

49 Interest rate collar An interest rate collar sets maximum (via purchase of a cap) and minimum (via sale of a floor) interest rate on a floating rate loan. The collar can be purchased either at loan signature or during the life of the loan. The client who purchases the collar can enjoy interest costs that are limited between an upper and lower level while market rates are outside the range of the collar for the duration of the collar. Under no circumstance shall interest rate collars be executed such that there is a net inflow of funds to the client. The client may not directly or indirectly strip the collars. 5 Table Summary Terms for RMP from AfDB Risk Management Products Terms and Conditions Maximum The maximum amount will always be limited to the outstanding transaction loan amount amount Minimum Generally, the equivalent of US$ 3million. The minimum transaction transactions amounts, however, may vary from one market to the amount other and are dependent on market conditions at the time of the transaction Maximum Dependent on the maturities available in the relevant market but maturity not longer than the outstanding maturity of the underlying loan or the portion of the loan being hedged Currencies US$, EUR, JPY, ZAR and other approved Bank lending currencies for which liquid derivative markets exist Starting date The starting date on a RMP transaction must coincide with an interest payment date on the underlying loan Ending date The ending date on an RMP transaction must coincide with an interest payment date and be beyond the starting date 5 To strip a collar means to trade the components of the collar separately 39

50 Payment dates Early termination Termination due to late payment Payment dates will coincide with the payment dates on the underlying loan or portion of the loan being hedged The client may terminate the RMP transaction at any time. The client shall pay, as a single payment, within five (5) business days from the date of the termination transaction, the applicable transaction fee on the terminated principal amount in addition to the settlement of the mark to market value of the terminated RMP The Bank retains the right to terminate a RMP transaction, if payment on the RMP transaction is late by more than 30 calendar days. The early termination provision, above, will apply Payment of premiums and fees Currency of payments Loan prepayment Application of partial payments Premiums and fees are payable as a single, up front payment within five (5) business days from the date of execution of the transaction. Premiums and fees must be paid from the client s own resources and not from the underlying loan proceeds Premiums and fees are paid in the currency of the hedges and not the currency of the undergoing loan The RMP transaction will be automatically terminated if the related portion of the underlying loan is prepaid. The early termination provision, above, will apply A partial payment 6 will be applied first to interest and other charges on the loan, then to the RMP transaction and finally to the loan principal. For public sector clients, if the partial payment net of interest and other loan charges is insufficient to settle the RMP transaction, for consistency with the Sanctions Policy, when applicable, a cure period of thirty (30) days from the payment due date will be granted. However, during the cure period the late payment fee for RMPs will apply 6 A partial payment is a payment that does not cover the net payment of the loan and the RMP transaction, as specified on the bill 40

51 Late payment 7 fee A late payment fee equal to the floating interest base rate in the currency of the payment plus one percent (1%) for public sector clients or two percent (2%) for private sector clients will apply to late payment amounts, in addition to any foreign exchange loss due to the delayed payment on the RMP transaction Risk Management Products of the IBRD The IBRD seeks to see its borrowers undertake prudent debt management. To this end the Bank is making available to its borrowers the following hedging products in connection with IBRD products and Non-IBRD products: i. An Interest rate Swap ii. A Currency Swap transaction and iii. For IBRD hedges only, an interest rate cap and an interest rate collar. iv. Commodity Swaps Hedging products for risk management are available in one of the following three ways: built-in into the IBRD Flexible Loan, on a stand-alone basis to manage risk on the entire portfolio of World Bank loans, or on a stand-alone basis to manage debt owed to other creditors. To access the hedging products, borrowers have to sign a Master Derivatives Agreement with the Bank. The borrowers may choose to use the hedging products to transform its loans by fixing, unfixing or re-fixing the interest rate, establishing caps or collars on variable rates, changing the currency of obligation or linking debt service payments to the spot price of a particular commodity or commodities. IBRD also offers the hedging products for debt owed by IBRD sovereign clients to creditors other then the IBRD itself. Interest rate swap This transforms the interest rate basis of a loan obligation from a fixed to floating rate or vice versa. Borrowers access built-in conversion options by requesting the desired type and terms of the conversion. For IBRD loans without embedded options or debt owed to 7 A payment is said to be late on the RMP transaction if the amount received net of interest and other loan charges is not sufficient to settle the payment on the RMP transaction on the due date. 41

