FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROJECT PAPER ON A PROPOSED ADDITIONAL LOAN AND RESTRUCTURING

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No: PAD1571 Public Disclosure Authorized INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROJECT PAPER ON A PROPOSED ADDITIONAL LOAN AND RESTRUCTURING IN THE AMOUNT OF US$200 MILLION Public Disclosure Authorized TO THE REPUBLIC OF INDONESIA FOR A INDONESIA INFRASTRUCTURE FINANCE FACILITY PROJECT (IIFF) MARCH 3, 2017 Public Disclosure Authorized Finance & Markets Global Practice EAST ASIA AND PACIFIC REGION This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. i

2 CURRENCY EQUIVALENTS (Exchange Rate Effective February 24, 2017) Currency Unit = IDR 13,336 = US$1 FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS ADB CAP CPF DEG E&S ESMF ESMS ESSF FY FIF GDP GOI IBRD ICR IFC IIF IIFF Asian Development Bank Corrective Action Plan Country Partnership Framework German Investment and Development Company Environmental and Social Environmental and Social Management Framework (SMI) Environmental and Social Management System (SMI) Environmental and Social Safeguards Framework (IIF) Fiscal Year Financial Intermediary Financing Gross Domestic Product Government of Indonesia International Bank for Reconstruction and Development Implementation Completion and Results Report International Finance Corporation PT Indonesia Infrastructure Finance Indonesia Infrastructure Finance Facility IIFF-AF MIGA NPF OJK OM PDO PPP RPJMN SEDD SEMS SMBC SMI SOE SRAP WB Indonesia Infrastructure Finance Facility Additional Finance Multilateral Investment Guarantee Agency New Procurement Framework Otoritas Jasa Keuangan (Financial Services Authority) Operations Manual Project Development Objective Public Private Partnership Rencana Pembangunan Jangka Menengah Nasional (National Medium Term Development Plan) Social and Environmental Due Diligence Social and Environmental Management System (IIF) Sumitomo Mitsui Banking Corporation PT Sarana Multi Infrastruktur State Owned Enterprises Supplemental Resettlement Action Plan World Bank Regional Vice President: Country Director: Senior Global Practice Director: Practice Manager/Manager: Task Team Leader: Victoria Kwakwa Rodrigo A. Chaves Sebastian Molineus Jennifer Isern Kalpana Seethepalli 1

3 INDONESIA INDONESIA INFRASTRUCTURE FINANCE FACILITY ADDITIONAL FINANCING (IIFF-AF) Table of Contents I. Introduction... 6 II. Background and Rationale for Additional Financing in the amount of US$200 million... 6 A. Country Context... 6 B. Sectoral and Institutional Context... 7 C. Relationship to CAS/CPF... 9 D. Financing... 9 E. Project Development Objective F. Overall Scope and Project Components G. Performance III. Proposed Changes IV. Appraisal Summary ANNEX 1. REVISED RESULTS FRAMEWORK ANNEX 2. IMPLEMENTING AGENCY ASSESSMENT ANNEX 3. SUMMARY OF MARKET CONSULTATIONS ANNEX 4. INSTITUTIONAL CAPACITY AND FINANCIAL ASSESSMENT OF IIF ANNEX 5. INSTITUTIONAL CAPACITY ASSESSMENT OF SMI ANNEX 6. SAFEGUARDS ANNEX 7. IMPLEMENTATION ARRANGEMENTS ANNEX 8. ECONOMIC ANALYSIS

4 . ADDITIONAL FINANCING DATA SHEET Indonesia Indonesia Infrastructure Finance Facility - Additional Financing (P154779) EAST ASIA AND PACIFIC Finance & Markets Global Practice Basic Information Parent Parent Project ID: P Original EA Category: Current Closing Date: Project ID: 31-Mar-2017 Basic Information Additional Financing (AF) P Regional Vice President: Victoria Kwakwa Country Director: Senior Global Practice Director: Practice Manager/Manager: Team Leader(s): Rodrigo A. Chaves Additional Financing Type (from AUS): Proposed EA Category: Expected Effectiveness Date: F - Financial Intermediary Assessment Scale Up 22-Aug-2017 Sebastian-A Molineus Expected Closing Date: 28-Feb-2022 Jennifer Isern Report No: PAD1571 Kalpana Seethepalli Borrower Organization Name Contact Title Telephone Republic of Indonesia Robert Pakpahan DG DMO Project Financing Data - Parent ( Indonesia Infrastructure Finance Facility-P ) (in USD Million) Key Dates Project Ln/Cr/TF Status Approval Date Signing Date Effectiveness Date Original Closing Date Revised Closing Date P IBRD Effective 24-Jun Jan Apr Dec Mar-2017 Disbursements Project Ln/Cr/TF Status Currency Original Revised Cancelled Disbursed Undisbu rsed % Disbursed P IBRD Effective USD

5 Project Financing Data - Additional Financing Indonesia Infrastructure Finance Facility - Additional Financing ( P )(in USD Mi llion) [X] Loan [ ] Grant [ ] IDA Grant [ ] Credit [ ] Guarantee [ ] Other Total Project Cost: Total Bank Financing: Financing Gap: 0.00 Financing Source Additional Financing (AF) Amount Borrower 0.00 International Bank for Reconstruction and Development Financing Gap 0.00 Total Policy Waivers Does the project depart from the CAS in content or in other significant respects? Explanation No Does the project require any policy waiver(s)? Explanation No Team Composition Bank Staff Name Role Title Specialization Unit Christopher Juan Costain Acting Team Leader (ADM Responsible) Lead Financial Sector Specialist Kalpana Seethepalli Team Leader Senior Financial Sector Economist Ahsan Ali Novira Kusdarti Asra Procurement Specialist (ADM Responsible) Financial Management Specialist Lead Procurement Specialist Sr Financial Management Specialist Financial Management GFM02 GFM08 GGO08 GGO20 4

6 Chau-Ching Shen Team Member Senior Finance Officer Finance Officer WFALN Dara Lengkong Team Member Consultant Finance GFM02 Ekapon Jivasantikarn Team Member Consultant Infrastructure Finance GFM02 Indira Dharmapatni Jennifer Isern Krisnan Pitradjaja Isomartana Pratyush Prem Prashant Extended Team Safeguards Specialist Program Manager Environmental Specialist Senior Operations Officer Practice Manager Senior Environmental Specialist Social Safeguards Environmental Safeguards GSUID GFM02 GEN2A Team Member Consultant Infrastructure Finance GFM02 Name Title Location Locations Country First Administrative Division Indonesia Jakarta Raya Daerah Khusus Ibukota Jakarta Location Planned Actual Comments X X Institutional Data Parent ( Indonesia Infrastructure Finance Facility-P ) Practice Area (Lead) Finance & Markets Contributing Practice Areas Additional Financing Indonesia Infrastructure Finance Facility - Additional Financing ( P ) Practice Area (Lead) Finance & Markets Contributing Practice Areas 5

7 INDONESIA INFRASTRUCTURE FINANCE FACILITY (IIFF) ADDITIONAL FINANCING (P154779) I. INTRODUCTION 1. This Project Paper seeks the approval of the Executive Directors to provide an additional loan in the amount of US$200 million following satisfactory implementation of the Indonesia Infrastructure Finance Facility (IIFF/P092218) (IBRD Loan 77310). The IIFF was designed to establish PT Indonesia Infrastructure Finance (IIF) as a non-bank financial intermediary to increase provision of private sector financed infrastructure. IIF is now fully operational and the original loan amount of US$100 million has been fully disbursed. The Government of Indonesia (GOI) has requested Additional Financing for IIFF (IIFF-AF) in the amount of US$200 million, which would help strengthen IIF s financial capacity further to increase provision of private sector financed infrastructure, thereby addressing Indonesia s infrastructure investment needs. 2. In addition, the following changes are proposed as part of the Additional Financing: (i) a revision to the PDO for simplification purposes; (ii) a revision to the Results Framework to account for the scale up of project activities; and (iii) a five year extension of the closing date from March 31, 2017 to February 28, Partnership arrangements. The Bank has collaborated with other international financial institutions, i.e. the International Finance Corporation (IFC), Asian Development Bank (ADB) and German Investment and Development Company (DEG) in support of IIF since its establishment in IFC and ADB provided both loan and equity investment, whereas DEG provided equity investment. ADB is currently also in the process of preparing additional finance to IIF, with an expected loan amount of US$100 million. II. BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING IN THE AMOUNT OF US$200 MILLION A. COUNTRY CONTEXT 4. Indonesia has made remarkable progress and emerged as a middle-income economy with macroeconomic and political stability. Indonesia proved to be resilient during the global economic downturn, bouncing back at one of the fastest rates in the G-20, and the economy continues to build momentum. The overall positive economic outlook provides a robust foundation for stronger and more inclusive growth, provided that necessary reforms continue to take place. In the next two decades, Indonesia aspires to generate prosperity, avoid a middleincome trap and diminish inequality as it attempts to catch up with high-income economies. Realizing these ambitious goals requires sustained high growth, job creation and reduced inequality. Indeed, Indonesia s economic progress will be dependent upon a growth strategy that unleashes the economy s productivity potential, and consistent implementation of a few longstanding structural reforms to boost growth and share prosperity. 6

8 B. SECTORAL AND INSTITUTIONAL CONTEXT 5. An essential and critical element of Indonesia s structural transformation is closing the country s large infrastructure gap. Despite rising government spending in recent years, Indonesia s core infrastructure stock - such as road networks, ports, electricity, irrigation and water and sanitation services - has not kept pace with economic growth and the infrastructure stock as a share of Gross Domestic Product (GDP) has actually declined over the past decade. It is estimated that Indonesia has lost more than 1 percent of additional GDP growth due to under-investment in infrastructure. Reduced access to basic infrastructure has translated into road congestion, health issues stemming from poor water and sanitation, energy shortages, as well as stunted business growth due to poor logistics and transportation. 6. It is estimated that the total financing gap for infrastructure is about US$50-60 billion a year. In 2014, the central government capital spending allocated was IDR188 trillion (two percent of GDP). The 2015 figure is reported at a significantly higher value of IDR290 trillion, but still falls far short of the investment needs in Indonesia. While subnational governments have stepped up their investment recently to 1.5 percent of GDP, spending remains insufficient and often misallocated. Overall, over the past decade, total government spending on and private investment in infrastructure have fallen in comparison with those in the 1990s. 7. There remains a shortage of long-term resources, both domestic and international, to appropriately finance infrastructure. While the GOI has announced recapitalization of State Owned Enterprises (SOEs) of US$7 billion, this appears inadequate to bridge the infrastructure financing gap. On the demand side, Indonesia s infrastructure market needs sustainable long term capital - both long duration debt and additional sources of equity to ensure that infrastructure projects are financially sustainable. There is increasing recognition that public funding alone will not be enough to fill the financing gap in infrastructure. Indonesia needs to explore alternative models of attracting and leveraging private financing into infrastructure. PPP is a promising alternative, but has been slow to develop despite numerous efforts by GOI with support from the Bank and other development partners. As a regulated PPP framework and a set of funding mechanisms have recently been put in place, the challenge now is to get and demonstrate some successful PPPs off the ground. 8. Banks financing of infrastructure is likely to be constrained by Legal Lending Limits and Basel III norms. Indonesian commercial banks infrastructure financing market has a small number of large lenders 1 and few large borrowers such as Astra, Salim, Bakrie, Medco, PLN, etc. Private business groups such as Astra, Salim, etc. have huge borrowing requirements that are typically serviced by the large commercial banks. This will lead to a situation of saturation of the Legal Lending Limits 2 to borrowers and borrower groups as prescribed by OJK. Commercial banks will also face challenges to lend long term (10-15 years) to infrastructure due to assetliability mismatches. Moving forward with the implementation of tighter financial regulations, 1 As per OJK s bank statistics for November 2015 there is a total outstanding of IDR 441 trillion by all banks to Infrastructure sector. Of this the four banks - BMRI, BRI, BNI and BCA - are estimated to have a 44% share. 2 As per OJK/BI Regulations, Legal Lending Limits for related party transactions should not exceed 10% of bank s capital. For non-related party transaction, the LLL are 20% of bank s capital for a single borrower and 25% for borrower group exposure. The limit for lending to SOEs is higher at 30% of bank s capital. 7

9 such as Basel III norms, banks would need to maintain higher capital adequacy requirements. This is likely to motivate banks to reduce their exposure to riskier assets, particularly infrastructure projects, and also to increase their lending costs. Moving forward, while banks are expected to play a leading role in infrastructure finance, there will be an imminent need to seek out alternative sources of funding. 9. Banks have conventional product offerings that do not adequately address Indonesia s infrastructure financing needs. Banks product offerings are conventional typically term loans and working capital finance of medium tenure (5-7 years) and mostly on a full recourse basis. Large banks also prefer to focus on SOEs and large corporate clients. Thus, in general, the medium sized companies are underserved. Furthermore, products such as promoter financing, bridge financing, mezzanine financing, take-out financing are not sufficiently available at present, as indicated below. Indeed, consultations with market players have highlighted unmet market needs, including: (i) flexible provision of debt financing packages, such as promoter funding, bridge finance and take-out financing; (ii) long term rupiah and dollar denominated loans; and (iii) longer tenor loans. Detailed findings of the market consultations are included in Annex 3. Table 1: Project Life Cycle Funding Needs Funding needs served by the market Funding needs not served by the market, usually Preparation & Financial Close Guarantees Debt Syndication Equity Bridge loans Promoter funding loans Project Life Cycle Construction Private Equity Term loans Working capital finance Equity Mezzanine financing Bond financing Operations Working capital finance Re-financing Guarantees Take-out Financing Bond financing 10. Pension funds and insurance companies have significant levels of assets under management in Indonesia, but the vast majority of funds are invested in short-term time deposits and government bonds. While the GOI is encouraging pension funds to finance infrastructure projects, because of their limited risk appetite, pension funds generally hesitate to invest in Greenfield projects. Similarly, most international institutional investors are wary of longterm investments in Indonesia. Institutional investors will require alternative investment structures and comforts to better manage the political/country-level and portfolio level risks. 11. Given the lack of depth and liquidity, capital markets in Indonesia do not appear to be a viable immediate option to raise new infrastructure finance. With the exception of government bonds (with average daily turnover of about US$885 million), the stock and corporate bond markets in Indonesia have much lower daily turnovers of about US$450 million and US$50-60 million, respectively. Thus the ability of private developers to raise new equity from capital markets is limited. Overall, there is a heightened need for securing long term and risk-taking capital to finance infrastructure. 12. Building on its unique market niche, IIF is now well-positioned to respond to evolving market needs. Significant institutional development has been achieved within IIF since its 8

10 establishment in IIF has now emerged as a small but credible player in the Indonesian infrastructure finance market based on its unique expertise vis-a-vis project finance and environmental and social (E&S) safeguards management. The proposed IIFF-AF will help consolidate IIF s market position by: (i) broadening IIF s capital base, thereby strengthening its ability to fund larger size projects and provide longer term, Rupiah financing; (ii) continuing to support IIF s senior debt and equity operations; and (iii) addressing unmet market needs by selectively engaging in riskier market segments, including bridge financing, promoter funding and take-out financing, all of which are already included in the World Bank (WB)-approved IIF Operations Manual (OM). 13. The proposed IIFF project is complemented by other various Bank instruments in support of the GOI infrastructure finance agenda overall. Over the past decade, the Bank has developed a robust partnership with GOI on helping strengthen infrastructure sector policy and leverage private capital into Indonesia s infrastructure through PPPs. On GOI s request, the Bank has provided financing support and technical advice on key strategic engagements that have contributed to developing the country s institutional architecture governing private infrastructure financing. These include the Infrastructure Development Policy Loan and Connectivity Development Policy Loan series, the establishment of the Indonesia Infrastructure Guarantee Fund (IIGF), IIF, Viability Gap Fund (VGF) program, and various key sector dialogues notably on power and transport. Similarly, over the past several years, the WB Group has been working with the GOI and public-private stakeholders in identifying and addressing the issues impeding financing for infrastructure. The work includes, among others, a Bond Market Study and stakeholder dialogues on new financial products for infrastructure (e.g. infrastructure bonds, securitization). The Bank is thus uniquely positioned to leverage its long-standing partnership with GOI and help support institutional clarity and interfacing required to make public and private capital work for infrastructure development. C. RELATIONSHIP TO CAS/CPF 14. The IIFF-AF is closely aligned with the World Bank Group (WBG) Indonesia Country Partnership Framework (CPF) filters of supporting the GOI priorities to build a more prosperous, equal and economically independent Indonesia, and eliminating extreme poverty and boosting shared prosperity. At the end of 2015, the WBG renewed its partnership with Indonesia through the CPF for the period of FY , which envisions analytical and lending support of over US$10 billion dollars from IBRD, IFC, and MIGA. The CPF is aligned with the GOI s national medium term development plan, known as the RPJMN, of and was developed through consultations with stakeholders, including civil society organizations, development partners and the private sector. The IIFF-AF is included in the FY IBRD Indicative Lending Pipeline and supports three engagement areas identified in the CPF: (i) national infrastructure programs that are essential for growth and improving the lives of Indonesians across the archipelago; (ii) the energy sector, in order to increase sustainable energy and connect millions of families to reliable electricity; and (iii) programs to build the maritime economy and improve connectivity. D. FINANCING 15. The original IIFF IBRD Loan (Ln7331-ID/P092218) for US$100 million was approved by the Bank on June 24, 2009 and became effective on April 25, The original 9

11 loan closing date was December 31, The loan closing date was first extended to November 30, 2015 to complete the project s activities and achieve the PDO. The second extension to November 30, 2016 and most recent third extension to March 31, 2017 were done to provide time to prepare for the additional financing operation. E. PROJECT DEVELOPMENT OBJECTIVE 16. The original IIFF project development objective was to strengthen and further develop the institutional framework of the financial sector to facilitate financing of commercially viable infrastructure projects, and thereby increase provision of private infrastructure in Indonesia. The IIFF project was expected to achieve the PDO by establishing IIF and building the necessary capacity and skills in providing long-term financing, innovative financial products, and advisory services. The proposed revised Project Development Objective (PDO) for the project is to strengthen the financial capacity of IIF to increase the access to private sector financing for infrastructure in Indonesia. As IIF has now been established and is fully operational, as part of the IIFF-AF processing, the PDO is being revised to make it clearer and related specifically to increasing IIF s capital and addressing Indonesia s huge infrastructure deficit, in particular through the provision of long-term, Rupiah financing. The ultimate objective is to increase the provision of infrastructure in Indonesia to support a more inviting investment climate, sustained growth, and poverty reduction in the long-term. F. OVERALL SCOPE AND PROJECT COMPONENTS 17. Consistent with the parent IIFF operation, the proposed IIFF-AF will have one component: an investment loan by the Bank to be made available to IIF as subordinated debt and/or perpetual/convertible capital instrument to be used for eligible infrastructure projects. The Bank s lending instrument will remain a Financial Intermediary Financing under OP Accordingly, the World Bank provides an investment loan to the Republic of Indonesia as the Borrower. The Borrower provides these funds to IIF as the sole participating financial intermediary, through SMI. IIF in turn, uses these funds to provide predominantly long-term loans, equity investment and other financial products as well as advisory services for infrastructure development. G. PERFORMANCE 18. Despite initial delays, implementation of the parent IIFF project has progressed well. The delays in loan effectiveness were largely attributed to legal, regulatory and institutional complexities, particularly surrounding the initial establishment of both SMI and IIF at the time. However, following loan effectiveness, these key institutions were able to build their capacities and made up for the initial delays. Hence, progress towards achievement of the PDO and Implementation Progress have been consistently rated Satisfactory for the past two years. The US$100 million existing loan funds have been disbursed, with only US$120,000 remaining, mainly due to exchange rate movements during the project implementation period. 3 As of end 2015, IIF had a portfolio of 15 infrastructure projects, with total commitments of US$333 million equivalent, and a robust pipeline of projects. IIF continues to strengthen its institutional capacity 3 IIF received the US$100 million loan funds from the GoI/SMI in IDR equivalent, and on-lent these to subborrowers in both IDR and US$. The US$120,000 remaining is largely due to the IDR depreciation against the US$. 10

12 and play an increasingly active role in the financing of infrastructure projects in Indonesia. Designed as a catalyst for funding infrastructure projects in Indonesia, IIF provides long-term financing products, including senior loans, mezzanine finance and equity participation. IIF continues to build its unique expertise and skills to support this niche business model, and has emerged as an experienced and credible repository of knowledge and skills in Indonesia s infrastructure financing, particularly vis-à-vis project finance, and environmental and social (E&S) safeguards management. Aiming to become among the most advanced non-bank financial institutions in Indonesia within the next few years, IIF estimates a funding need of IDR10 trillion (about US$722 million), which is expected to be raised through alternative sources, e.g. capital, subsidiary loans from the GOI based on Multilateral Development Bank borrowings, and commercial loan or bonds/medium term notes. 19. An Implementation Completion and Results Report (ICR) on the parent IIFF project has been completed, which rates the project overall outcome as Moderately Satisfactory and risk to development outcome as Substantial. The overall outcome rating is based on the aggregation of the ratings of three criteria: (i) relevance of objectives and design; (ii) efficacy on the achievement of the PDO as measured through the associated results indicators; and (ii) efficiency in the costs involved in achieving the PDO in comparison with the benefits. The ICR highlights the project outcomes in terms of both efficacy and efficiency as Substantial. Yet the initially weak PDO formulation led to a Modest rating of the overall relevance, thereby resulting in an overall project outcome rating of Moderately Satisfactory. Indeed, such weak PDO formulation is an important issue, and the PDO is thus one of the changes requested under this proposed IIFF-AF. 20. The proposed AF complies with OP10.00 Investment Project Financing, paragraph 29: (i) both progress with implementation (IP) and towards the achievement of the development objective (DO) have been rated Satisfactory for the past 12 months; and (ii) all key loan covenants including audit and financial management reporting requirements have been complied with. There are no overdue audit reports. III. PROPOSED CHANGES Summary of Proposed Changes The GOI had initiated a proposal to amend the PDO for the IIFF Project, as the current PDO was considered too broad, and thereby difficult to measure. It is proposed that the loan closing date is extended from March 31, 2017 to February 28, 2022, in order to support the scaling-up of IIF activities. The IIFF project has been extended three times. The first extension from December 31, 2013 to November 30, 2015 provided time to complete project activities and achieve the PDO. Indeed, this extension fulfilled its purpose. During this first extension period, IIF significantly built its operational capacities and led to a rapid take off of disbursements (IIFF's disbursements increased from US$25 million as of end 11

13 2013 to virtually the entire US$100 million loan amount at end February 2017). The second extension from November 30, 2015 to November 30, 2016 and third extension from November 30, 2016 to March 31, 2017, were to provide additional time to prepare the proposed IIFF-AF. The GOI and the Bank agreed to proceed with the AF rather than a new loan in order to save processing and implementation time within Government, as well as within the Bank, and to ensure project continuity overall. Change in Implementing Agency Yes [ ] No [ X ] Change in Project's Development Objectives Yes [ X ] No [ ] Change in Results Framework Yes [ X ] No [ ] Change in Safeguard Policies Triggered Yes [ ] No [ X ] Change of EA category Yes [ ] No [ X ] Other Changes to Safeguards Yes [ ] No [ X ] Change in Legal Covenants Yes [ X ] No [ ] Change in Loan Closing Date(s) Yes [ X ] No [ ] Cancellations Proposed Yes [ ] No [ X ] Change in Disbursement Arrangements Yes [ ] No [ X ] Reallocation between Disbursement Categories Yes [ ] No [ X ] Change in Disbursement Estimates Yes [ ] No [ X ] Change to Components and Cost Yes [ X ] No [ ] Change in Institutional Arrangements Yes [ ] No [ X ] Change in Financial Management Yes [ ] No [ X ] Change in Procurement Yes [ ] No [ X ] Change in Implementation Schedule Yes [ X ] No [ ] Other Change(s) Yes [ ] No [ X ] Project s Development Objectives Original PDO Development Objective/Results PHHHDO The objective of the Project is to strengthen and further develop the institutional framework of the financial sector to facilitate financing of commercially viable infrastructure projects and thereby increase provision of private infrastructure in Indonesia. Key performance indicators to judge PT. IIF's success include the following outcomes: (i) increase in the number of commercially viable infrastructure projects achieving financial closure through long-term debt financing, other financial products, and advisory services from the IIFF over the life of the project; (ii) Increase in the amount of private capital (including long-term debt and equity) available for infrastructure projects over the life of the project; (iii) Increased support to Government s policy making in private provision of infrastructure through advisory services from IIFF; and (iv) Increase in privately financed infrastructure in Indonesia. 12

14 Change in Project's Development Objectives Explanation: PHHCPDO The GOI had initiated a proposal to amend the PDO for the IIFF Project, as the current PDO was considered too broad, and thereby difficult to measure. Proposed New PDO - Additional Financing (AF) To strengthen the financial capacity of IIF to increase the access to private sector financing for infrastructure in Indonesia Change in Results Framework Explanation: PHHCRF Given that the project was intended to focus on the establishment of IIF as an institution and on delivering its infrastructure financing mandate, the development of the institutional framework of the financial sector is beyond the project s scope. Compliance PHHHCompl Covenants - Additional Financing (Indonesia Infrastructure Finance Facility - Additional Financing - P ) Source of Funds IBRD IBRD Finance Agreement Reference Section I.B.5 Section II.A. Description of Covenants The Borrower shall cause PTSMI to exercise its voting powers in relation to the Company and all powers of control available in relation to its nominee to the Board of Commissioners and Board of Directors of the Company (if any) in favor of the Company undertaking the Project in accordance with the Operations Manual. The Borrower shall monitor and evaluate the progress of the Project and, through PTSMI, prepare Project Reports in accordance with the provisions of Section 5.08 of the General Conditions and on the basis of indicators agreed with the Bank. Each Project Report shall cover the period of one (1) calendar semester, and shall be furnished to the Bank not later than forty-five (45) days after the end of the period covered by such report. Date Due Recurrent Frequency Action Recurrent Recurrent IBRD Section II.C The Borrower shall cause PTSMI to cause the Company to prepare and furnish to the Bank not later than six (6) months after the end of each calendar year an annual social and environmental performance report in accordance with the requirements in the SEMS. Recurrent Covenants - Parent (Indonesia Infrastructure Finance Facility - P092218) Change in Legal Covenants 13

15 Section I.B.6(a) of Schedule 2 to the Loan Agreement is amended to read as follows: Financial Covenant. (a) Except as the Bank and the Borrower shall otherwise agree, the Borrower shall exercise its rights under the Subsidiary Loan Agreement to cause PTSMI to exercise its rights under the Shareholders Agreement and the Subsidiary Loan Agreement to such that the Company shall not incur any subordinated debt if after the incurrence of such subordinated debt, the ratio of subordinated debt to equity shall be greater than 5 to 1. The definition of subordinated debt in Section I.B.6(b)i of Schedule 2 to the Loan Agreement is amended to read as follows: The term subordinated debt means any indebtedness of the Company under: (A) the Subordinated Loan Agreement; (B) the contract, agreement or other instrument between the Company and PTSMI pursuant to which the proceeds of the Co-financing Agreement are made available to the Company; and (C) any other contract, agreement or other instrument under which the repayment obligations of the Company to the lender are subordinated to those of certain senior lenders with regard to claims on the Company's assets or earnings. This amendment was proposed by IIF on the basis that the restriction on use of subordinate debt placed IIF at a competitive disadvantage to other institutions and the ratios of subordinate debt to equity are effectively established by the financial sector regulation in Indonesia. Source of Fund IBRD IBRD IBRD IBRD Finance Agreement Reference Article V, 5.01(c) Article V, 5.01(d) Article V, 5.01(e) Article V, 5.01(f) Description of Covenants Date Due Status The Company shall have been legally incorporated pursuant to the Borrower s laws and regulations and the Articles of Association of the Company shall have been executed by the founding Shareholders and approved by MLHR. The Borrower, through the MOF, shall have issued the Business License to the Company. The Cofinancing Agreement shall have been executed and delivered and all conditions precedent to its effectiveness or to the right of the Borrower to make withdrawals under it (other than the effectiveness of this Agreement) have been fulfilled. The Shareholders Agreement, and any related share subscription documents to be entered into by and among the founding Shareholders and/or between the Company and the founding Shareholders shall have been executed and delivered on behalf of the parties and shall have become effective and binding upon such parties in accordance with their respective terms. 25-Apr Apr Apr Apr-2011 Complied with Complied with Complied with Complied with 14

16 IBRD Article V, 5.01(h) The Operations Manual, including the ESSF, acceptable to the Borrower and the Bank, shall have been adopted by the Company. 25-Apr-2011 Complied with IBRD Article V, 5.01(i) Each founding Shareholder shall have subscribed and paid up its respective initial capital contribution in such amount as required by the Shareholders Agreement. 25-Apr-2011 Complied with IBRD Article V, 5.01(j) PTSMI shall have made available and disbursed financing in an amount of not less than Rupiah 600,000,000,000 (less the amount of the initial equity contribution of PTSMI as required under the Shareholders Agreement). 25-Apr-2011 Complied with IBRD Article V, 5.01(k) The Company shall have appointed and employed a chief executive officer, a chief financial officer and an environment and social safeguards staff acceptable to the Borrower and the Bank. 25-Apr-2011 Complied with Conditions Source of Fund Name Type IBRD-8715 Article V, 5.01(a) Effectiveness Description of Condition The Subsidiary Loan Agreement, acceptable to the Bank, shall have been duly executed and delivered on behalf of the Borrower and PTSMI and shall have become effective and binding upon such parties in accordance with their respective terms, subject only to the effectiveness of the Loan Agreement Source of Fund Name Type IBRD-8715 Article V, 5.01(b) Effectiveness Description of Condition The Subordinated Debt Arrangement, acceptable to the Bank, shall have been duly executed and delivered by or on behalf of PTSMI and the Company and shall have become effective and binding upon such parties in accordance with their respective terms, subject only to the effectiveness of the Loan Agreement Source of Fund Name Type IBRD-8715 Article V, 5.01(c) Effectiveness Description of Condition The Project Agreement, shall have been duly executed and delivered on behalf of PTSMI and the Company and shall have become effective and binding upon PTSMI and the Company in accordance with their respective terms Source of Fund Name Type IBRD-8715 Article V, 5.01(d) Effectiveness Description of Condition 15

17 The Action Plan, acceptable to the Bank, shall have been adopted and publicly disclosed on its website by the Company Risk PHHHRISKS Risk Category Rating (H, S, M, L) 1. Political and Governance Substantial 2. Macroeconomic Moderate 3. Sector Strategies and Policies Substantial 4. Technical Design of Project or Program Moderate 5. Institutional Capacity for Implementation and Sustainability Moderate 6. Fiduciary Low 7. Environment and Social Substantial 8. Stakeholders Moderate 9. Other N/A OVERALL Finance Moderate PHHHFin Loan Closing Date - Additional Financing (Indonesia Infrastructure Finance Facility - Additional Financing - P154779) Source of Funds IBRD Guarantee Proposed Additional Financing Loan Closing Date 28-Feb-2022 Allocations - Additional Financing (Indonesia Infrastructure Finance Facility - Additional Financing - P154779) Source of Fund IBRD Currency USD Category of Expenditure Company Investments in Sub-projects Allocation Proposed Total: 200,000, Disbursement %(Type Total) Proposed 200,000, IV. APPRAISAL SUMMARY PHHHAppS Economic and Financial Analysis Explanation: 16 PHHASEFA 1. The proposed IIFF-AF will help IIF build on its track record of providing debt financing, and allow it to mobilize new financial products into infrastructure projects in

18 Indonesia. IIF s activities are expected to attract additional private investment (domestic and international institutional investors) that will provide much-needed investments in Indonesia s infrastructure projects. In addition, these infrastructure projects/spvs/holding companies would also raise debt capital, further amplifying the multiplier effect. The growth payoff of greater investment in infrastructure cannot be overstated underinvestment in infrastructure has been a substantial drag on Indonesia s growth over the past decade. The WB loan proceeds would have a significant leveraging effect on the boost in private investment in infrastructure that the project would generate. 2. Positive developmental impacts are expected to be generated on IIF and Indonesia s infrastructure investments. The IIFF-AF will support IIF in expansion of its asset base and credibility, and in turn lead to a multi-fold increase in Indonesia s infrastructure over the next five years (more details on IIF s financial projections are provided in Annex 4). The key developmental benefits are enumerated below. (i) World Bank financing enables IIF to leverage much more in the future and scale up its operations and consequent developmental impact. Due to IIFF-AF, the IIF is able to increase its leverage to 4.08 times by FY2020 from the current level of 1.5 times in FY2015. This enables IIF to not only grow its asset base by 4.13 times to IDR 22,758 billion (~US$ 1714 million) by FY2020 (FY2015: IDR 5509 billion or ~ US$ 415 million) but also improve its Return on Equity to 12.2 percent by FY2020 (FY2015: 3.5 percent). (ii) The long duration loan from the World Bank under IIFF-AF will help IIF better manage its asset-liability mismatch and support IIF s credibility to raise additional debt as well as IPO and listing by The positive implications of IIFF-AF long duration loan on the overall duration of IIF s liabilities can be seen from Figure 1 below. Without the IIFF-AF, the long term borrowings of IIF will only be 16 percent (i.e. less than half of the share in FY 2015) thus impacting its asset liability mismatch. Figure 1: Positive Impact of IIF AF Loan on Duration of IIF s Liabilities in 2020 Source: Financial projections for provided PT IIF 17

19 (iii)iif s developmental impact will be substantial as through IIF s investment operations it would be able to catalyze infrastructure investments of 5 times its asset base, i.e. approximately IDR 113,792 billion (US$ 8,571 million) assuming that IIF invests up to 20 percent of the project cost in each sub-project. 3. The economic analysis of potential subprojects to be financed under the IIFF-AF will be undertaken as part of IIF s appraisal of the identified subprojects. Therefore, for the purpose of the IIFF-AF, it is more appropriate to elaborate the appraisal framework being used by IIF. The same appraisal framework has been used by IIF to disburse the initial financing under the parent IIFF operation and has been found satisfactory, as also noted in the ICR. Indeed, a robust economic analysis can help IIF in its assessment of market, sectoral, financial and other risks. 4 IIF is well established in undertaking the necessary economic analysis as part of its work, thereby improving the quality of the projects it invests in, which is described as follows. Each sub-project has a feasibility study and appraisal conducted by IIF prior to any loan or investment approval. The exact template for their feasibility studies varies somewhat depending upon the type of sub-project and when the feasibility study was conducted. However, in general it includes: industry and sub-project analyses; a financial analysis of the borrower, with financial projections and a sensitivity analysis; a detailed management review; a risk and mitigation analysis; and clear recommendations on amounts of financing, type of financing and pricing. Important aspects of IIF s Economic Analysis are incorporated in the Environmental and Social (E&S) Safeguards section of the Risk Analysis. Effectively, this addresses the Costs side of any Cost-Benefit Analysis that would underlay any formal calculations of an Economic Rate of Return. The main instrument in this regard is a Corrective Action Plan (CAP), which includes clear target dates and priorities for the sub-project developer. A typical CAP covers all applicable E&S principles, such as environmental degradation; land acquisition; re-settlement; community relations; and continuing local employment opportunities. Effectively, IIF s Economic and Financial Analysis of the sub-project examines carefully the financial benefits to IIF while minimizing the broader economic cost to society. It is difficult to imagine private sector arrangements that go much beyond this. Examples of the broader economic impact of sub-projects financed by IIF are provided in Box 1. These illustrate how better infrastructure contributes to Indonesia s improved economic and social well-being. Moving forward, similar results can be reasonably expected under the IIFF-AF. 4 Robust micro-economic analysis and modelling can shed light on: (i) how a new toll road might attract traffic or result in lower volumes than anticipated as people seek to avoid the toll road; (ii) willingness of users to pay for services; (iii) economic costs of delays and disruptions in infrastructure services; (iv) social benefits and costs, including externalities; (v) optionality value of increasing size of infrastructure today and/or allowing scope for future growth; and (vi) benefits of co-locating multiple infrastructure services along same land corridor/easement (e.g. road, water, power, telephone/ict, gas, trains). 18

20 Box 1: Illustrating Broader Economic Benefits of IIF s Sub-projects Roads: The LMS toll road helps connect all provinces across Java, and traffic volume is estimated at 20,000 vehicles per day. Reduces travelling time by 2 hours vis-à-vis the national road, which cuts logistical costs and consumer prices. Reduces congestion on the national road, including during heavy traffic of the Idul Fitri religious festival. Power Sector: A power platform company has established more than 150MW of power in remote areas of the country, using clean, gas-fired plants. The equity portion improves the company s debt capacity and the shareholder profile to attract new investors. A solar power plant in northern Sulawesi provides electricity to a province with a large gap between electrical supply and demand. The Solar power is coupled to an existing diesel generator. This reduces diesel consumption; lowers maintenance costs; extends the generator s lifetime; and supports the government s objective of increased renewable energy. Telecommunications: Supports the acquisition of 3,500 towers from a major, telecom services provider. Ownership of the towers by a third party encourages competition in the industry because telecommunication providers are more comfortable with leasing the tower for their network equipment. Air Transport Purchase of equipment to establish of new aircraft hangar. Improves maintenance, repair and safety of aircraft in the rapidly growing local airline industry Source: Data provided by IIF and field interviews. Technical Analysis Explanation: Institutional Assessment of IIF PHHASTA 4. IIF has emerged as a small but credible player in the Indonesian infrastructure finance market based on its unique expertise vis-a-vis project finance and social and environmental (S&E) safeguards management. IIF is now taking a calibrated approach to expand into riskier market segments, and grow into a mature platform for financial intermediation to mobilize and channel private investments into infrastructure projects, and bridge Indonesia s infrastructure financing gap. The following are IIF s key achievements to date (Details on IIF s institutional assessment are provided in Annex 4). (i) IIF is an important additional source of infrastructure financing. Supported by a strong capital base from its shareholders and 25-year subordinated loan on-lending facilities from the World Bank and the Asian Development Bank, IIF is well positioned to assist in bridging the 19