52 creditors other than IBRD, the borrower accesses the swap by signing a Master Derivatives Agreement with IBRD. Currency swap This alters the currency terms of a loan obligation if risk management requirements have changed since the initial choice of loan currency. Borrowers access built-in conversion options by requesting the desired type and terms of the conversion. For IBRD loans without embedded options or debt owed to creditors other than IBRD, access to swaps is by signing a Master Derivatives Agreement with IBRD. Availability of currency hedging products presupposes a sufficiently liquid swap market in the desired currency. Interest rate caps and collars This product limits interest rate variability with a cap or a collar. Caps set an upper limit on the variable interest rate of the loan. Collars set an upper limit (a cap) and a lower limit (a floor) on the interest rate of the loan. Both require payment of an up-front premium to purchase the interest rate protection. For IBRD loans without embedded options or for debt owed to creditors other than IBRD, caps and collars are accessed by signing a Master Derivatives Agreement with IBRD. Commodity swaps Link IBRD debt service payments to the prices of a particular commodity or commodities in order to reduce commodity price risk. One set of cash flows is linked to the market price of a commodity or index. The other is a fixed cash flow or a cash flow based on a variable rate of interest. In this way, a commodity swap is a hybrid, spanning interest rate swap and commodity swap markets. IBRD commodity swaps are individually negotiated transactions provided on a case-by-case basis. 42

53 5.3.4 Summary Terms of RMP from IBRD Hedging Products Risk Management Products Terms and Conditions Minimum For IBRD Hedges, the minimum principal amount of a related loan amounts in respect of which a borrower may request a swap transaction in a single request is US$ 3,000,000 equivalent or 10% of the total amount of the loan, whichever is higher. Maximum amounts For non IBRD hedges, the minimum principal amount in respect of which a borrower may request a swap transaction in a single request is US$ 3,000,000. For both IBRD Hedges and Non-IBRD Hedges: I. US$ 500,000,000 equivalent for a currency swap transaction with currency pairs in US Dollars, Euro or Yen; II. (ii) US$ 1,000,000,000 equivalent for an interest Rate Swap Transaction where the currency of denomination is US Dollars, Euro or Yen; and III. such other amount as reasonably determined by the Bank Eligible instruments Maturity date All or any portion of the principal amount withdrawn and outstanding of a Related loan. Maturity date for any Swap Transaction in respect of an IBRD Hedge must fall no later than the final maturity date of the Related loan African Development Fund As described in chapter three, the African Development fund is the soft lending window of the Bank group. This particular windows offer to its clients concessional loan products with long maturities of up to forty years. A service fee calculated at one half of a percent is charged per annum on the disbursed and outstanding debt. A commitment fee of three 43

54 quarters of a percent is also charged on the committed undisbursed amounts. The objective of the Bank group is to reduce poverty in the regional Member countries hence the concessional loans and grants offered. These products do not have embedded risk management products although creditors may use a third party to manage risks exposed to the borrower through the AfDF loans. Borrowers may however use the prepayment option to change the structure of these instruments IDA Just like the AfDF, IDA is the soft lending window of the World Bank Group. IDA for the same reasons as the AfDF offers concessional products in terms of credits and grants. The terms of the credits resemble those of the Fund loans in that they have long maturities, charge no interest except a service fees at the same rates as the AfDF. The commitment fee is reviewed annually and ranges from zero to one half of a percent. IDA also allows for prepayment of its credits and the risk management products are therefore not available for these instruments although borrowers may use third parties to execute the risk management products Bilateral Lenders Bilateral lenders on their part have no standard risk management products that they offer their borrowers. Each bilateral creditor deals bilaterally with the borrower and may get into various one-on-one arrangements on a case by case basis. The arrangements include debt write offs, debt for development swaps and even currency swap as what Tanzania negotiated with the governments of Libya and Belgium. However, generally most bilateral creditors do not offer direct and voluntary liability management products Commercial lenders Commercial lenders do not have any standardized risk management products but offer all types of hedging products. These deals are arranged on case by case basis and different solutions are implemented depending on the circumstances of the case under review. But generally the products are the same as those offered by the multilateral institutions although may be more expensive and risky. 44