21 gaps in the country s requirements for infrastructure financing. IIF provides long-term fundbased products such as senior loans, mezzanine finance and equity participations, in addition to non-fund-based products such as guarantees and fee-based services, and thereby provides an important additional source of funding for infrastructure projects in Indonesia. (ii) High standards for appraisal and safeguards. IIF applies international-standard best practices in terms of social and environmental safeguards and exercises good corporate governance in order to promote more sustainable infrastructure project development in Indonesia. For social and environmental management, it has adopted IFC performance standards 2012 and the World Bank standards. (iii)good risk management. IIF has instituted a comprehensive risk management framework in line with international practices. This is implemented through an independent Risk Management Directorate (RMD) under the leadership of Chief Risk Officer; while the risk management process includes active supervision from the Risk Management Committee of the Board of Directors (RMC) and oversight by the Risk Oversight Committee of the Board of Commissioners (ROC). The RMD monitors at least four key risks credit risk, market risk and portfolio management, operational risk and compliance/kyc, social and environment risk; and reports on a quarterly basis to the RMC and ROC. IIF s risk management framework aims at keeping IIF s risk appetite at moderate level. Its current self-assessment of enterprise level risk is at Low to moderate level thus placing IIF in a comfortable zone. IIF also prepares and submits a quarterly risk management report to its shareholders. (iv) Future deal pipeline. IIF expects to have a strong pipeline of future deals aggregating to about US$1 billion, consisting of US$792 million of dollar denominated loans and IDR2.87 trillion of rupiah loans. A sample indicative list of projects from the future deal pipeline is presented below. Table 2. Sample of IIF Project Pipeline No. Indicative Projects Rupiah Loans In IDR Billion US$ Facility In US$ million 1 Palapa Ring II Kuala Tanjung Seaport Sumatra Power Transmission Line Telecom Towers Aircraft Maintenance Overhaul & Repair Facility MW Batang Toru Hydro Power km Cirebon Semarang Gas Pipeline 35 8 Bintan Airport MW Mini Hydro Platform MW Gas Fired Power Plant LNG Receiving Terminal 30 20

22 5. While IIF has set high standards of corporate governance and risk management, the following areas could be strengthened further in order for IIF to realize its growth aspirations: Performance benchmarking and development of medium term strategy and business plan for IIF. This could include undertaking a benchmarking exercise with select global infrastructure financing institutions, and helping IIF shape a medium strategy and business plan for an accelerated growth and development impact. Strengthening the public disclosure and developing a grievance redressal mechanism on projects financed by IIF. This could include certain disclosure of relevant project information on its website so that it enables the stakeholders to get information about the project being financed by IIF, as long as the sub-projects provide clearance to IIF for such disclosure. In addition, IIF could establish a dedicated contact person in its web to address grievance redress platform to receive and resolve stakeholder concerns and grievances about the client or project s environment and social performance. Human resource development and training. For example, global twinning programs with infrastructure banks and financing agencies. Helping IIF s HR function to shape skill upgrade training and career development programs. Financial Assessment of IIF 6. IIF s total assets has grown at a compound annual growth rate of 41 percent from IDR1,969 billion (~US$148 million5) in FY2012 to IDR5,509 billion (~US$415 million) as of FY2015. Within this the loans advanced constitute IDR3,343 billion (~US$252 million) as of FY2015 (FY2012: Nil). The loan book is well balanced between local currency and USD lending, with a large proportion of long term loan assets. With no Non Performing Loans, the quality of the IIF s loan book is stable. In addition, IIF has invested in equity and mandatorily convertible bonds, demonstrating the diversification of investment across various classes of facilities. The equity and marketable securities constitute IDR1,050 billion (~US$79 million) as of FY2015 (FY2012: IDR152 billion or ~ US$11 million). 7. Since inception, IIF has shown stable growth by expanding its product and service offerings and diversifying its sectorial and geographical coverage. IIF s revenues have grown at a CAGR of 67 percent from IDR66 billion (~US$5million) in FY2012 to IDR306 billion (~US$23 million) as of FY2015, with a healthy net profit margin of percent. 8. IIF has achieved solid investment ratings. Strong shareholders, strategic importance of IIF for achieving the infrastructure development agenda of the government, increased demand for infrastructure financing, tight control, improved financial performance and substantial borrowing capacity has enabled IIF to achieve a National Long-Term Rating of AAA(idn) with a Stable Outlook from Fitch Ratings Agency. For its recent bond issuance, IIF has obtained a credit rating from Pefindo (the local affiliate of S&P) of Ind AAA reflecting highest level of credit rating. 5 The conversion rate is based on BI reference exchange rate for March 31, 2016 of IDR 13,276 = US$1. 21

23 9. During FY2015, IIF has raised additional equity by IDR233 billion (~US$17.55 million and includes share premium paid by SMBC) to reach IDR 2 trillion and fulfill the minimum requirement of capital in accordance with the MOF Regulation No.100/2009. Consequently, the shareholding pattern has slightly changed: SMI 30 percent (PY:34 percent); ADB 20 percent (PY:20 percent); IFC 20 percent (PY:20 percent); DEG 15 percent (PY:11 percent); and SMBC 15 percent (PY:15 percent). 10. IIF s borrowings are well balanced as they have a high proportion of long duration loans, and mix of local currency and USD denominated debt. To increase its domestic borrowings, recently IIF has diversified its borrowings portfolio by raising IDR denominated debt from Bank Mandiri of IDR1 trillion (~US$75.32 million) in FY2015. In addition, IFC has sanctioned an additional loan of US$150 million, which is expected to be disbursed during IIF has sufficient borrowing capacity with a debt-to-equity ratio of 1.5 times. IIF maintains a high level of liquidity (~35 percent of its assets are held as cash and cash equivalent) and is not facing any asset liability mismatch as majority of sources of financing for IIF are longterm in nature. It has a Capital Adequacy Ratio of percent, well above the minimum 12 percent stipulated as financial covenants 6 in IFC s loan agreement to IIF. 12. IIF launched a public issue of new bonds aggregating IDR2 trillion in July The bonds are rupiah denominated with tranches of 3, 5 and 7 year durations. The bond proceeds will go towards IIF s investment in infrastructure projects in Indonesia. The bonds carry a fixed interest rate payable quarterly and aligned to an Indonesian AAA rating. The 5 and 7 years tranches are attractive to pension funds and insurance companies, while the 3 year tranche is of interest to retail and other investors. For the new bond issuance, IIF has obtained a credit rating from Pefindo (the local affiliate of S&P) of IndAAA reflecting highest level of credit rating. 13. In line with its growth strategy for , IIF has set for itself an ambitious target as reflected in its financial projections. These include: a. Asset Growth. By FY 2020, IIF s total assets are projected to grow at a CAGR of 18 percent to IDR22,758 billion (~US$1714 million) from IDR11,754 billion (~US$885 million) budgeted in FY2016. The loan book is projected to grow at CAGR of 23 percent and the equity and mezzanine investments at a CAGR of 47 percent. b. Profitability Ratios. IIF s operating and net profit margins improve to 39.8 percent and 25.9 percent by FY2020 from 30.2 percent and 17.6 percent in FY2016, respectively. Similarly, the ROA and ROE improve to 2.2 percent and 12.2 percent by FY2020 from 1.4 percent and 5.3 percent budgeted in FY2016, respectively. c. Capital Adequacy. IIF is projected to maintain a healthy Capital Adequacy Ratio of 30.4 percent by FY2020 and remaining well above the minimum CAR requirement of 12 percent as per IIF s OM. 6 Financial covenants under IFC s loan agreement require IIF to maintain a risk weighted capital adequacy ratio >12%, debt to capitalization ratio of 3:1 and a current ratio of 1.2:1. 22

24 d. Leverage. The growth in asset base and ROE is primarily due to the increase in leverage of IIF to 4.08 times by FY2020 from the current level of 1.5 times in FY2015. IIF also aspires to do an IPO and listing of equity in FY2020 of around IDR1 trillion. Thus reflecting a strong fund raise program. However, the IIFF-AF will be vital for IIF s credibility in future fund raise and IPO. Without the IIFF-AF, the long term borrowings of IIF will only be 16 percent (i.e. less than half of the share in FY2015) thus impacting its asset liability mismatch and possibly the ability for future fund raise and IPO. Assessment of SMI 14. SMI is the executing agency for the IIFF-AF, which will channel the WB loan borrowed through GoI and on-lend to IIF. Accordingly, it is in this context that SMI s capacity assessment has been undertaken. 15. SMI is an infrastructure financing company that supports the GOI s infrastructure development agenda. The company is a state-owned enterprise operating under the Ministry of Finance. SMI was established under Government Regulation No. 66/2007, which has been amended subsequently by various government regulations. The company obtained the license to operate as an infrastructure financing company based on the Minister of Finance Decree No. 396/KMK.010/2009, and commenced commercial operations on October 12, With the objective of catalyzing private investment and infrastructure development, SMI formed a joint venture company IIF together with the ADB, IFC and DEG. The proposed IIFF-AF reflects continued support by GoI/SMI to IIF in furthering Indonesia s infrastructure development agenda. 16. SMI has instituted satisfactory internal controls and procedures to transparently and efficiently manage the continued on-lending operations under IIFF-AF Project. The terms and conditions of this pass-through will be back-to-back, with fees, margins and other costs at costrecovery levels with no subsidies involved. They will also include fiduciary and implementation undertakings by SMI commensurate with those contained in the Bank s legal agreements with the GOI. Even though the GOI is its sole shareholder, SMI is professionally managed via a Board of Commissioners and a Board of Directors reflecting its role as prudential non-banking financing institution. 17. SMI is now transforming into Indonesia Development Financing Institution (or Lembaga Pembiayaan Pembangunan Indonesia/LPPI), with the GOI: (i) entrusting SMI the asset portfolio of former Government Investment Unit (Pusat Investasi Pemerintah/PIP), a sovereign wealth fund previously managed by the Ministry of Finance; (ii) expanding SMI s mandate to local government financing through the PIP and RIDF (under a proposed World Bank lending operation); and (iii) initiating dialogue with SMI on covering new sectors such as industry, agriculture and maritime. SMI s capital structure, human resourcing and operational procedures are being strengthened to manage the expanded role, which also reflects the continued support of GOI. 18. SMI has a strong credit rating and financial position. SMI has been rated idaaa with a Stable Outlook by PEFINDO Rating for local rating and global rating of BBB- which reflects the sovereign rating from Fitch Rating. The rating assigned to SMI is supported by key considerations, 23

25 such as sufficient capital infusions by the GOI (Rp 24.4 trillion already invested by GOI over the last five years), very strong asset quality indicators and a low leverage. It can be reasonably expected that SMI will continue to enjoy support from GOI in the medium term, given the vital nature of SMI s role in infrastructure development in Indonesia. 19. SMI s corporate governance structure is consistent with a professionally managed financing company. Pursuant to SMI s Articles of Association, the company s oversight and management is conducted by three major organs namely, the Shareholders, the Board of Commissioners and the Board of Directors. 20. On safeguard standards, SMI has developed an Environmental and Social Management Framework (ESMF) focusing on ensuring that the national and international standards are implemented. The ESMF has been developed as SMI prepared for the Regional Infrastructure Development Fund (RIDF) project with the Bank for local government infrastructure financing and also for PPP sub projects. The ESMF was developed on the basis of SMI s Environmental and Social Management System (ESMS) and the World Bank safeguards policies. SMI s ESMS has two components: (i) The ESMS project has adopted national laws and regulations pertaining to land acquisition and environmental management, and applies to projects funded from SMI s own financial resources. (ii) The ESMS multilateral has adopted national laws and regulations as well as some international standards, and applies to projects financed by multilateral agencies. SMI currently uses the ESMSs in its current operations, mainly PPP projects, whereby social and environmental safeguards due diligence is undertaken once a subproject is defined as eligible for financing based on the financial and investment assessments. 21. Moving forward, SMI aspires to adopt international standards (i.e. the ESMF from 2017 onwards). The ESMF has been consulted with stakeholders in June This ESMF was approved by the Bank in September 2016 and SMI has adopted this ESMF in November Accordingly, SMI s staff would need training and hand-holding assistance in implementing the ESMF. SMI will need to undertake awareness socialization and training for its internal staff on the requirements specified in the ESMF, as well as technical capacity building of the staff of the Environmental Social Safeguards and Business Continuity Management under the Directorate of Risk Management to enable it to cope with the increased project portfolio that would arise from the Government Investment Center (PIP) and RIDF activities. It needs to be noted that SMI and IIF are different entities with different project nature and clients, hence they will be having different safeguards management frameworks. 22. From the perspective of the limited role of channeling the Bank s sovereign loans to IIF, SMI has instituted satisfactory internal controls and procedures to transparently and efficiently manage the continued on-lending operations under IIFF-AF Project. Certain suggestions on strengthening the coordination between MOF, SMI and IIF in relation to financial management standard operating procedures have been made by the financial management specialists in the Task Team. These are in the process of being socialized and finalized. Other than this, the overall performance of SMI as the executing agency has been satisfactory. There are several indications that the GOI support to SMI will continue in coming years and that SMI will continue to implement capacity strengthening policies to manage its performance on par with 24

26 applicable national and international standards. More detailed assessment of SMI s institutional capacity is provided in Annex 5. Social Analysis Explanation: PHHASSA 23. As reflected in the IIF s portfolio and pipeline, the nature of subprojects to be financed by IIF-AF will remain the same as those by the parent IIFF operation. As is the case with IIFF, the IIFF-AF will continue to trigger OP 4.10 on Indigenous Peoples and OP 4.12 on Involuntary Resettlement. Subprojects will have low, medium and high risks defined based on potential impacts identified during the screening of the proposals, which then confirmed during the Social and Environmental Due Diligence (SEDD). Experiences in the IIF subprojects suggested that seven of 16 subprojects in the portfolio are high risks, and the remaining are medium risks. Only one out of 16 subprojects in the IIFF portfolio involved large-scale land acquisition carried out by the government, i.e. the Cikampek-Palimanan toll road. Issues on vulnerable groups due to land acquisition impacts were addressed in the Supplemental Resettlement Action plan (SRAP) and Livelihood Restoration Program. Most of other subprojects did not involve land acquisition, however, those that did, only required land from a much smaller number of land owners than that of the toll road, ranging from 3 to 63, which all were obtained through willing-buyer-willing-seller scheme. 24. The indicative pipeline indicates that two subprojects, i.e. Telecom Towers and Mini hydropower are likely to be medium risks, while other subprojects are likely to be high risks. As has been the case with IIFF-financed subprojects, only few subprojects under IIFF-AF as shown in the indicative pipeline would involve involuntary resettlement including land acquisition. In such cases most land acquired will be small scale, and very likely will be obtained through willingbuyer-willing-seller scheme. IPs might be presence and affected in the Palapa Ring II and Sumatera Transmission Line subprojects, as these subprojects will have long alignments surpassing remote areas. IIF will continue to use its current SEMS as specified in its Operations Manual and an SOP during the project cycle for loan processing whereby environmental and social safeguards management is part of. The principles of the SEMS is disclosed in the IIF s website. Environmental Analysis Explanation: PHHASEnvA 25. The proposed IIFF-AF will continue as a Category FI project that triggers OP/BP 4.01 Environmental Assessment, OP/BP 4.04 Natural Habitats, OP/BP 4.36 Forests, OP/BP 4.37 Safety of Dams and OP/BP 4.11 Physical Cultural Resources. IIFF-AF will trigger the same World Bank safeguards policies as those under the parent IIFF operation. No new safeguards policy is triggered. IIFF-AF shall continue to promote environmentally responsible investment decisions. Potential large scale, significant/irreversible impacts from the indicative sub-projects under this IIFF-AF are still similar in nature and scale to the parent IIFF operation. They are mainly derived from the construction activities of the linear infrastructure such as road, gas pipeline, transmission line, and the construction of airport improvement and seaport facilities, medical waste management facilities, biomass and biogas plant, LNG processing plant, floating storage facility, port terminal automatization, fiber optic telecommunication, Mini Hydro Power Plant and industrial estate. The 25

27 impacts to natural habitats, forest, people (from land acquisition) and to Indigenous People are likely. However, for this IIFF-AF, the magnitude of potential impact is not as large as the parent IIFF (e.g. Cikampek-Palimanan Toll Road and Run off river power plant). Other than that there are still possibilities of induced impact, such as a new access to forest area or natural habitats or access restriction. In addition, there are likely cumulative impacts and other impacts related to dam safety and linked activities funded by government or other donors and potential impacts of ancillary facilities such as quarry management. The potential downstream impacts from IIF s advisory services are also possible. The current 2014 SEMS has already ensured that IIF s advisory services are also consistent with the safeguards requirements in the SEMS. Overall, the list of potential subprojects pipeline is dynamic, and preliminary Social and Environmental screening are being carried out in reference to IIF s Social and Environmental Management System (SEMS) to identify the level of potential risks of each sub-projects. The risk level will be reconfirmed during the Social and Environmental Due Diligence (SEDD) based on the complete set of sub-project proposal package. Given the nature of eligible sectors of IIF, potential environmental and social impacts of subprojects will range from medium to high, significant, diverse, and irreversible. The assessment of the applicability of the current SEMS of IIF and the capacity of its S&E unit in managing safeguards aspects of the future projects is elaborated in Annex The nature of sub-projects to be financed under IIFF-AF will be similar to that under the parent IIFF project. All sub-projects to be financed under IIFF-AF will be screened by IIF based on its SEMS to determine safeguards policies triggered, EA category, safeguards instruments and associated analyses to incorporate risk and impact minimization, mitigation measures and monitoring program. Based on the screening result, a subproject might be rejected for IIFF-AF financing if critical safeguards requirements could not be met- as already happened previously. Previously, full environmental assessments (including social impact assessment) were prepared for some IIFF-financed subprojects, such as the Cikampek-Palimanan toll road and gas fired power plant; whereas EMPs were prepared for others, such as the micro hydro projects, solar power generation plant, aircraft maintenance facilities, gas processing plant and telecommunication service provider. IIF also requested sub-projects to prepare CAP (Corrective Action Plan) should the client not meet IIF standards (see Table 16-Annex 4). As part of project supervision, the Bank together with IIF S&E staff conducts field visits to high risk sub-projects to ensure adequate capacity building and comprehension of the Bank s safeguards policies requirements. 27. The potential downstream impacts from advisory services are also likely, such as from project structuring and feasibility studies. The current 2014 SEMS has already stipulated that their advisory services shall also be consistent with the environmental and social safeguards requirements of their SEMS. The assessment of the applicability of the current SEMS of IIF and the capacity of S&E unit in managing safeguards aspects of the future projects is elaborated in more detail at Annex 2, 4 and Annex 6. A checklist to do the assessment of IIF s safeguards capacity is presented in Annex 6. Social and Environmental Due Diligence (SEDD) on the complete set of sub-project proposal package including safeguards instruments will be conducted during project implementation. As was the case of the parent IIFF, sub-projects that cannot meet the SEMS or investment requirements may be dropped from IIFF-AF financing support. 26

28 28. Implementation Issues of SEMS. Although the overall implementation of the IIF project is considered satisfactory and IIF is considered among the best infrastructure investment facilities in its field in Indonesia, issues of safeguards compliance and quality during the implementation of the initial project have been raised during a recent desk supervision undertaken by IFC. Safeguards compliance and/or quality issues cover several aspects of project implementation such as the documentation of safeguards instruments, screening of sub-project potential impacts, timing of preparation of safeguards instruments, preparation of TORs, public consultations and ongoing engagement with communities. 29. In order to address any outstanding safeguards compliance issues and to improve the quality of safeguards instruments and oversight, an Action Plan has been developed and agreed upon with IIF and will be adopted and publicly disclosed by IIF prior to effectiveness of the Additional Financing. The Action Plan agreed upon, which includes a requirement for IIF to set up an S&E related Grievance Redress Mechanism, will be implemented by the IIF within an applicable timeline agreed with the Bank. The Action Plan will contain measures to support project monitoring in particular for high risk projects as well as measures to further develop the environmental and social safeguards technical capacity of IIF. IIF recognizes the importance of the actions designed to strengthen IIF safeguard capacity and enhance oversight and monitoring of high risk projects. The Action Plan combined with the existing SEMS allows IIF to address outstanding safeguards compliance, quality and capacity issues. Because of the complex revision procedures, notably the requirement that IIF shareholders must approve any amendments, IIF is not able to agree on a specific timeline for concluding the revision of an updated SEMS. It is noteworthy that the previous revision of the SEMS required approximately a year to complete. However, IFF has committed to update the SEMS to include the specific dispositions of the Action Plan agreed upon with the Bank and the agreed Action Plan which already requires IIF to implement a plan with actions designed to strengthen IIF safeguard capacity and enhance monitoring and reporting of high risk projects. The updated SEMS was disclosed on the IIF s website on February 24, Furthermore, the role of IIF engaged in promoting private sector investment in infrastructure is taken into account, especially the commitment from IIF to do far more on environmental and social safeguards than many of its competitors in Indonesia. Financial Management Explanation: 30. A Financial Management Assessment (FMA) was undertaken to assess the adequacy of the financial management system of the implementing agencies, particularly IIF and SMI, to produce timely, relevant and reliable financial information on project activities. The FMA also assesses whether the accounting systems for project expenditures and underlying internal controls are adequate to meet fiduciary objectives and allow the Bank to monitor compliance with agreed implementation procedures and appraise progress towards its objectives. 31. The overall the project financial management risk is assessed as being moderate. There is no outstanding audit report under the original financing. The project financial management arrangements follow the government systems and IIF procedures agreed by the Bank, as reflected in IIF s standard operational procedures. Overall, IIF management and staff have sufficient experience in implementing the previous project. At appraisal, IIF has undertaken mitigation 27

29 actions of associated risks that were previously identified, which will continue to be supervised closely throughout project implementation, particularly with regards to the following: Based on the FY2015 annual audit report findings, two weaknesses were observed by the auditor in relation to internal control on disbursements and absence of regular bank reconciliation. At appraisal, follow-up actions on the audit findings have been taken. The internal control on disbursement has been strengthened by adding a new layer of review through the recruitment of new accounting manager and implementation of new accounting system. With regards to absence of regular bank reconciliation, IIF has currently performed 100 percent reconciliation for all of its accounts, including non-active bank accounts. On treasury procedures, including management of World Bank excess funds, 7 IIF has agreed to add general statement "The placement of funds that are originated from the borrowing proceeds must also follow the requirements as agreed with lenders." This statement is meant to accommodate the Bank s request to maintain either in the project Designated Account or in a 1 month time deposit (not in automatic rollover mode), in keeping with the spirit that the advance of the DA should be readily available to meet expenditures. The strengthening of IIF computerization has accommodated IFR preparation. The data for IFR was received from loan system T24 and Axapta (for World Bank designated account management). However, minor manual process is still needed before its submission to the World Bank. With regards to the improvement of coordination among stakeholders of the project, the Directorate of Information Management System under DG Treasury, MoF has agreed to closely monitor the project by initiating regular meetings in line with the project s IFR preparation period. 32. The overall disbursement arrangements established under the parent IIFF operation will continue under the IIFF-AF. The current DA will continue to be maintained and there will be no separate DA for the proposed IIFF-AF. Under the parent IIFF project, there is only one disbursement category Company Investment in Sub-projects. The IIFF-AF will carry the same disbursement category description with allocation of the entire US$200 million. Procurement Explanation: 33. Procurement arrangements under the proposed IIFF-AF shall continue to be carried out in accordance with the Guidelines: Procurement of Goods, Works and Non-consulting Services under IBRD Loans and IDA Credits and Grants by World Bank Borrowers, dated January 2011 (revised July 2014) and Guidelines: Selection and Employment of Consultants under IBRD Loans and IDA Credits and grants by World Bank Borrowers dated January 2011 (revised July 2014). IIF has demonstrated adequate overall capacity to manage procurement activities under the parent IIFF project financing. Further, IIF has strengthened and enhanced its relevant components of institutional capacity so that its procurement related functions continue to 7 IIF has been using IFR as the basis for disbursement. The 6 months projection of funds needed is transferred to the DA. Within the 6 months period, the DA balance should be maintained to ensure fund available to finance PPP project (as the purpose intended in this project) and not use to earn interest by treasury unit. The Bank s excess fund refers to the balance of the DA which is waiting to be used by IIF for its investments. 28

30 perform satisfactorily. For further strengthening, improvement of fiduciary capacities at both the IIF institutional and sub-project enterprise levels are recommended in the following areas: (a) checking the eligibility of the contractors, suppliers, or consultants procured and selected by the sub-borrowers against WB s suspended and debarred firms and individuals; (b) ensuring compliance with WB s Anti-Corruption Guidelines (ACGL) for all future procurements, including those by the sub-borrowers under the Project; (c) maintaining IIF s procurement functions, which includes overall spelling out IIF s responsibility for carrying out the procurement to meet its own requirements, and also assessing the adequacy of the procurement and contract management systems of the sub-project enterprise during sub-project preparation and overseeing their compliance with the agreed procedures during implementation through regular project monitoring. Risk Explanation: PHHASRisk 34. The overall risk towards achievement of the PDO is increased from Low to Moderate, based on key considerations below. a b Political and Governance. Since taking office in 2014, the current Government administration has indicated infrastructure development particularly in the areas of connectivity and maritime - as a key priority. Some important actions have been taken to support this priority, such as the launching of key infrastructure projects (US$20 billion), capitalization of SOEs ($7 billion) and strengthening of GOI financial institutions to support long term infrastructure financing. Some reforms have also been implemented, aimed at greater autonomy and simplification of procedures within large infrastructure entities such as PLN, which are expected to help strengthen overall governance. Yet the GoI s ownership in IIF might be seen as creating a conflict of interest, particularly with regards to ensuring the financial viability, versus socio-economic considerations, of IIF s investment decisions. There is also the possibility IIF could undercut the market price for infrastructure financing in Indonesia, thereby distorting the market and crowding out funding from the private sector. However, such risks are reasonably mitigated, particularly with IIF s track record, established governance structure, the minority GoI shareholding and medium term plan for an IPO. The proposed project is also expected to promote the strengthening of governance further, through its support and application of standards and procedures through IIF. Overall, as the overarching political and governance environment remains complex and vulnerable to be influenced by vested interests, the associated risks surrounding the political and governance environment remain Substantial. Macro-economic. The Government faces fiscal pressures, amidst a potentially more challenging international environment. However, the overall macro policy framework is responsive to risks of imbalances, and a range of contingency financing and crisis protocols are in place. The Government has also developed a track record in undertaking precautionary and proactive measures to counter external shocks. The policy decision to reduce fuel subsidy has also created much needed fiscal space, not only for better macroeconomic resilience, but also increased capital expenditure on infrastructure. The proposed project is also expected to promote higher infrastructure investments, which would further contribute to improved macroeconomic conditions overall. Hence, the macroeconomic risk is rated as Moderate. 29

31 c d e f g Sector strategies and policies. Although the Government continues to push for acceleration of infrastructure investment, there is still a need for more systemized and prioritized approach towards amending the laws and regulations that are relevant for infrastructure investments in general. The establishment of an infrastructure prioritizing body (KPPIP) and PPP center is expected to encourage good coordination and decision making overall, thereby promoting private sector involvement in the sector. Nevertheless, the lack of coordination and policy coherences among the various infrastructure related institutions in Indonesia remains a significant challenge, undermining investors sentiments. Against this backdrop, the proposed project s Fund approach for its equity component is will involve the need to strengthen the underlying regulatory and taxation frameworks. Hence, the risk surrounding the sector strategies and policies is rated as Substantial. Technical design of Project. The proposed additional financing will support IIF in deepening its lending operations. IIF has developed a good pipeline of projects for infrastructure financing and the additional financing will be used to help IIF address the market need effectively. IIF has in place a robust corporate governance and risk management framework that has been tested well during the implementation of ongoing IIFF project. Hence, the risk with regards to the technical design of the proposed project is rated as Moderate. Institutional capacity for implementation and sustainability. The proposed IIFF-AF entails scaling-up of IIF s operational capacities. As it has significantly built its operational capacity overall within the last few years, IIF has developed a solid track record in terms of its institutional development capacities. IIF will therefore likely to be able to build its capacities further, in order to support its scaling-up of activities, particularly as it is now taking a calibrated approach to expand into riskier market segments, and grow into a mature platform for financial intermediation to mobilize and channel private investments into infrastructure projects, and bridge Indonesia s infrastructure financing gap. Hence the institutional capacity risk is rated as Moderate. Fiduciary. The fiduciary arrangements of the ongoing IIFF project have been assessed as satisfactory. The fiduciary arrangements follow the government system and IIF procedures agreed by the Bank and reflected in the IIFFs standard operational procedures. To further improve the fiduciary arrangements, proposed strengthening measures include efforts to enable robust coordination among stakeholders during project implementation, enhance the appraisal and supervision by IIF of procurement and contract implementation carried out by the beneficiaries under the sub-projects, including ensuring consistency of provisions in the sub-project and contract documents with the Bank s requirements on Anti-corruption and Safeguards. The resulting Fiduciary risk is Moderate. Environment and social. Although IIF has demonstrated significant progress towards building its environment and social safeguards management capacities, the potential increase in investments deal volume could put pressure on social and environmental safeguards (S&E) management, which would require careful planning in accordance with the SEMS and institutional capacity build-up. The ongoing outreach and hands-on assistance of IIF on S & E safeguards to its potential clients has strengthened their capacity in managing the S & E risks meeting the requirements of the SEMS. Hence, the environment and social risk is rated as Substantial. 30

32 h Stakeholders. The IIFF project has helped in setting up a platform for engaging some key stakeholders in infrastructure investments. There is a multiplicity of stakeholders involved in the ongoing IIFF project, which include MOF, SMI and IIF. While coordination has been satisfactory, there remains a need to further strengthen the coordination between these agencies, as mentioned in the Financial Management analysis. The risk is rated as Moderate. V. World Bank Grievance Redress Communities and individuals who believe that they are adversely affected by a World Bank (WB) supported project may submit complaints to existing project-level grievance redress mechanisms or the WB s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address project-related concerns. Project affected communities and individuals may submit their complaint to the WB s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank s corporate Grievance Redress Service (GRS), please visit For information on how to submit complaints to the World Bank Inspection Panel, please visit 31

33 Project Development Objectives Original Project Development Objective - Parent: ANNEX 1. REVISED RESULTS FRAMEWORK The objective of the Project is to strengthen and further develop the institutional framework of the financial sector to facilitate financing of commercially viable infrastructure projects and thereby increase provision of private infrastructure in Indonesia. Key performance indicators to judge PT. IIF's success include the following outcomes: (i) increase in the number of commercially viable infrastructure projects achieving financial closure through long-term debt financing, other financial products, and advisory services from the IIFF over the life of the project; (ii) Increase in the amount of private capital (including long-term debt and equity) available for infrastructure projects over the life of the project; (iii) Increased support to government s policy making in private provision of infrastructure through advisory services from IIFF; and (iv) Increase in privately financed infrastructure in Indonesia. Proposed New Project Development Objective Additional Financing: To strengthen the financial capacity of IIF to increase the access to private sector financing for infrastructure in Indonesia Results Core sector indicators are considered: Yes Results reporting level: Project Level Project Development Objective Indicators Status Indicator Name Core Unit of Measure Baseline Actual(Current) End Target Marked for Deletion Marked for Deletion Revised Increase in the amount of private capital (including longterm debt and equity) available for infrastructure projects over the life of the project (values in USD million). Increase in number of privately financed infrastructure projects made bankable through the IIF?s advisory services The amount of financing from Bank funds provided by IIF to commercially viable infrastructure projects. Amount(USD) Value Date 27-Mar Nov Nov-2015 Comment Amount(USD) Value Date 27-Mar Nov Dec-2013 Comment X Amount(USD) Value Date 28-Feb Feb Feb-2022 Comment 32 Basic Bank indicator of project progress.

34 New New The amount of private capital supported by IIF relative to its own investment. Number of infrastructure financing supported by IIF using innovative financing, such as: (i) rupiah financing; (ii) take out financing; (iii) maturity greater than 10 years. Intermediate Results Indicators IIF will track the composition of IIF financing committed by financial products transacted by IIF Number Value Date 28-Feb Feb Feb-2022 Comment For project financing: to be calculated as [total project costs]/[total IIF financing] For corporate financing: to be calculated as [total debt and equity of the company]/[total IIF financing] Number Value Date 28-Feb Feb Feb-2022 Comment Includes all sub-projects receiving financial instruments that are considered as innovative in nature. Status Indicator Name Core Unit of Measure Baseline Actual(Current) End Target Revised New Number of infrastructure subprojects financed by IIF Number of IIF advisory engagements Number Value Date 28-Feb Feb Feb-2022 Comment Includes all IIF s sub-projects. Number Value Date 28-Feb Feb Feb-2022 Comment Includes both public and private sector advisory engagements. 33

35 ANNEX 2. IMPLEMENTING AGENCY ASSESSMENT 1. IIF as an institution has established itself as a small but credible player in Indonesia s project finance market, and is seen as an important vehicle to deliver privately financed infrastructure projects to help address the huge infrastructure gap. After five years of IIFF Project implementation, IIF is now fully operational, with well-developed institutional capacity and with an infrastructure investment portfolio of nine projects, with total commitments of IDR 2.5 trillion ($201 million) and outstanding investments of IDR 1.8 trillion (US$145 million). IIF also continues to build its advisory services business line, through which it is contributing to GOI s broader policy-making in relation with PPP and infrastructure financing. 2. Capital structure. IIF s total equity currently stands at IDR 1.91 trillion (US$154 million), comprising IDR 1.8 trillion (US$144 million) in paid-in capital and retained earnings of IDR 110 billion ($9 million). With IDR 1.8 trillion in paid-in capital, IIF is close to reaching its target of maintaining total equity of IDR 2 trillion and is actively engaged in meeting this requirement. At inception, IIF had four shareholders, of which SMI had the largest stake of 40 percent. The original shareholding of SMI and International Financial Institutions (IFIs) is expected to be diluted over time as private sector investors acquire stakes in IIF. On the debt-funding side, WB and ADB each made loans of US$100 million to IIF at inception. Subsequently in June 2014, IFC, together with Standard Chartered (SC) Bank and Deutsche Bank (DB), led a syndication of 16 banks to provide loans of US$250 million to IIF, which are expected to help diversify IIF s funding base and increase its access to longer term funding. 3. Institutional development marked the conclusion of a three-year phase of initial institutional development, and IIF is ready to progress to its next three-year plan. IIF has engaged in developing the areas of human capital, organization structure, risk management, standard operating procedures, and corporate finance. IIF is implementing a risk management framework that includes the areas of credit risk, operational and compliance risk, market risk and portfolio management, and social and environmental risk. IIF s Risk Management Directorate (RMD) monitors and reports its risk management activities to the organization and leadership. 4. Safeguards. IIF continues to build on progress made towards establishing good S&E management capacity. IIF is demonstrating robust capability in implementing the Social and Environment Management System (SEMS) as specified in the OM consistently for its portfolio and pipeline projects, with its Standard Operating Procedures (SOP) in place and its S&E team comprising of four S&E specialists with extensive relevant experiences prior to joining IIF. The proposed IIFF-AF will continue to finance subprojects through the range of IIF s financial products that are already included in the OM (as detailed in Annex W of the OM). There will therefore be no changes to the IIF OM. An explanatory note has been, describing specific implementation procedures to administer the IIFF-AF. 5. IIF s institutional capacity in managing social and environmental safeguards. IIF has demonstrated strong capacity in managing S&E safeguards that is governed by its Social and Environmental Management Systems (SEMS) for its current portfolio and pipeline. An S&E Division (SED) under the Risk Management Directorate has been established and well-functioned, which is mainly responsible for ensuring that the SEMS, which is part of the Operations Manual, is consistently followed by all subprojects financed by IIF. S&E safeguards have been 34

36 mainstreamed in the IIF s subproject loan processing cycle as governed in the Safeguards Standard Operating Procedures (SOP), an operational tool for implementing the SEMS. IIF management has strong commitment to strengthen its S&E capacity through recruitment of necessary S&E safeguards staff and providing continuous capacity building and training activities. Beyond the call of duty, IIF has actively promoted sustainable infrastructure financing by sharing its S&E principles and experiences with some commercial and regional development banks in the country as well as with the largest private bank in Indonesia. In line with these achievements, the Bank has noted that IIF has successfully conducted the SEDD and managed to implement the SEMS consistently for all of its portfolio projects. The recent WB safeguards specialists field visit to the MW Solar Power Plant Project in Gorontalo also confirms this overall assessment. 6. IIFF-AF implications for safeguards management. The proposed IIFF-AF will continue to finance projects through the range of IIF s financial products that are already included in the OM (as detailed in Annex W). There will therefore be no changes to the IIF OM. As the proposed IIFF- AF s financial products, sub-project types and sectors will remain the same as those of the ongoing IIFF project, the S&E safeguards risks of projects to be financed by IIFF-AF will remain similar to those of the IIFF project. Therefore, the 2014 SEMS and current practice of S&E management of the IIFF remain appropriate for the proposed IIFF-AF. IIF will continue to adopt the current principles, procedures, requirements and institutional arrangements of S&E safeguards management as specified in the 2014 SEMS. Further, IIF will continue to strengthen its current S&E staff through training, more exposures in the workshops or seminars, recruit new S&E manager and staff to manage S&E safeguards in accordance with its growing portfolio and pipelines. IIF is also planning to strengthen its grievance redress mechanisms and disclosure arrangements. 7. Financial Management and Procurement. Through implementation of the IIFF project, the WB Task Team has consistently found fiduciary performance to be satisfactory. As IIF has progressively built its business and operations, it has boosted its relevant components of institutional capacity so that its financial management and procurement related functions continue to perform satisfactorily with improvement of PT IIF control over disbursement and its treasury procedures to include management of Bank s excess fund and coordination among all stakeholders of the project. 8. Overall, IIF has emerged as a fully operational non-bank financial institution set to meet current and future business demands, playing an increasingly important and visible role in the financing of infrastructure projects in Indonesia. In particular, IIF presents unique value proposition in: Financing. IIF is the one of the few local financial institutions that can provide US dollardenominated financing and with tenures over seven years. While foreign banks may be able to offer products with those attributes, unlike IIF, foreign banks are generally reluctant to take long-term public sector counterparty risk without some element of sovereign support. Capacity. Indonesian banks are drawn to collaborate with IIF due to its unique expertise in project finance and due diligence, skills that have added a previously missing element to the Indonesian infrastructure finance market and mark a paradigm shift. In addition, Indonesian banks have come to realize the value of the environmental and social safeguards expertise arising from WB and IFC involvement with IIF that allows IIF deals to meet international standards. 35