55 5.3.8 Conclusion Executing and contracting risk management products (RMP) is one of the preferred tool for debt managers undertaking active liability management operations. Most creditors (lenders) are now offering products that include embedded derivative products. The RMPs are available only from the non concessional lending windows of the multilateral institutions. Most bilateral creditors do not offer such products although borrowers can use a third party to hedge loans contracted from bilateral sources. The fact that multilateral institutions offer risk management products only from nonconcessional window may be an indication on the complexity and risk nature of these products. 45

56 CHAPTER 6: 6.1 CS-DRMS Usage in the MEFMI Region Macroeconomic and Financial Management Institute (MEFMI) is a regional organization that brings together thirteen East and Southern Africa countries: Angola, Botswana, Kenya, Lesotho, Malawi, Mozambique, Namibia, Rwanda, Swaziland, Tanzania, Uganda, Zambia and Zimbabwe. MEFMI seeks to contribute towards sustainable poverty reduction process and improvement of governance in the key areas of macro-economic and financial management in the public sector of which Debt management is one of the key components. Of the thirteen member countries, eight of them Botswana, Kenya, Lesotho, Malawi, Mozambique, Namibia, Swaziland and Tanzania use the CS-DRMS as the computer based debt management system of their choice. This chapter looks at these countries engagement with the multilateral organizations and seeks to understand how they have made or not made use of the risk management products offered by the latter. It seeks to find out why they may not be using the products and suggest how this may be done. The chapter also summarizes the findings of the survey conducted by use of a questionnaire that was sent to all CS-DRMS user countries within the MEFMI region. The responses to the questionnaire by the various countries are provided as Annex Debt and Risk Management in the MEFMI CS-DRMS member states Worldwide, risk management has become an increasingly important tool for achieving strategic debt targets; and is now an integral part of a wider strategic debt management framework and liability management operation. Most sovereign borrowers have now moved from the concept of just recording their debt obligations to active management of their portfolios and thus the need to have access to risk management financial products. This involves critical examination of the portfolio and the use of the various risk management tools to mitigate the risks inherent therein to achieve optimal levels of debt 46

57 based on bench marks set in the various jurisdictions and more importantly to integrate debt and cash management. From the sovereign debt management perspective, the most common risks inherent in debt portfolios include: i. Interest rate risks - the risk to which a portfolio or institution is exposed because future interest rates are uncertain. This applies to portfolios with variable interest rates. The upward movement of the rates will adversely affect the borrower. Likewise, the downward movement of the rates will negatively affect the lender. ii. Currency/ Exchange rate risk - the risk that arises from the change in price of one currency against another. If the portfolio contains liabilities in a currency whose price rises against the borrower s currency, then the borrower may find it difficult to raise resources to service the debts. To assist the borrowers manage such risks, the multilateral organizations such as the International Bank of Reconstruction and Development and the African Development Bank have restructured their instruments to include embedded options to allow for liability management operations. Such risk management operations include; currency conversions, interest rate conversions, currency swaps, interest rate caps and collars. The flexibility provided through these embedded options allows borrowers to customize repayment terms for the loans among other things. These flexible loans also offer pricing predictability in that lending rate consists of a variable base rate plus a spread, at the same time allowing the borrower to opt for a fixed for life spread. Since these flexible loans are disbursed in any currency offered by the creditors including the borrowers local currency where applicable, the borrower is given an option to manage the currency composition of its debt portfolio. The borrower may also utilize the currency swap option which is available. In the case of collars, the borrower may purchase a cap (upper limit) on the interest rate and sell a floor (lower limit) for the same allowing the borrower enjoy the 47