37 ANNEX 3. SUMMARY OF MARKET CONSULTATIONS In order to better understand the existing challenges to long term infrastructure finance, market consultations were held in two rounds, broader consultations in 2015 and more focused consultations in Market consultations 2015 The first round of one-on-one market consultations with key market players were held in 2015, which is summarized below. Table 3.1: Market Consultations: Key Messages Category Organization Key Messages Banks BNI Typical loans have 5-7 years term. Difficult to lend longer term due to ALM. CIMB BCA Mostly lending to government/ SOE projects, with promoter guarantees. Avoid lending to infrastructure projects as high political and operational risks, land acquisition. Many instances - need to restructure loans. Prefer club deals to manage borrower exposure norms and risks. Financial Investors Macquarie Capital Bahana Pembinaan Saratoga Investama Developers Medco Power Nusantara Infra Astratel Bakrie Global Institutional Investors DPPLN Bahana TWG There is a limited local pool of money for infrastructure. Few bankable deals, long development cycle for green-field projects. Small but growing private equity interest in consumer and retail sectors. Few PE deals done in infrastructure that too largely in telecom towers. High tax incidence on equity transactions, especially on private trade. Macquarie has been highly selective in picking up deals, sees high political and regulatory risks in infrastructure projects. Need for new sources of equity and quasi-equity in Indonesia, as today promoters have to rely primarily on internal accruals to fund equity. Equity returns expectation should be moderated to the Indonesian environment with longer term holding period, given profitability constraints. The President s infrastructure push is welcome but major concerns voiced (i) Delays due to poor preparation and government s capacity constraints, and (ii) SOEs likely to get good deals and dominate investments. Historically have been investing in government bonds and bank deposits. Most investments are made of 3-5 years in view of the 5-year term of the board members of the PF. A practice that requires modification based on greater awareness/ education. Indonesian PFs are now exploring infrastructure investments, as the GOI is asking PF s to invest 10% of funds into infrastructure. Lack of clear exit options will be a major concern for this risk-averse group of investors. Market consultations 2016 During April-May 2016, consultations were held with select market participants to reconfirm market appetite for IIF s financing products and IIFF Additional Financing. Key findings of the consultations include: The findings are encouraging and confirm a niche market for IIF s financing. 36

38 However, accelerating the off-take of IIF s financing products would need greater market engagement with project sponsors, regional and local banks, government contracting agencies, and collaboration with key infrastructure financiers such as IIGF and SMI. Besides deal origination, deal incubation should form a major strategy for IIF to accelerate off-take of IIF s financing products. The following are summaries of the findings from consultations. (i) Equity bridge financing (consultation with PT Dharma Hydro Nusantara) For undertaking large infrastructure projects, developers find difficulty in raising large portions of equity from internal resources. It is also difficult to find strategic investors at the development and construction stage for large infrastructure projects given high risks. Foreign investors are wary of the government approval and long project development cycle of infrastructure projects in Indonesia. Thus, a product like equity bridge finance provides developers with an alternative to supplement their own equity during the early stages of the project. Once the project is constructed and operational, the project s risk profile reduces significantly and the project is able to attract additional equity from strategic investors. Such a product can improve the equity returns for developers. Furthermore, developers also feel that initially having one or two equity investor(s) facilitates speedier decision making and tighter project management. IIF is in an early stage dialogue with the developer for providing an equity bridge finance to a large renewable energy project. (ii) Promoter Funding (consultation with PT Len Industri [Persero]) PT Len is a diversified electronics company that is recently moving into infrastructure development. Having a small equity capital base, it is finding investing into large infrastructure projects difficult. It has stable cashflows coming from government contracts related to supply and commissioning of equipment and construction works. It has contracts with Angkasa Pura II, Department of Defense, GOI, PLN, etc. It has recently won the availability based payment PPP for central Palapa ring project and is facing constraints in raising its internal resources to meet the equity commitments for the project. For such infrastructure developers, Promoter Funding can be an attractive alternative to raise additional funding for meeting its equity commitments in the medium term. Promoter Funding loans could be serviced at the promoter company level, i.e. at PT Len level through stable cash flows from government contracts while the funds could be channeled into infrastructure projects as equity or subordinate debt from promoters. There is a niche market for Promoter Funding till such time that infrastructure developers are able to raise additional equity through capital markets or from strategic investors. (iii) Take out financing (consultation with Commonwealth Bank of Australia) Foreign banks such as CBA are keen to invest in infrastructure projects in Indonesia that have a balanced risk sharing structure. As most foreign banks, it is constrained to lend more than 7 years and thus is keen to explore blending its loans with take-out financing. As of date CBA does not have a large loan book in Indonesia and hence seeks to build it through well structured financing solutions. Lending from CBA will likely be as senior debt with standard security and collaterals such as charge on fixed assets, lien on accounts receivables, escrow arrangements, and with project 37

39 completion and cost over risks with project promoters. For large infrastructure projects, CBA will prefer club deals in a consortium of 5-10 banks depending on deal size. In terms of take-out financing structure, it would be prefer to have an option to be taken out rather than a mandatory take out. In recent months, CBA has received a few enquiries on infrastructure financing where it feels that take out financing could provide a suitable solution. An issue raised by CBA in the context of IIF was the latter s single borrower exposure limit that is restricted to 35 percent of the project cost and may not be sufficient to cover all senior debt in a project. A possible solution proposed by IIF is to structure the deal wherein IIF could lend to midsize projects to the extent of say 50 percent of debt while providing a take-out financing for the remaining portion that would be financed by other lenders. By the take out date, say after 5-7 years, a significant portion of the principal of both types of loans would have been repaid (say, 30 percent- 50 percent of the debt) thus allowing IIF to take over the loans from other lenders while still maintaining its exposure within the single borrower exposure norm. The success of the product would depend upon its attractiveness for borrowers (cost vs benefits) and the manner in which it is structured. Therefore, CBA is keen to explore the structuring of take-out financing with IIF. (iv) Debt financing for PPPs (consultation with IIGF) There is inherent need for providing comprehensive financing for infrastructure PPPs in Indonesia. A full financing package can be offered to project developers and thus reduce the financing risk and delays in financial closure. The demand for providing a comprehensive PPP financing solution also depends on how and where it is deployed. For instance, such financing could work well in projects that are not too large in scale where developers find it difficult to tie up funding from large national or international banks, or in sectors where PPPs are not so well established. The financing would work well in availability based payment PPPs as well as user charges based PPPs. Projects in sectors such as ICT, roads, water, wastewater, waste management are more likely to have an appetite for comprehensive financing solutions as against electricity, airports, oil and gas. A major factor for IIF to consider is that they will only be able to finance a portion of the project s debt. Hence, in order to provide a full package solution, IIF would need to lead a syndicate of banks and lenders. Another factor to consider is the learning curve within the GCA s team. So there will be a need to generate awareness amongst GCAs and considerable hand-holding to make the project structure bankable. IIGF is working with a few GCAs on projects that can benefit from a comprehensive financing solution and this could be a good opportunity for IIF to collaborate with IIGF to introduce comprehensive PPP financing solutions in Indonesia. According to IIGF, they envision 2-3 deals over the next 2 years that could utilize such financing. 38

40 ANNEX 4. INSTITUTIONAL CAPACITY AND FINANCIAL ASSESSMENT OF IIF A. Review of IIF s Institutional Positioning and Strategic Objectives Company profile 1. PT Indonesia Infrastructure Finance (IIF) was established on January 15, 2010 as a private non-bank financial institution, under an initiative of the Government of Indonesia, in cooperation with the World Bank, Asian Development Bank (ADB) and other international multilateral agencies under regulation (PMK) No. 100/PMK.010/2009 dated May 27, 2009 with a focus on investing in commercially viable infrastructure projects in Indonesia and to encourage private sector engagement in the country s infrastructure development. 2. IIF provides long-term fund-based products such as senior loans, mezzanine finance and equity participations, in addition to non-fund-based products such as guarantees and feebased services, and thereby provides an important additional source of funding for infrastructure projects in Indonesia. Supported by a strong capital base from its shareholders and 25- year subordinated loan on-lending facilities from the World Bank and the Asian Development Bank, IIF is well positioned to assist in bridging the gaps in the country s requirements for infrastructure financing. 3. Designed as a catalyst for this particularly unique but strategically vital sector, IIF also plays a distinctive role in providing advisory services and supporting the Indonesian Government in infrastructure policy making by providing transactional advisory services to public sector clients for the procurement of infrastructure services under the Public Private Partnership (PPP) model. This is in line with IIF s determination to emerge as an experienced and respected repository of knowledge and skills in the field of commercially Vision To become the leading catalyst for financing infrastructure in Indonesia. Mission Shareholders IFC, % ADB, % DEG, % SMBC % To ensure investor needs are reflected in contractual structures and concessions. To lead in offering a mix of long term financing instruments appropriate for infrastructure To work with Indonesia s financial institutions and other institutional investors to channel the nation s savings into the long term development of Indonesia s infrastructure. viable infrastructure project development and financing, including those projects under the PPP model. 4. IIF applies international-standard best practices in terms of social and environmental safeguards and exercises good corporate governance in order to promote more sustainable infrastructure project development in Indonesia. SMI, 30% SMBC SMI DEG ADB IFC 39

41 Business lines 5. IIF has two business lines, viz. Investment business that provides senior debt, subordinate finance and equity investments to commercially viable infrastructure projects in Indonesia; and Advisory business that provides advisory services to public and private sector on policy issues, project preparation and financial structuring of bankable infrastructure projects in line with international standards. IIF s business lines focus on creation of infrastructure in sectors such as, transportation, roads, irrigation, drinking water, waste water, telecommunication and information, electricity, oil and gas. Select examples are provided in Table 4.1. Table 4.1: Products and Services of IIF Products and Services Investment Products Fund based - Senior debt, subordinated debt, mezzanine finance and equity investment Non fund based guarantees, credit enhancement, performance bonds, standby facilities Advisory Services Transaction advisory services to the government Infrastructure policy, legal and regulatory advisory Transaction advisory services to private sponsors Source: IIF s Annual Report, 2015 Select Deals Financing of 2 MW solar power plant in North Gorantalo Financing of expansion of terminal 3 of Soekarno Hatta International Airport Mandatory convertible bonds for a renewable energy platform Co-advisory on Trans Sumatra toll toad Private sector advisory on Batam PPP project Advisory to Ministry of Home Affairs on regulatory framework for availability payment based PPPs at regional government level Loan and Investment Portfolio 6. IIF has commitments of IDR 5479 billion (~US$ million), of which investments made of IDR 4175 billion (~US$ million). Following figures highlight the portfolio s composition. Figure 4.1: IIF s current loan and equity portfolio, as of March

42 Source: Loan and equity investment monitoring data from IIF, April 2016 Credit Rating 7. Fitch Ratings has assigned IIF with a national long-term rating of AAA(idn) with a stable outlook. The rating assigned to IIF is supported by the following key considerations. Table 4.2: Key considerations for IIF s credit rating Strengths Strategic importance of PT IIF: PT IIF is a credit-linked public sector entity created to act as a catalyst for achieving the infrastructure development agenda of the Government of Indonesia through various fund based, non-fund based, and fee based instruments and services. Infrastructure improvement is a highly strategic priority of the Government of Indonesia. Therefore, PT IIF is expected to receive strong support from the Government of Indonesia in terms of political and financial commitments. Strong shareholders: The major shareholder of PT IIF is PT SMI, a government-owned entity with a credit rating of idaaa with a Stable Outlook by PEFINDO Rating for local rating and global rating of BBB- which reflects the sovereign rating from Fitch Rating. In addition, three other shareholders of PT IIF are multilateral agencies with an investment grade rating and a stable outlook. The only non-public sector shareholder of PT IIF also has an investment grade rating and a stable outlook. Given the strong commitment of support to PT IIF from these shareholders, based on their weighted average rating, the rating of AAA(idn) with a Stable Outlook of PT IIF is justified. Tight control: The daily operations and management of PT IIF are actively supervised and monitored through regular meetings between the Board of Commissioners (BoC) and the Board of Directors (BoD). The BoD need approval from the BoC for projects above a threshold level. There are nine members of the BoC including, one member of each shareholder group, two representatives from the MoF and three independent commissioners. This tight control and monitoring by government justifies the rating of AAA(idn) with a Stable Outlook of PT IIF. Improved financial performance of PT IIF: The major source of revenue for PT IIF is the interest income from loans advanced. The interest income increased from IDR 118 billion in FY2014 to IDR 196 billion in FY2015. As its lending portfolio grow, PT IIF is expecting its interest income to increase to IDR 832 billion by FY2019. In addition, PT IIF also receives treasury income from investments in time deposits and bonds with its large holdings of funds that have not been lent out. The treasury income has been growing at a healthy CAGR of 29 percent from FY2012 to FY2015. This healthy financial performance of PT IIF justifies its rating of AAA (idn) with a Stable Outlook. Increased demand for infrastructure financing: The loans advanced by PT IIF increased two-fold from IDR 1,592 billion in FY2014 to IDR 3,343 billion in FY2015. Majority of these loans have been advanced by PT IIF 41

43 in sectors of Telecommunications, Toll Roads, Energy, Airports, Seaports, and Aircraft Maintenance. Loans to other mandated sectors including roads and drinking water are likely to increase in the medium term. In addition, nearly 48 percent of the total loans advanced are denominated in US$, reflecting the demand for foreign-currency loans for infrastructure projects. This robust demand for infrastructure loans justifies the rating of AAA (idn) with a Stable Outlook of PT IIF. Sufficient borrowing capacity: PT IIF has been maintaining a debt to equity ratio of less than 1.5 times and a debt to capital ratio of less than 0.6 times. With regular equity capital infusions and maintaining more than 35 percent of the total assets as cash and cash equivalents and marketable securities, PT IIF has been adhering to the various financial covenants agreed in the borrowing agreements with existing lenders. With sufficient borrowing capacity available with PT IIF and a track-record of successfully and satisfactorily adhering to the financial covenants agreed in the borrowing agreements with existing lenders, PT IIF is not likely to face any borrowing constraints. This justifies the rating of AAA(idn) with a Stable Outlook of PT IIF. Some of the critical considerations that are likely to trigger a ratings downgrade for PT IIF include, a reduction in the shareholding of PT SMI and the multilateral agencies below 50 percent (controlling stake), and a reduction in MoF s influence on the BoC of PT IIF. Source: Fitch Ratings Indonesia, IIF has recently launched a public issuance of new bonds aggregating IDR 2 trillion in July For the new bond issuance, IIF has obtained a credit rating from Pefindo (the local affiliate of S&P) of IndAAA reflecting the highest level of credit rating. B. Corporate Governance Arrangements 9. IIF follows the principles of good corporate governance transparency, accountability, responsibility and impartiality. It has incorporated a code of conduct that supports governance activities within the company s structure. This section summarizes the institutional framework of IIF including its existing and proposed organization structure, staffing and governance practices. 1. Governing Bodies 10. The main organs of good corporate governance that are instituted in IIF are the General Meeting of Shareholders (GMoS), the Board of Commissioners (BOC) and the Board of Directors (BOD). They are assisted by the committees of the BOC and BOD. More details below. 11. General Meeting of Shareholders. The GMoS is the highest governing body, whose authority is regulated by law and IIF s articles of association. The GMoS consists of the annual GMoS and, if required, the extraordinary GMoS. The GMoS has the following authority, amongst others: Table 4.3: Authority of the General Meeting of Shareholders Appointment and termination of the BoC and the BoD members Evaluation of the performance of the BoC and the BoD members. Approval of IIF s financial statements, and Determination of the remuneration of the BoC and the BoD members. Source: Information from IIF,

44 12. Board of Commissioners. The Board of Commissioners (BOC) assisted by its specialized committees is at the apex of IIF s organization structure. The BoC is responsible for overseeing the policies and management of the company, which is under the responsibility of the Board of Directors (BOD), as well as providing counsel and recommendations to the BoD. This includes supervising the execution of the IIF s business plan and budgeting, ensuring compliance with the articles of association, resolutions from the GMoS, and prevailing laws and regulations, in accordance with the Company s best interests. The composition of the current BOC is presented below. Table 4.4: Composition of IIF s Board of Commissioners No. Name Representation 1 M Chatib Basri President Commissioner & Independent Commissioner, and former Minister of Finance of Republic of Indonesia 2 Edwin Gerungan Independent Commissioner & former President Commissioner of Bank Mandiri and former Independent Commissioner at Bank Danamon and Bank Central Asia 3 Zulkifli Zaini Independent Commissioner & former President Director of Bank Mandiri and former Commissioners of Bank BNI and PLN 3 Marwanto Harjowiryono Director General of Treasury, Ministry of Finance of the Republic of Indonesia 4 Robert Pakpahan* Director General of Budget Financing and Risk Management, Ministry of Finance of the Republic of Indonesia 5 Robert Dolk ADB representative and independent ED of Zurich Financial Services Australia Limited, Law Cover Insurance Pty Limited, and Amber Holdings 6 Hans-Juergen Hertel DEG representative and former Director of DEG Office in Jakarta 7 Richard Ranken* IFC representative 8 Rajeev Kannan SMBC representative and General Manager, Project & Export Finance Department in Sumitomo Mitsui Banking Corporation *) Appointed as members of Board of Commissioners since March Source: Information from IIF, Committees of the Board of Commissioners. In line with good corporate governance practices and to support the effective discharge of the Commissioners duties and responsibilities, the BOC has constituted the following specialized Committees. Table 4.5: Committees of IIF s Board of Commissioners No. Name Responsibilities 1 Audit Committee Supervises internal controls, accounting policy, financial reporting, and the internal and external auditors 2 Investment Committee Supervises IIF s investment activities and considers investment proposals 3 Nominations and Remuneration Committee Recommends the remuneration for members of the Board of Directors and Independent Commissioners and also sets forth the general remuneration policies for the company s staff 4 Risk Oversight Committee Supervises IIF s risk management function, introduction of adequate risk controls for IIF s assets and liabilities, and provision of recommendations on risk mitigation Source: Information from IIF,

45 14. Board of Directors: Headed by the President Director, the BOD is accountable for the achievement of IIF s corporate objectives. Throughout the implementation of its duties and responsibilities, the BOD represents IIF in any circumstance within and outside courts, and has the power and authority to bind IIF with any third party and undertake any action pertaining to IIF s property ownership and disposition. The BOD is collectively and individually responsible for coordinating, monitoring and leading the company in accordance with the company s interests and for managing and safeguarding its assets. The composition of the current BOD is presented below. Table 4.6: Composition of IIF s Board of Directors No. Name and Designation 1 Ari Soerono President Director & Chief Executive Officer 2 Indrawati Darmawan Director & Chief Financial Officer 3 Harold Tjiptadjaja Director & Investment Officer 4 Wito Krisnahadi Chief Director & Chief Risk Officer 5 Hilda Savitri Director & Chief Investment Officer Source: Information from IIF, 2016 Role Responsible for establishing and executing IIF s policies, budgets, objectives, strategy and vision while ensuring alignment with and support from the BOC and shareholders, and to provide direction to the company and the Corporate Directorate. Responsible for contributing to IIF s strategic plan and developing yearly plan, objectives, budgets, policies, procedures and systems in order to give direction to the company and the Finance Directorate. Responsible for contributing to IIF s strategic plan and developing yearly plan, objectives, budgets, policies, procedures and systems in order to give direction to the company and the Investment Directorate. Responsible for contributing to IIF s strategic plan and developing yearly plan, objectives, budgets, policies, procedures and systems in order to give direction to the company and the Risk Management Directorate. Responsible for contributing to IIF s strategic plan and developing yearly plan, objectives, budgets, policies, procedures and systems in order to give direction to the company and the Investment Directorate. 15. Committees of the Board of Directors. To support the effective discharge of the Directors duties and responsibilities, the BOD has constituted the following specialized Committees. Table 4.7: Committees of IIF s Board of Directors No. Name Responsibilities 1 Investment Committee Reviews all investment proposals to be submitted to BOC-IC for further assessment, subject to approval thresholds. Coordinates with Assets & Liabilities Committee to ensure funding adequacy for proposed investments, monitors implementation of all investments and periodically reviews credit investment policies. 2 Assets and Liabilities Committee Monitors the risk and management of funds and other resources, primarily in managing market risk and liquidity risk. 3 Risk Management Committee Monitors the risk management of IIF s business activities and provides recommendations in formulating risk management policies and strategies. 4 Information Technology Steering Committee Prioritizes and aligns IT initiatives with business strategy, and oversees major IT related strategies, projects and technology architecture decisions. 44

46 No. Name Responsibilities 5 Human Resources Committee Legislate and review the Company s internal regulation and policy regarding employment, human resources, benefits. Source: Information from IIF, Organization Structure 16. IIF s organization structure has been aligned to the good corporate governance framework adopted. Some reorganization is being effected in 2016 to better align with the business plan for The organization structures for 2015 and are provided in 3. Following section provides a brief overview of the salient features. 17. Divisional reporting. Below the BOD, various divisions of IIF report to their respective Directors. Investment Directorate. Within the Investment vertical, the Investment Managers, Transaction Legal and Project Supervision report to their respective Directors (Chief Investment Officers - A and B). The Syndications division, which was earlier reporting to the Advisory Group Head, will now report to the CIO A, from 2016 onwards. This effectively segregates the investment functions from advisory functions and will bring in greater synergy between investment and syndication activities. Advisory Group. The public sector and private sector advisory divisions that were working independently have been regrouped under the head of the Advisory Group. The syndications team has now been relocated within the investment function. Risk Management Directorate. The Risk Management function works independently under the Chief Risk Officer. This includes credit risk management, social and environmental management, market risk and portfolio management, operational, KYC and compliance risk management. Finance, Operations and Corporate Planning Directorate. The functions of finance, operations and corporate planning report to the Chief Financial Officer. At present, the President Director holds the interim charge of CFO. Corporate Secretary, Human Resources and General Administration (HR & GA) and Internal Audit are under Corporate Directorate and report directly to the President Director. 45

47 Figure 4.2: Organization Structure of IIF Note: The Committees of the BOC and BOD are reflected in grey. Table 4.7: Headcount 2015 to 2020 Figure 2.3: Manpower Distribution 2015 to CEO CFO CIO CRO Advisory Total Source: Information from IIF,

48 18. Headcount. IIF increased its total staff strength by 32 percent from 57 employees in 2015 to 75 employees in 2016 to gear up for its growth in business. By 2020 it plans to increase the staff strength to 100 employees, almost double its size today. The planned increase in manpower is evenly distributed across its business verticals. Details are provided in Table 4.7 and Figure 4.3 above. 19. Corporate Governance Policies. IIF has implemented good corporate governance policies in line with international standards. The principles underlying the company s good corporate governance are transparency, accountability, responsibility, independence and fairness. IIF implements good corporate governance based on its shareholders agreement, articles of association, charters of BOC, BOD and their committees, IIF s operations manual, policies, standard operating procedures and guidelines, company regulation for employees, code of ethics. 3. IIF s Risk Management Framework 20. IIF has instituted a comprehensive risk management framework in line with international practices. This is implemented through an independent Risk Management Directorate (RMD) under the leadership of CRO who acts under the supervision of BOD RMC and BOC ROC. The RMD monitors at least four key risks credit risk, market risk & portfolio management, operational & compliance risk management, and social and environment risk. An overview of the framework is provided below. Table 4.8: IIF Risk Management Framework 1.Risk Management Policies Credit Risk Operation Manual Operational Risk Operation Manual Market Risk Operation Manual Social and Environment (S&E) Operation Manual Policy in Managing Potential Conflicts of Interest for IIF s Loan and Equity Investments 3.Charters BOC Investment Committee Charter BOD Investment Committee Charter Asset and Liability Committee Charter Risk Oversight Committee Charter Risk Management Committee Charter 4.Standard Operating Procedures (SOP) Credit SOP Operational Risk SOP Market Risk SOP Portfolio Management SOP Social and Environment (S&E) SOP 5.Service Level Agreement (SLA) SLA with Investment Directorate (Credit and S&E Unit) SLA with Finance Directorate 6.Delegation of Authority from BoC to BoD-IC Source: Information from IIF, Guidelines & Policy Implementation Procedures Portfolio Management Guideline Exposure Limit Framework Insurance Guideline Policy Implementation Procedure for Credit Risk Policy Implementation Procedure for Capital Adequacy Policy Implementation Procedure for Loan Loss Provisioning Group Exposure Guideline Business Continuity Management Guideline Data Protection Guideline Policy Implementation for Risk Rating Policy Implementation Procedure for Investment Pricing Policy Implementation Procedure for Corporate Risk Rating Adjustment Commitment Fee Guideline Sector Allocation Guideline Credit Risk Appetite Statement Guideline for KYC Principle Periodic Review Document Template Credit Risk Department and Investment Directorate 47

49 21. Credit risk management. This focuses on assessing counterparty risk and in assuring appropriate credit management analysis, structures and decisions processes. Key activities include, appraising, site visit and due diligence of the financial opportunity and the project, and then rating the level of credit risk exposure to a project company or borrower. If the financing proposal is approved by the BOD-IC/ BOC-IC then the suitable covenants are placed in the financing documents as conditions to be fulfilled by the borrower. Thereafter, the credit risk is monitored annually and re-rating of the borrower is undertaken as required. 22. Rating Tools. IIF has its internal rating tools to rate the level of credit risk exposure of a project company to which the IIF extends financing facility. Each proposed transaction is rated before an approval to transact is given. The rating process includes evaluation of the transaction using specific internal rating tools. For project financing, IIF has acquired the project finance rating model from S&P Capital IQ, a subsidiary of S&P, which has been implemented starting October For corporate financing, IIF has conducted an exercise to adjust IIF's risk rating model from CRISIL for corporate financing, of which the first version has been approved by RMC on Dec 2, This will be a continuous project for Risk Team. Table 4.9: Rating tools used by IIF Project Finance Rating Tool 1. Model uses 5 parameters to determine for rating: Revenue and contract Competitive market position Financial strength Construction, operation and technology Legal and financial structure 2. Each parameter has several risk factors that are scored between 1 to 10 (from best to worst). The tool takes the lowest score of factors within each parameter as the overall score of that parameter. 3. All five parameters will be combined together to obtain Project level score that will be become the Implied Project Rating ( IPR ) 4. Final Project Rating ( FPR ) will be determined by another three adjustments, if any: Force majeure adjustment, if there are any major force majeure anticipated that would notch down the IPR to max four notches Country risk cap, to be applied if country risk rating is lower than IPR Credit enhancement In the absence of the above adjustments, IPR will be the same with FPR. Source: Information from IIF, 2016 Corporate Finance Rating Tool 1. Model uses 4 parameters for rating: Business risk Financial risk Sector/Industry risks Management and governance 2. As in project finance scorecard, each of the factors is scored between 1 to 10 (from best to worst) based on the characteristics of the project. 3. Unlike the S&P Capital IQ model for project finance rating, the corporate rating model from CRISIL has determined specific weighting of the factors for each parameter. 4 Using the score of 1 to 10 and weight of each factors, the tool will generate total risk score that will later determine the overall rating. There is no adjustment flexibility to overall rating to determine final rating as in the project finance scorecard. 48

50 23. Rating Scale. The risk rating is scaled between IIF1 (the best) to IIF10 (the worst). The Investment Team will propose the rating using the tool for Credit Risk Team review. In case there is difference opinion between Investment and Credit Risk Team, the BOD-IC will provide final decision. The lowest rating of any projects for investment consideration is limited at IIF 7. Table 4.10 below provides illustrative ratings assigned by IIF. Table 4.10: Select ratings of IIF s loan portfolio No Name Sector Rating Financing Facility Approval Date Loan Agreement Date Monitoring Latest Rating Date 1 Project A Road IIF2 Project Senior Loan Semi Annual Project B Electricity IIF3 Operational Senior Loan Annual Corporate A Telecom IIF3 Corporate Revolving Facility Annual Project C Electricity IIF4 Project Senior Loan Semi Annual Corporate B Airport IIF4 Corporate Senior Loan Annual Source: Information from IIF, Exposure limits based on ratings. The ratings assigned to each project determines the level of IIF s exposure. This is based on the following prudential norms that have been adopted by IIF. Table 4.11: Maximum exposure limits of IIF Based on Project Cost Based on Rating of the Project Group Exposure Limit Sector Exposure Limit 3 Project Exposure Limit Facility Limit % of project cost Senior 20% for Large Project ( L ) 35% for Mid/Small ( M ) Equity & 10% (L) or 15% (M) sub- debt within respective overall exposure cap Rating Limit % of project cost Overall Portfolio Exposure Limit Based on Rating Limit overall (% of Total IAUM 2 ) Portfolio Grade 8 and below 0% Composition Grade 7 and above 5% Grade 6 and above 15% Grade 5 and above 30% % Grade 4 and above 50% % Grade 3 and above 80% % Grade 2 and above 100% 8-10 Do not lend Grade 1 and above 100% 30% of IIF s capital (group = 2 or more entities that are associated through commonality of management or effective control on the management ) Sub-Debt and Equity Portfolio Limit 40% of IIF s capital (this limit include all Sub-Debt/Mezzanine/Non- Dilutive Instruments and Equity Portfolio) 25% of IIF s capital (this limit include any direct equity stake, participation through the secondary market and any sponsor funding done against equities as collateral) *) Sector Score Limit Sector Score Limit Electricity % Airport % Oil and Gas % Railways & MRT % Telecommunication % Water & Waste % Roads % Others - 15% Port % 49

51 Source: Information from IIF, 2016, Reference: IIF s Investment Manual Lending Guidelines, IIF s Credit Risk Management Policy, Memo to BoC-IC June 13, 2012, ROC s Group Exposure Guideline dated on June 11, 2014 and Portfolio Management Guideline as approved in the RoC meeting dated on June 8, Large Projects are with total costs >IDR 1 trillion, while Medium and Small Project are with total costs IDR 1 trillion 2. Limit refers to Total Investment Asset Under Management (IAUM) as confirmed by RMC and ROC dated October 1, IAUM is defined as total equity, subordinated loans, syndicated loans (including undrawn portion); after deducting 10% reserve for liquidity purpose. 3. At any time, total commitment for each sector cannot exceed 50% of Total Current Portfolio. Sub-limit for coal-based projects not more than10% of Total Exposure. Maximum allocation each sector with buffer up to 10% ; which needs to be properly justified by the portfolio management, by taking into account credit profile of the portfolio, diversification and correlation risk, including market opportunity and macroeconomic condition. 25. Social and environment risk management. Each project or borrower needs to comply with all applicable national S&E laws and regulations, as well as IIF s SEMS which are in line with the Bank s requirements on an on-going basis, during the tenure of IIF financing. The 2014 SEMS Chapter 2.2 stipulates that IIF will comply with: Indonesian laws and regulations; 8 The 2012 IFC Performance Standards (PS), which are also utilized by DEG in its E&S assessment and management process; The seven World Bank Safeguard Policies that could be triggered by IF s subprojects; and, The ADB Safeguard Policies that would be triggered by the IIF s subprojects. Table 4.12: S&E compliance with key country requirements Related to the S&E requirements, all of the project activities financed by IIF have to comply with the Indonesian Government Regulations, among others: Law of the Republic of Indonesia No. 1 of 1970 on Safety. Law of the Republic of Indonesia No 13 of 2003 on Manpower Labor. Law of the Republic of Indonesia No. 32 of 2009 on Environmental Protection and Management. Law of the Republic of Indonesia No. 2 of 2012 on Land Acquisition for the Development of Public Interest. Indonesian Government Regulation Number 18 of 1999, regarding Management of Hazardous and Toxic Wastes. Indonesian Government Regulation No. 41 of 1999, concerning Control of Air Pollution. Indonesian Government Regulation No. 82 of 2001, regarding Management of Water Quality and Water Pollution Control. Indonesian Government Regulation Number 16 of 2004, regarding Land Stewardship. Indonesian Government Regulation No. 15 of 2005, on Toll Roads. Indonesian Government Regulation No. 27 of 2012 regarding Environmental Permit. President Regulation No. 71 Year 2012 regarding Land Acquisition for the Development of Public Interest. President Regulation No. 40 of 2014 regarding First Amendment of President Regulation No. 71 Year 2012 regarding Land Acquisition for the Development of Public Interest. President Regulation No. 99 of 2014 regarding Second Amendment of President Regulation No. 71 Year 2012 regarding Land Acquisition for the Development of Public Interest. Regulation of the Ministry of Environmental, No. 21 of 2008 regarding Emission Threshold Value of Static Source for the Thermal Power Plant. Regulation of the Ministry of Environment, No. 5 of 2012 regarding Types of Activities and/or Businesses that require AMDAL. Regulation of the Ministry of Environment, No. 51 of 2004 regarding The Threshold Value for Seawater Quality. Regulation of the Ministry of Environment No. 51 of 1995 about the Waste Water Threshold Value. Regulation of the Minister of Health Republic of Indonesia, Number: 4167/MENKES/PER/IX/1990, on Terms of Water Quality Monitoring. Decree of the Minister of Environment / Head of BAPEDALDA Number: KM-48/MENLH/11/1996, about Raw Noise Level. Decree of the Minister of Environment Number: KEP-299/11/ Technical Guidelines Review of Social Aspects In the preparation of Environmental Impact Assessment. Decree of the Minister of Environment Number: KEP-124/11 / Technical Guidelines Review of Public Health Aspects of the Preparation of Environmental Impact Assessment. As reference for the preparation of the EIA documents for societal health aspects. 8 Notwithstanding the list as specified in Table 15, as a financial entity operating in Indonesia, IIF shall comply with all prevailing Indonesian laws and regulations. 50

52 Decree of the Minister of Public Works 295/PRT/M Rl No. 2005, on Toll Roads. As a reference preparation of the EIA document. Source: IIF Annual S&E Performance Report, Social and Environmental Management System (SEMS). IIF s S&E Principles are consistent with the requirements of the IIF s Strategic Investors as defined in the Shareholders Agreement dated March 19th, 2012, as amended from time to time. In 2014, IIF has augmented and harmonized its SEMS to comply with the 2012 IFC PS. IIF S&E Principles consists the following: Table 4.13: IIF s S&E Principles IIF s S&E Principles under its Social & Environmental Management System (SEMS) Principle 1: Social and Environmental Assessment and Management System (SEMS) Incorporates the following elements: Screening and categorization of projects; Social and Environmental (S&E) Assessment; S&E management program; Organizational capacity and competency; Training Emergency preparedness and response; Stakeholder engagement; Monitoring and review; and Reporting. Applicable to all IIF projects. Principle 2: Labor and Working Conditions Promote the fair treatment, non-discrimination, and equal opportunity of workers; Establishes, maintains and improves worker - management relationship; Addresses child labour, forced labour, migrant workers, workers engaged by third parties, and workers in the client s supply chain; and Promotes safe and healthy working conditions and practices. Applicable to all IIF projects. Principle 3: Pollution Prevention and Abatement and Climate Change Addresses pollution prevention and management of impacts arising from project activities; Ensures conformance with global good practice and standards; Promote more sustainable use of resources; and Ensures that climate change issues associated with projects activities are assessed, mitigated and monitored over the life of IIF s investment. Applicable to all IIF projects. Principle 4: Community Health, Safety and Security/Dam Safety Seeks to avoid or minimize the risks and impacts to Affected Community health, safety and security that may arise from project activities; The project s direct impacts on priority ecosystem services may result in adverse health and safety risks and impacts to Affected Communities; Ensures that the safeguarding of personnel and property is carried out in accordance with relevant human rights principles and in a manner that avoids or minimizes risks to the Affected Communities; and Includes special requirements related to the safety of dams associated with projects. Applicable to all IIF projects. Principle 5: Land Acquisition and Involuntary Resettlement Refers to both physical displacement (relocation or loss of shelter) and economic displacement (loss of assets or access to assets that leads to loss of income sources or means of livelihood) as a result of project-related land acquisition; Does not apply to physical or resettlement resulting from voluntary land transactions; Avoid, minimize, mitigate or compensate for adverse social and economic impacts from land acquisition or restrictions on land use through the process of Social and Environmental Assessment under Principle 1; and No forced evictions will be carried out except in accordance with law and the requirements of this Principle. Applicability of this Principle will be determined during project screening and appraisal. Principle 6: Biodiversity Conservation and Natural Resource Management Includes protection, conservation and sustainable management of biodiversity and living natural resources; Maintain the benefits from ecosystem services; and Evaluate primary suppliers risk of significant conversion of natural and/or critical habitats. Applicability of this Principle will be determined during project screening and appraisal. Principle 7: Indigenous Peoples (IP) Includes identification of all impacts (positive & negative) on IP; social assessment, informed consultation and Participation (ICP) to Indigenous Peoples Development Plan; Anticipate and avoid, or when avoidance is not possible, minimize and/or compensate project adverse impacts on communities of Indigenous Peoples; and applies to projects that impact individuals or communities that meet the definition of Indigenous People, determination of which may require Free, Prior, Informed, and Consent (FPIC). Applicability of this Principle will be determined during project screening and appraisal. Principle 8: Cultural Property and Heritage Recognizes the importance of cultural property and heritage for current and future generations, consistent with the Convention Concerning the Protection of the World Cultural and Natural Heritage; and Seeks to guide IIF project sponsors in identifying and protecting cultural heritage in the course of project design and execution. Applicability of this Principle will be determined during project screening and appraisal. Source: IIF Annual S&E Performance Report, SEMS Assessment & Monitoring. The SEMS is implemented through a dedicated SEMS unit of IIF that independently works under the CRO. The SEMS unit ensures that the S&E safeguards are integrated by developer or borrower into the project design prior to financing, 51