58 benefit of the rates within the range of the collar irrespective of how high the rates swing upwards beyond the cap. The creditor on his part enjoys the same privilege irrespective of how low the rates swing below the floor. To be able to analyze the MEFMI member countries engagement with the multilateral organizations and therefore access to liability management products, a questionnaire was prepared and sent out to the respondents. (Refer to Annex 1 for the responses from the countries). Out of the eight MEFMI CS-DRMS country members surveyed, only six responded. The six that responded were Kenya, Malawi Mozambique, Lesotho, Swaziland and Tanzania representing a seventy five per cent response rate. From the six respondents, it was established that the CS-DRMS has been in use for a 24 years in Kenya, 15 in Malawi, 20 in Mozambique, 13 in Lesotho, 17 in Swaziland and 22 in Tanzania. Kenya reported having three CS-DRMS sites, Tanzania and Swaziland reported two sites, Mozambique and Lesotho one site each and Malawi did not answer the question. The answer clearly showed that the software has been in use for a considerably long time and it indicates that CS-DRMS is an integral tool for debt management in these countries. The findings however do not mean that it is comprehensively understood and used hence the attempt by this paper to look at how it is being used to record risk management products. This is more important especially considering that the system has since been used for recording legacy loans and might be weak on the new products being designed by the creditors. Of the existing external debt stock as at end April 2010, the respondents reported the proportion of the debt owed to multilateral institutions as follows; Kenya 62% Malawi 84% Mozambique 54% Lesotho 85% Swaziland 53% and Tanzania 66% 48

59 Apart from Mozambique and Swaziland who have relatively low proportion of multilateral debt, the rest of the countries have borrowed heavily from these institutions and it is very likely that this trend will continue. The survey also indicated that all the respondents are classified as IDA only but still have active loans from IBRD and AfDB. Swaziland, however, has recently been classified as a low middle income country and no longer qualifies to borrow from the soft window of the World Bank. The instruments in their database are most probably those that were contracted while the country was classified as IDA only. Since all the countries except Swaziland are IDA only countries, it can be safely assumed that most of the multilateral debt is from the soft lending windows of the World Bank and African Development Bank and other organizations such as OPEC and BADEA which do not have inherent embedded options available for risk management apart from prepayment. Through these findings, the following can be concluded; i. Most of the MEFMI countries are not eligible for non-concessional borrowing and therefore are quite limited in their access to the RMPs through multilateral borrowing; MEFMI countries would only benefit from these products if they are also offered through the concessional borrowing ii. Except Tanzania, which has conducted a currency swap with bilateral lenders, MEFMI countries have not used the risk management products although a number of countries have been approached by commercial lenders; iii. Most MEFMI countries have not converted the legacy IBRD or ADB loans that still exist in their portfolio to take advantage of the available risk management products. It should however be mentioned that the benefit would not be much unless they intend to execute derivatives products; 49

60 iv. Lastly, apart from Mozambique, MEFMI countries through the questionnaire demonstrated awareness to these products. The capacity to effectively execute such products is however a different issue all together. It has not been established, however, whether these products are useful to concessional borrowers. This notwithstanding, it is important to look at risk management in the debt management context and consider how this may be recorded and utilized in the CS- DRMS especially considering that countries such as Swaziland have graduated from the IDA only category and may start accessing resources from IBRD and AfDB. Recent literatures seem to indicate that as the demand for more risk management tools grow, it might not be in a long distant future before these products are available from the concessional window of the multilateral products. In addition, the market already offers such products through commercial creditors or banks (i.e. countries can hedge any of their loans through a third party arrangement). Of the six respondents, two agreed that the CS-DRMS has enough features to record and manage multilateral institutions financial products. These can be attributed to the fact that since they are IDA only countries, their borrowing is largely from the soft windows and the instruments are standard and can easily be recorded and managed by the current CS-DRMS features. Three respondents indicated that the current features are not adequate and one specifically mentioned that currency swaps and commodity swaps are not taken care of. One respondent indicated that hedge agreements with third parties cannot be recorded while only one respondent mentioned that risk management products cannot be recorded. 50

61 The table below shows a summary of the findings from the six countries that responded to the questionnaire. Table 6.2 Summary of MEFMI CS-DRMS countries use of Risk Management Products Specified Rate Fixing Interest Rate Conversion Currency conversion Kenya Lesotho Malawi Mozambique* Swaziland Tanzania x x x N/A N/A N/A x x x N/A N/A N/A x N/A N/A Currency Swap x x x N/A N/A N/A Commodity Swap Interest Rate Swap Interest Rate Cap Interest Rate Collar x x x N/A N/A N/A x x x N/A N/A N/A x x x N/A N/A N/A x x x N/A N/A N/A Prepayment x x N/A N/A N/A Futures/Forwar d x x x N/A N/A N/A *it should be noted that Mozambique responded that they have used all these products although it is officially known that it has not used any. It is likely that the question was misunderstood due to language difficulties as the questionnaire was in English. Their response was therefore recorded as N/A. Although it is evident from the survey that the countries in question do not, at the moment, use risk management products extensively, they all agreed that the CS-DRMS should have features for recording and managing them. 51

62 Countries demand for the feature to be included in CS-DRMS can be interpreted as country s awareness of the risk management products and therefore the need to have a system that helps then analyse and implement the products Treatment of IMF financing is not the main focus of this paper. However, it is known that all of the MEFMI countries are under some IMF programmes. Although IMF products does not support risk management products, the study wanted to find out how these products are recorded and managed. The key question was whether countries use CS- DRMS to manage such products. The survey revealed that for countries that recorded such products in CS-DRMS, the products or facilities are recorded as standard multilateral instruments and pose no challenge in recording and managing such facilities. In addition to recording IMF products, countries were also asked how they treat and record SDR allocations. The BPM6 classifies SDR allocations as external debt and borrowers are required to add these to their external debt stock when reporting to the Quarterly External Debt Statistics initiative. None of the six respondents reported recording of the product as part of their debt portfolio. This is therefore one of the areas that the CS-DRMS should provide a solution to enable the users report comprehensively. 52

63 CHAPTER 7 This chapter looks how derivatives could be recorded and managed in CS-DRMS and gives recommendations on work around solutions in cases where the products are not adequately catered for by CS-DRMS. 7.1 Recording Instruments in CS-DRMS From the outset, CS-DRMS was developed to record and manage external debt instruments. In this regard, loan agreements form a crucial basis for recording loans in CS-DRMS. In general, loan agreements that can be recorded in CS-DRMS can be grouped into the following categories as summarized in the table below. Table Categories of Agreement Types that can recorded in CS-DRMS Instrument Type Trade Credits Loan Grant Frame Agreement Commitment under Frame Description Refers to claims and liabilities arising from the direct extension of credit by suppliers for transactions in goods and services, and advance payment by buyers for goods and services and for work in progress. Refers to a single instrument or an instrument with a number of components or tranches with clearly defined standard amortization and interest payment schedules. A grant is an irredeemable instrument. Thus it is not to be repaid back. Some grants attract minimal interest. Refers to a commitment to finance a series of projects or activities, each of which requires an individual agreement or contract. Is an individual agreement under a frame. 53

64 Instrument Type Debt Relief Direct Liabilities to Affiliated Enterprises Direct Liabilities to Other Enterprises Description Refers to an agreement by a lender to ease a borrower s debt servicing burden Loans established through the provision of economic value that is assets, services and or income. Loans established through the provision of economic value that is assets, services and or income. CS-DRMS is used to record and manage a wide range of instruments. To enable the software to be used uniformly by all the users, loan agreements are entered in CS-DRMS through a standardized framework. The standardized framework is through the adoption of a pre-defined Data Entry Sheets (DES) that is used to extract the financial aspect of the loan agreement for the purpose of entering the loan details CS-DRMS. Below is the screen that is used to record instrument details in CS-DRMS. Figure CS-DRMS Instrument Details Screen 54