53 during the construction, and operational phases. The unit ensures the project developer follows national labor laws and regulations and internationally recognized labor practices, and mitigates S&E risks of the projects through corrective actions acceptable to IIF, project developer and/or its sponsors. The SEMS unit aims at transparency in IIF s S&E risk assessment and mitigation process. The project cycle comprises of three stages as presented in the Table below. Table 4.14: IIF s Social and Environment SOP Preliminary review stage In this stage, all procedures required before the in-principal approval of the project, are carried out. Source: IIF Annual S&E Performance Report, 2015 Project appraisal and sanction stage In this stage, all procedures required before the project is appraised for funding are performed. It includes a detailed appraisal of the project to be funded. Post loan signing and Post operation monitoring stage In this stage, all procedures required for project monitoring during implementation as well as at the end of funds disbursement period are performed. Subsequently, these procedures are followed during the project operation cycle until IIF exits the investment. 28. Hence during initial project assessment, IIF has to conduct a separate S&E Due Diligence (SEDD) for each project (either self-conducted by IIF s S&E Team or with assistance from IIF s S&E Consultant) to review compliance against its S&E requirements as specified in the SEMS. Based on SEDD results, a customized Corrective Action Plan (CAP) is normally prepared if there are any gaps found. As part of IIF s financing requirements, the project needs to implement CAP by the required deadline. Generally, CAP will be part of the transaction document. Compliance with the CAP and other standard covenants will be imposed in the loan documentation or other legal agreements. However, certain project cases may need a degree of flexibilities in the approach of documentation (for example: when the project involves a large syndication and that IIF s participation in the project is post the financing and therefore, it would not be feasible to re-open the existing financing document), that instead of putting the CAP requirements as covenants in the main documentation, IIF uses other arrangements. The following table presents an illustrative example of S&E assessment. 52

54 Table 4.15: Illustrative Example of S&E Assessment in IIF s portfolio No Project Type Status Categorization & Rationale & Key Safeguards Issues 1 Toll Road (Cipali, PT Lintas Marga Sedaya) 2 Telecom (Corporate Financing): Indosat, XL, Solusi Tunas 3 Gas Fired /Engined Power Plant LPG Processing Plant- Gas Piping. Batam and Jakarta 4 Airport and Port (Corporate Financing)- Garuda Maintenance Facility-and Terminal III upgrading _in Jakarta. Port stevedoring and equipment supply in Jakarta and Makassar. Operating, partly disbursed Operating, fully disbursed Greenfield project, fully disbursed Operating, Partly disbursed A B A, B A, B The project potentially contributes significant adverse impact to the environment and social. About 6000 HH affected by the project. The project potentially contributes very limited adverse environmental or social impacts. No involuntary resettlement involved The project potentially contributes significant adverse impact to the environment and social. Key issue: Health and Safety during construction, operations. Noise. The project potentially contributes limited adverse impact to the environment. No involuntary resettlement involved. Key safeguards issues: Health and Safety issues during construction, operations and waste management. S&E Assessment and Safeguards Instruments Prepared SEDD and CAP, ESIA ESMP CAP is part of the covenant in the loan agreement. Implementation and monitoring of CAP. Supplemental RAP SEDD and CAP. CAP is part of the Statement letter. Monitoring of CAP. EMP SEDD and CAP. CAP is part of the covenant in the loan agreement. Implementation and monitoring of CAP. ESIA and ESMP, abbreviated LARAP SEDD and CAP. Statement letter. AMDAL/ESIA 5 Renewable Energy (Mezzanine- Mandatory Convertible Bond)- Solar Power, Wind, mini hydro. Operating, fully disbursed B The project potentially contributes limited adverse impact to the environment. No involuntary resettlement involved. Key safeguards issues: Health and Safety issues during construction and operations. SEDD and CAP. CAP is part of the covenant in the loan agreement. EMP/UKL UPL Source: IIF Annual S&E Performance Report,

55 29. Market risk & asset liability management: The management of market risk & liquidity risk is closely monitored by the ALCO, which meetings are held regularly on monthly basis to discuss (a) market updates & economic indicator, (b) assets & liabilities position, and key ratios including IIF fulfillment to financial covenants, (c) investment portfolio profile including available funds for investments (IDR & USD), (d) treasury portfolio composition, yields, modified duration, (e) maturity and re-pricing gap, cash flow monitoring of which no negative cash flows are permissible in buckets 0 6 months, (f) pricing guideline. In order to avoid currency mismatch, so far IIF s strategy has been to mainly allocate USD funds to fund investments denominated in USD currency (where borrowers have mainly USD revenues). 30. IIF s internal policy stipulates (a) minimum 10% reserve of total funds available for liquidity purposes, which can be invested in treasury instruments such as marketable securities rated AA (domestic scale) or better, and deposits placement in banks, (b) deposits placement in state owned banks must be split at least among three banks, whereas deposits placement in selected private banks rated AA (domestic scale) or better, (c) the available surplus fund to maintain the required liquidity can also be placed in marketable securities with the sub limits for bonds up to 50% and mutual funds at 30% of available surplus funds, respectively and (d) the average modified duration of the surplus funds invested above shall be less than 2.5 years. 31. Operational risk management. This deals with managing the risks resulting from inadequate or failed internal processes, people, and system or from external events. To manage these risks, IIF has implemented/introduced several programs/initiatives: Business Continuity Plan ( BCP ), including call tree exercise for all employees (12 Dec 15). In 2016, IIF will implement Disaster Recovery Center and do BCP exercise using DR server. SOP and Guidelines. Guideline for KYC Principle (Nov 15). Project Compliance Checking. To monitor project s compliance to laws and internal policies. Training through employee awareness sessions related to Call Tree Exercise (10 Dec 15). Internal Audit. Periodic review on the effectiveness of the operational risk policies/procedures. Insurance. The current insurance protection that IIF is already been covered includes D&O, FIPI, BBB, CGL, CyberEdge, PAR, and Movable PAR. 32. Quarterly risk management report: IIF s Risk Management Directorate continuously monitors the level of risks inherent to IIF s business operation through risk parameters. IIF selfassesses the level of each risk type as well as the composite risk profile; considering business activities that IIF is operating and its risk profile based on risk grading of measurable risks and non-measurable risks. IIF s risk management is reported on a quarterly basis to RMC and ROC and is also submitted to IIF s shareholders. 33. Enterprise level assessment: Under current risk parameters framework, the self-assessment of both measurable and non-measurable risk parameters is combined to determine overall risk profile of the Company s enterprise level. As per the quarterly risk management report December 2015, based on IIF s self-assessment on business activities and risk parameters monitoring during the last quarter of 2015, the composite measurable risk parameters for the period has changed from Low to Low to Moderate as a result of increased credit risk profile, while the rest of risk 54

56 parameters remained the same compare to that of previous quarter. This is well within the overall risk appetite of the BOD and consistent with the increase in investment operations of IIF. 34. Measureable risk parameters. As per IIF s Risk Management Report Q4 2015, the Credit risk profile has changed from Low to Low to Moderate in Q4 2015, mainly as a result of (i) increased number of projects with outstanding S&E CAPs in this period to 5 (five) projects or represented 33 percent of total number of projects, thus increasing the inherent risk level for the indicator from Low to High, even though these are mostly due to late submission of documents related to S&E which have been submitted in the following period; (ii) increased percentage of total mezzanine plus equity investment to IIF s total capital following investment in mandatory convertible bonds ( MCB ) for an investee amounted to IDR300bn in December 2015, thus increasing the inherent risk level for the indicator from Low to Low to Moderate, however it is still within IIF s acceptable risk appetite; and (iii) the additional indicator to incorporate credit rating downgrade as approved by ROC on December 7, 2015, which was measured at Low to Moderate in Q4 2015, which is also still within IIF s acceptable risk appetite. For measurable risk parameters, IIF s risk self-assessment for Q is summarized below in Table Table 4.16: Summary of risk assessment for measurable risk parameters Risk Type December 31, 2015 September 30, 2015 Outlook Credit Risk Low to Moderate Low Negative Market Risk Low Low Stable Liquidity Risk Low Low Stable Operational Risk Low Low Stable Other: Business, Reputation, Legal Risks Low to Moderate Low to Moderate Stable Composite Risk Profile Low to Moderate Low Stable Source: IIF s Risk Management Report Q4 2015, as of 31 December Non-measurable risk parameters: As per IIF s Risk Management Report Q4 2015, the political risk in Q has improved from Low to Moderate in the previous quarter to Low, particularly on the convergence of political parties coalition to support the Government. Meanwhile, the risk assessment on other non-measurable risk parameters remain unchanged from the previous quarter, thus the overall risk level for the non-measurable risk parameters remains at Low to Moderate ; given the Moderate level of macroeconomic condition, the Low to Moderate level of IT risk, yet offset with the Low level for the rest. Strategic Risk is deemed Low to Moderate for this period. The assessment of non-measurable risk parameters is summarized in Table. Table 4.17: Summary of risk assessment for non-measurable risk parameters Risk Type December 31, 2015 September 30, 2015 Outlook Macroeconomic condition Moderate Moderate Stable Political risk Low Low to Moderate Stable Regulatory and legal risk Low Low Stable Strategic risk Low to Moderate N.A. Stable 55

57 Risk Type December 31, 2015 September 30, 2015 Outlook IT risk Low to Moderate Low to Moderate Stable Severity of audit findings Low Low Stable Insurance risk Low Low Stable Compliance risk Low Low Stable Composite Risk Profile Low to Moderate Low to Moderate Stable Source: IIF s Risk Management Report Q4 2015, as of 31 December Financial Assessment 36. Summary financial position. Since inception, IIF has shown stable growth by expanding its product and service offerings and diversifying its sectorial and geographical coverage. The total revenues have grown at a CAGR of 67 percent from IDR66 billion in FY2012 to IDR306 billion as of FY2015, with a healthy net profit margin of percent. Strong shareholders, strategic importance of IIF for achieving the infrastructure development agenda of the government, increased demand for infrastructure financing, tight control, improved financial performance and substantial borrowing capacity has enabled IIF to achieve a National Long-Term Rating of AAA(idn) with a Stable Outlook from Fitch Ratings Agency. More details provided in section 1 of this Annex. This section provides an assessment of IIF s existing financial position. Table 4.18: Summary of IIF s key financials during 2012-FY2015 Particular FY2012 FY2013 FY2014 FY2015 Income Statement (IDR Billion) Revenue Operating Costs Operating Profit / Profit Before Tax Tax Expense Net Profit / Profit After Tax from operations Other Comprehensive Profit (Loss) - net of tax (0.1) (2.8) Total Net Profit to equity investors Balance Sheet (IDR Billion) Cash and Cash Equivalents 1,783 2,462 2,646 1,026 Marketable Securities Equity Investments Loans Advanced ,592 3,343 Other Assets Total Assets 1,969 3,865 4,749 5,509 Borrowings 778 2,032 2,790 3,249 Other Liabilities Total Equity 1,174 1,810 1,904 2,208 Total Liabilities and Equity 1,969 3,865 4,749 5,509 Key Financial Ratios 56

58 Particular FY2012 FY2013 FY2014 FY2015 Net Interest Margin NA 0.24% 4.02% 3.25% Operating Profit Margin 23% 27% 42% 34% Net Profit Margin 22% 22% 31% 24% Return on Assets 0.77% 0.86% 2.57% 1.88% Return on Equity 1% 2% 5% 3% Debt to Equity Ratio 66% 112% 147% 147% Debt to Capitalization Ratio 40% 53% 59% 59% Cash and securities as a % of Total Assets 98% 73% 61% 35% Cash Ratio NA 286% 183% 58% Source: Analysis based on audited annual reports of PT IIF Observations on key financial ratios 37. Net Interest Margin. Over the past four years, the NIM has increased in line with the growth in the loan book of 61 percent from FY2013 to FY2014, and 110 percent from FY2014 to FY2015. During these years, the loans were advanced at market-linked interest rates with support from loan term and cost-effective borrowing from international development agencies. The average interest rate realized by IIF in FY2015 is percent p.a for IDR and 5.08 percent p.a for US$ denominated loans (FY2014: IDR percent p.a., US$-4.96 percent p.a.) In FY2015, the NIM has marginally reduced due to increase in interest expenses on account of borrowings from IFC and Bank Mandiri. For details please refer to Table. 38. Operating and Net Profit Margins. The operating profit and the net profit have grown at a CAGR of 89 percent and 73 percent respectively, from FY2012 to FY2015. The company is operating at a healthy Operating Profit Margin of percent and a healthy Net Profit Margin of percent. The margins are relatively higher than Indonesian banks averages (average banking sector OPM ~ percent and NPM ~ percent). This is attributable to the availability of cost-effective and long-term capital from international development agencies to IIF, as compared to Indonesian banks that rely on more expensive short term deposits as their major source of funds. However, IIF s OPM/NPM dipped in FY2015 due to increase in interest expenses to IDR87.33 billion or 28.5 percent of revenue in FY2015 (FY2014: IDR billion or 18.4 percent of revenue) and recognition of unrealized loss on its equity investment 9 of IDR billion in FY2015 (FY2014: unrealized profit of IDR billion). 39. Return on Assets (ROA). Over past four years, the ROA 10 has improved in line with the growth in IIF s business. During FY2012 and FY2013, the ROA was around 1 percent as IIF s business was getting established. During FY2014, the ROA improved to 2.8 percent with operating profit increasing at 266 percent as compared to only 23 percent increase in total assets (majorly contributed by a 61 percent increase in loans advanced). However, during FY2015, the ROA has 9 In July 2014, the company has invested USD12.5 mn as equity in PT Maxpower Indonesia. In accordance with the company s accounting policies, the Fair Value of this investment was reduced to US$ mn in FY2015. This reduction in unrealized loss in value of investment has been recognized in the company s accounts for FY Return on Assets (ROA) is calculated as operating profit divided by average total assets. 57

59 declined to 2 percent resulting from a 15 percent decrease in operating profit as against a 16 percent increase in the total assets. 40. Return on Equity (ROE). Between FY2012 to FY2014, IIF s ROE 11 has grown in line with the growth in the business. During FY2015, the ROE has declined to 3.5 percent resulting from a decrease of 24 percent in the net profit and 16 percent increase in the total equity. 41. Leverage Ratios. Between FY2012 to FY2015, IIF has been operating at a debt to equity ratio of less than 1.5 times, indicating that IIF has sufficient borrowing capacity. Along with healthy growing retained earnings, the company has infused equity capital at regular intervals. The company is not expected to face any challenges to leverage its Balance Sheet to finance the growth in its business moving forward and maintain the financial covenants 12 of IFC s loan. 42. Solvency. The cash ratio indicates the solvency position of IIF vis-à-vis the loans advanced to external borrowers and indicates the ability to absorb losses resulting from loan impairment. From FY2012 to FY2015, the cash ratio is at least 57.8 percent, well above comparable international benchmarks like IIFCL-India and KDB-South Korea that maintain a cash ratio of percent as a regulatory requirement and a prudent fiscal management practice. In addition, with more than 35 percent of the total assets accounted for by cash and cash equivalents and marketable securities from FY2012 to FY2015, and with sufficient equity capital infusion at regular intervals, IIF is expected to sufficiently cover its asset risk (majorly attributable to the loan book). 43. Asset quality. With no Non Performing Loans, the quality of the IIF s loan book is stable. In line with international good practices IIF makes provisions for impairment losses as per its prudential norms by reporting the fair value of the loans outstanding and making provisions for impairment losses on a year-on-year basis. The impairment losses for a particular year are calculated as the book value of the loan less the expected present value of the cash flows from the borrower for the loan. From FY2013 to FY2015, the impairment loss provisions have grown at a CAGR of 62 percent, in line with the growth in IIF s loan book, accounting for 3 percent of the total operating expenses in FY2013, 9 percent of the total operating expenses in FY2014, and 4 percent of the total operating expenses in FY2015. During FY2015, the company has reclassified a few loans to better reflect its loan portfolio and make it consistent with its impairment provisioning methodology 13. This has resulted in a decrease in current years provisioning to IDR 8.2 billion (FY2014 : IDR billion). 44. Capital adequacy. According to IIF s Risk Management Report December 31, 2015, the company has sufficient level of Capital Adequacy Ratio (CAR) to provide ample capital cushion, which also still far above the minimum capital requirement to cover credit risk of 12 percent as 11 Return on Equity (ROE) is calculated as net profit divided by average total equity 12 Financial covenants under IFC s loan agreement require IIF to maintain a risk weighted capital adequacy ratio >12%, debt to capitalization ratio of 3:1 and a current ratio of 1.2:1. 13 IIF classifies its loan portfolio into corporate finance (where source of payment will be from the operations of the borrower company) and project finance (where source of payment will solely be from the revenue generated from the project financed by IIF). In calculating provisions for impairment of loans classified as corporate finance, IIF uses the probability of default and loss given default as provided from a study by S&P. For project finance, IIF uses the impairment rate 2% of outstanding loan value for projects that have not commenced operations and 1% of outstanding loan value for projects that have commenced operations. 58

60 stipulated in IIF s OM. IIF s CAR after taking into account the Risk Weighted Assets (RWA) for credit, market and operational risk as of December 31, 2015 was percent. 45. Asset Book. Total assets of IIF have grown at a CAGR of 41 percent from IDR1,969 billion in FY 2012 to IDR 5,509 billion as of FY Within this the largest share is of loans and advances, followed by cash and cash equivalents, investments in marketable securities and equity investments. Table below provides more details. Table 4.19: IIF s Assets during FY2012-FY2015 Particular (in IDR Billion) FY2012 FY2013 FY2014 FY2015 Cash and Cash Equivalents 1,783 2,462 2,646 1,026 % Growth 38% 7% -61% Marketable Securities % Growth 140% -27% 237% Equity Investments % Growth NA NA -14% Loans Advanced ,592 3,343 % Growth NA 61% 110% Other Assets % Growth 41% 60% 21% Total Assets 1,969 3,865 4,749 5,509 Source: Analysis based on audited annual reports of PT IIF % Growth 96% 23% 16% Loans advanced: The company has built a growing loan book over the last three years from IDR990 billion in FY2012 to IDR3,343 billion in FY2015, reflecting a CAGR of 84 percent from FY2013 to FY2015. The portfolio is well balanced between local currency and US$ lending, with a large proportion of long term loan assets. 46. Figure below shows the composition of IIF s loan book. 59

61 Figure 4.4: Loan Book of IIF as of December 31, 2015 Source: Analysis based on audited annual reports and Risk Management Report December 2015 of PT IIF 47. Equity investment. In addition, IIF has made an equity investment in PT Maxpower Indonesia in July 2014 for US$12.5 million. In accordance with the company s accounting policies, the Fair Value of this investment was reduced to US$10.48 mn (~ IDR billion) in FY2015. This reduction in unrealized loss in value of investment of IDR41.29 billion in FY2015 (FY2014: unrealized profit of IDR11.16 billion) has resulted in 14 percent reduction in value of equity investment for FY Marketable securities, cash and cash equivalent. With growth in loan disbursements, the relative contribution of cash and cash equivalents has decreased from FY2012 to FY2015. However, during the corresponding period, the investment in marketable securities has grown at a CAGR of 81 percent. This highlights the sufficient liquidity position of IIF. In addition during FY2015, IIF has invested in Mandatorily Convertible Bonds (MCBs) issued by PT Sumberdaya Sewatama, demonstrating the diversification of investment across various classes of instruments and facilities. 49. Sources of Funding. IIF s major sources of capital has been equity from shareholders and medium-to-long term borrowings from international development agencies. Total equity and liabilities of IIF have grown at a CAGR of 41 percent from IDR1,969 billion in FY2012 to IDR5,509 billion as of FY2015. Table below provides more details. Table 4.20: IIF s Liabilities and Equity during FY2012-FY2015 Particular (in IDR Billion) FY2012 FY2013 FY2014 FY2015 Borrowings 778 2,032 2,790 3,249 % Growth 161% 37% 16% Other Liabilities % Growth 40% 133% -6% Total Liabilities 795 2,056 2,846 3,301 60

62 Particular (in IDR Billion) FY2012 FY2013 FY2014 FY2015 % Growth 158% 38% 16% Paid-up Capital 1,193 1,797 1,797 2,030 % Growth 51% 0% 13% Retained Earnings (19) % Growth -166% 757% 67% Total Equity 1,174 1,810 1,904 2,208 % Growth 54% 5% 16% Total Liabilities and Equity 1,969 3,865 4,749 5,509 % Growth 96% 23% 16% Source: Analysis based on audited annual reports of PT IIF 50. Equity capital: The shareholders of IIF have infused equity capital from time-to-time to ensure sufficient capital adequacy in line with the growth in the loan book and loans advanced. The company has been capitalized three times with IDR1.2 trillion at inception, IDR605 billion in FY2013, and more recently IDR233 billion in FY2015. The company has been capitalized through issuance of new shares to equity investors, and through additional paid-in capital including premium for shares paid by the equity investors. Figure below provides a snapshot of fund raise by IIF through various sources. Figure 4.5: Capitalization and Debt Financing of IIF through Various Sources Source: PT IIF Annual Reports 51. Debt financing: IIF s major source of borrowings are from international development agencies. The World Bank and the Asian Development Bank have channelled long term subordinated loan facilities of US$100 million each through SMI. IFC (through an A and B Loan structure) has provided medium term senior loan facility of US$ 50 million in June 2014 and US$150 million in February IFC s syndications were participated by 16 banks for the first loan and 8 banks for the second loan. More recently, IIF has diversified its borrowings portfolio by raising IDR denominated debt from Bank Mandiri (Persero) Tbk. of IDR1 trillion in FY2015. The proceeds from the borrowings are proposed to be used for financing infrastructure projects. From FY2012 to FY2015, the borrowings have grown at a CAGR of 61 percent in line with IIF s lending operations. Table 4.21 below provides the terms of debt financing from various sources. 61

63 Table 4.21: Terms of debt financing raised by IIF Facility WB channeled through PT SMI ADB channeled through PT SMI IFC I A+MCPP (Managed Colending Portfolio Program) IFC I B Loan IFC II A Loan IFC II B Loan PT Bank Mandiri (Persero) Tbk. Source: PT IIF Terms Tenor 24.5 years Amount US$ 100 million Interest Rate 6-month LIBOR % per annum payable semi-annually Repayment Semi-annually (November 1, 2018 November 1, 2033) Tenor 25 years Amount US$ 100 million Interest Rate 6-month LIBOR % per annum payable semi-annually Repayment Semi-annually (September 1, 2014 March 1, 2034) Tenor 7 years Amount US$ 52.5 million Interest Rate 3-month LIBOR % per annum payable quarterly Repayment Bullet payment on Maturity (June 19, 2021) Tenor 5 years Amount US$ million Interest Rate 3-month LIBOR % per annum payable quarterly Repayment Bullet payment on Maturity (June 19, 2019) Tenor 5 years Amount US$ 15million Interest Rate 3-month LIBOR % per annum payable quarterly Repayment Bullet payment on Maturity (February 22, 2021) Tenor 3 years Amount US$ 135 million Interest Rate 3-month LIBOR % per annum payable quarterly Repayment Bullet payment on Maturity (February 22, 2019) Tenor 3 years Amount IDR 1 Trillion Interest Rate 1-month JIBOR % per annum payable monthly Repayment Bullet payment on Maturity (December 16, 2018) IIF s borrowings are well balanced as they have a high proportion of long duration loans and mix of local currency and US$ denominated debt. About 47 percent of IIF s borrowings are for more than 20 years (this includes World Bank loan for 24.5 years and ADB loan of 25 years). IFC s lending constitutes 38 percent, which is medium term in duration and Bank Mandiri s lending which constitutes 15 percent is for 3-year duration. 62

64 Figure below provides the composition of IIF s borrowings. Figure 4.6: Composition of IIF s Borrowings, 2015 Source: PT IIF Annual Reports 52. Retained earnings: From FY2013 onwards, IIF s profitability has improved and the retained earnings have shown a healthy growth at a CAGR of 279 percent from FY2013 to FY Leverage ratios: IIF has been operating at a debt to equity ratio of less than 1.5 times indicating that IIF has sufficient borrowing capacity. With more than 35 percent of the total assets accounted for by cash and cash equivalents and marketable securities, which are likely to have a zero risk weight, and with sufficient equity capital infusion at regular intervals, IIF is expected to sufficiently cover its asset risk (majorly attributable to the loan book). In addition, majority of the sources of financing for IIF are long-term in nature. More than 50 percent of the loans advanced by IIF are medium to long-term in nature with a minimum tenure of 5 years. Therefore, IIF is not expected to face Asset Liability Management issues. 54. Operating Income. IIF s revenues are derived from three sources, namely: (a) investment income, (b) advisory income and (c) other income. Table 4.22 below provides a break-up of the revenue from FY2012 to FY2015. Table 4.22: IIF s Operating Income During Particular (in IDR Billion) FY2012 FY2013 FY2014 FY2015 Investment Income % Growth 91% 127% 19% - Interest Income from loans advanced % Growth NA 390% 67% - Interest from investment in bonds and marketable securities (Treasury income)

65 Particular (in IDR Billion) FY2012 FY2013 FY2014 FY2015 % Growth 54% 65% -15% Advisory Income % Growth -75% -100% NA Other Income (Loss) (31.66) % Growth 27542% 365% -499% Total Revenue Source: Analysis based on audited annual reports of PT IIF % Growth 93% 130% 5% 55. Investment Income. The investment income accounts for approximately 99 percent of the total revenue. The investment income has grown at a CAGR of 73 percent from FY2012 to FY2015. This includes both interest from lending operations and treasury income. 56. Interest Income. With growth in the loan book, the interest income grown at a CAGR of 186 percent from FY2013 to FY2015, and the contribution of interest from loans advanced to the investment income has increased from 19 percent in FY2013 to 58 percent in FY Treasury Income. The treasury income is earned from investments in bonds, time deposits, mutual fund units, and other marketable securities. With no loans advanced during FY2012, the investment income was majorly contributed by treasury income. However, with the growth in the loan book, the contribution of treasury income to the investment income has decreased from 100 percent in FY2012 to 42 percent of investment income in FY2015. In absolute terms, the treasury income has grown at a CAGR of 29 percent from FY2012 to FY2015 and has accounted for a sizeable portion of the investment income. This is attributable to IIF maintaining at least 35 percent of the total assets in cash and marketable securities from FY2012 to FY2015 as a prudent fiscal management practice. 58. Advisory Income. IIF selectively provides advisory services to government and private sector clients. Between FY2012 to FY2015 the advisory income has grown at a CAGR of 3 percent. FY2014 was an exception with no advisory income because of delays in advisory projects due to general and presidential elections. However, the advisory income got revived in FY2015, with MoUs signed with West Java provincial government for transaction advisory services in Geothermal Fund Facility and with the Governor of Central Sulawesi for the development of the Borapulu geothermal site. 59. Other Income. The other income is contributed by income (gain) from the sale of securities, income (gain) from the fair value of equity investment, and foreign exchange gain. The other income has been contributing a fractional portion of the total revenue and has been fluctuating with movements in various macro-economic variables, capital markets, and valuation, accounting and reporting mechanisms for securities. 60. Operating Expenses. The three contributors to the operating expenses are general and administrative expenses, interest expense, and impairment loss provisions. Table 4.23 below provides a breakdown of the operating expenses from FY2012 to FY

66 Table 1: Operating expenses of IIF (FY2012-FY2015) Particular (in IDR Billion) FY2012 FY2013 FY2014 FY2015 General and Administrative Expenses % Growth 38% 47% 7% - Employee salaries and benefits % Growth 70% 10% 20% Interest Expense % Growth 2817% 148% 63% Impairment Loss Provision % Growth NA 405% -48% Total Operating Expenses Source: Analysis based on audited annual reports of PT IIF % Growth 85% 82% 19% 61. General and administrative expenses. The general and administrative expenses have grown at a CAGR of 29 percent from FY2012 to FY2015. Their share in total operating expenses has decreased from 99 percent in FY2012 to 53 percent in FY2015. This decrease is attributable to the relative increase in the contribution of the interest expense to the total operating expenses resulting from increased borrowings to part finance the growth in the loan book. 62. Employee salaries and benefits expenses. A major component of the general and administrative expenses is the employee salaries and benefits accounting for at least 55 percent of the total general and administrative expenses from FY2012 to FY2015. The employee salaries and benefits expense has grown at a CAGR of 31 percent from FY2012 to FY2015. This growth is majorly attributable to increase in headcount in line with IIF s business growth and accrual of incentive on management s compensation aligning to shareholders objectives Interest expenses. The interest expense has been the second major contributor to the total operating expenses. The interest expense has grown at a CAGR of 390 percent from FY2012 to FY2015, contributing 1 percent of the total operating expenses in FY2012, 23 percent of the total operating expenses in FY2013, 32 percent of the total operating expenses in FY2014, and 43 percent of the total operating expenses in FY2015. This increase in the interest expense has been in line with the increased borrowings to part finance the growth in the loan book from FY2012 to FY2015. Until FY2013, the IIF s borrowings were limited to two subordinated long term loan facilities of US$100 million each from the Asian Development Bank and the World Bank channeled through SMI. These subordinated loan facilities are at a relatively lower LIBOR linked interest rate. However, during FY2014, the company obtained a medium term (7 year) senior loan facility of US$250 million from IFC. Also, in FY2015, the company obtained a short term (3 year) IDR denominated senior loan facility of IDR 1 trillion from PT Bank Mandiri. The relatively higher spread of 2.21 percent to 2.51 percent over LIBOR for the IFC facility and the market (JIBOR) linked interest rate for the PT Bank Mandiri facility has also contributed to the increase interest expense. 65

67 64. Impairment loss provisions. With increase in loan portfolio from FY2013 to FY2015, the impairment loss provisions have grown at a CAGR of 62 percent accounting for 3 percent of the total operating expenses in FY2013, 9 percent of the total operating expenses in FY2014, and 4 percent of the total operating expenses in FY2015. During FY2015, the company has reclassified a few loans to better reflect its loan portfolio and make it consistent with its impairment provisioning methodology 14. This has resulted in a decrease in provisioning to IDR 8.2 billion (FY2014:IDR billion). As of FY2015 ending, IIF does not have any non-performing assets, and has not incurred any impairment losses. 4. Financial Projections 66. In line with its growth strategy for , IIF has set for itself an ambitious target as reflected in its financial projections. Table 4.24: IIF s Financial Projections for Particular FY2016 FY2017 FY2018 FY2019 FY2020 Income Statement (IDR Billion) Revenue Operating Costs Operating Profit / Profit Before Tax Tax Expense Net Profit / Profit After Tax from operations Other Comprehensive Profit (Loss) - net of tax Total Net Profit to equity investors Balance Sheet (IDR Billion) Cash, Cash Equivalents & Marketable Securities 4,122 3,856 4,130 3,909 4,555 Equity Investments & Mezzanine 474 1,045 1,529 1,774 2,197 Loans Advanced (net of provisions) 7,034 8,483 10,347 12,953 15,907 Other Assets Total Assets 11,754 13,507 16,117 18,736 22,758 Borrowings 9,390 10,987 13,378 15,718 18,244 Other Liabilities Total Equity 2,326 2,482 2,701 2,981 4,477 Total Liabilities and Equity 11,754 13,507 16,117 18,736 22,758 Key Financial Ratios Net Interest Margin 4.2% 4.0% 4.0% 4.1% 4.3% Operating Profit Margin 30.2% 29.5% 33.7% 32.4% 39.8% Net Profit Margin 17.6% 15.6% 19.7% 20.0% 25.9% Return on Assets 1.4% 1.2% 1.6% 1.7% 2.2% Return on Equity 5.3% 6.5% 9.0% 10.7% 12.2% 14 IIF classifies its loan portfolio into corporate finance (where source of payment will be from the operations of the borrower company) and project finance (where source of payment will solely be from the revenue generated from the project financed by IIF). In calculating provisions for impairment of loans classified as corporate finance, IIF uses the probability of default and loss given default as provided from a study by S&P. For project finance, IIF uses the impairment rate 2% of outstanding loan value for projects that have not commenced operations and 1% of outstanding loan value for projects that have commenced operations. 66

68 Debt to Equity Ratio Cash and marketable securities as a % of Total Assets 35.1% 28.6% 25.6% 20.9% 20.0% Capital Adequacy Ratio 38.8% 32.8% 28.1% 24.6% 30.4% Source: Financial projections for provided PT IIF 67. Asset growth. By FY 2020, IIF s total assets are projected to grow at a CAGR of 18 percent to IDR22,758 billion from IDR11,754 budgeted in FY2016. The loan book is projected to grow at CAGR of 23 percent and the equity and mezzanine investments at a CAGR of 47 percent. 68. Revenue growth. IIF s revenues are projected to grow at a CAGR of 27 percent to reach IDR1753 billion in FY2020 (FY 2016: IDR684 billion). 69. Profitability ratios improve. IIF s operating and net profit margins improve to 39.8 percent and 25.9 percent by FY2020 from 30.2 percent and 17.6 percent in FY 2016, respectively. Similarly, the ROA and ROE improve to 2.2 percent and 12.2 percent by FY 2020 from 1.4 percent and 5.3 percent budgeted in FY2016, respectively. 70. Solvency. Cash and marketable securities as a percentage of Total Assets remains over 20 percent during FY2016 to The ratio declines from an initial high of 35.1 percent in FY 2016 when the funds raised by IIF are not fully deployed in core investment operations and as more funds get invested in core activities the ratio stabilizes to 20 percent. 71. Capital Adequacy. IIF is projected to maintain a healthy Capital Adequacy Ratio of 30.4 percent by FY2020 and remaining well above the minimum CAR requirement of 12 percent as per IIF s OM. 72. Leverage. The growth in asset based and ROE is primarily due to the increase in leverage of IIF to 4.08 times by FY2020 from the current level of 1.5 times in FY 015, thus reflecting a strong debt raising program by IIF. 73. New Fund Raising. Between FY , IIF plans to raise debt from different sources. These include: the proposed US$ million under the IIFF-AF; an additional loan from ADB of US$100 million; short-to-medium term US$ loans of ~ US$480 million; IDR bonds issuance in 2016 of IDR2 trillion and subsequent issuances between FY aggregating to IDR4 trillion; and additional short-to-medium term IDR term loans. IIF also plans to do an IPO and listing of equity in 2020 of around IDR1 trillion. Therefore, the long duration and dollar denominated loan from the World Bank under IIFF-AF will be critical for IIF s credibility in future fund raise and IPO. The positive implications of IIFF-AF long duration loan on the overall duration of IIF s liabilities can be seen from Figure below. Without the IIFF-AF, the long term borrowings of IIF will only be 16 percent (i.e. less than half of the share in FY2015) thus impacting its asset liability mismatch. 67

69 Figure 4.7: Positive Impact of IIFF-AF Loan on Duration of IIF s Liabilities Source: Financial projections for provided PT IIF 68

70 ANNEX 5. INSTITUTIONAL CAPACITY ASSESSMENT OF SMI Introduction and Context 1. SMI is the executing agency for the proposed IIFF-AF that will channel the World Bank loan borrowed through GOI and then on-lent to IIF. Accordingly, it is in this context that the institutional capacity assessment has been undertaken. 2. SMI is an infrastructure financing company that supports the GOI s infrastructure development agenda. The company is a state-owned enterprise (SOE) operating under the Ministry of Finance (MoF). SMI was established under Government Regulation No. 66 Year 2007, which has been amended subsequently by various government regulations. The company obtained the license to operate as an infrastructure financing company based on the Decree of the Minister of Finance No. 396/KMK.010/2009 and commenced commercial operations on October 12, With the objective of catalyzing private investment and infrastructure development, together with the ADB, IFC and DEG, SMI formed IIF as a joint venture company. The proposed IIFF-AF is a logical next step in continued support by GOI/SMI to IIF in furthering Indonesia s infrastructure development agenda. 3. SMI has instituted satisfactory internal controls and procedures to transparently and efficiently manage the continued on-lending operations under the IIFF-AF Project. The terms and conditions of this pass-through will be back-to-back, with fees, margins and other costs at costrecovery levels with no subsidies involved. They will also include fiduciary and implementation undertakings by SMI commensurate with those contained in the Bank s legal agreements with the GoI. Even though the GOI is its sole shareholder, SMI is professionally managed via a Board of Commissioners and a Board of Directors reflecting its role as prudential non-banking financing institution. 4. SMI is now transforming into a national development bank, with the GOI (i) entrusting SMI the Government Investment Center (Pusat Investasi Pemerintah/PIP) portfolio, (ii) expanding SMI s mandate to local government financing through the PIP and the proposed WB RIDF, and (iii) initiating dialogue with SMI on covering new sectors such as industry, agriculture and maritime. SMI s capital structure, human resourcing and operational procedures are being strengthened to manage the expanded role, which also reflects the continued support of GOI. Financial position 5. SMI has a strong credit rating and financial position. SMI has been rated idaaa with a Stable Outlook by PEFINDO Rating for local rating and global rating of BBB- which reflects the sovereign rating from Fitch Rating. The rating assigned to SMI is supported by key considerations, such as sufficient capital infusions by the GOI (Rp 24.4 trillion already invested by GOI over the last five years), very strong asset quality indicators and a low leverage. It can be reasonably expected that SMI will continue to enjoy support from GOI in the medium term, given the vital nature of SMI s role in infrastructure development in Indonesia. Accordingly, based on SMI s business plan the five year financial projections are summarized below. 69

71 Table 5.1: Summary of SMI s Financial Projections 2015 to 2019 In IDR Billion Audited Actual Projected Particular FY 2014 H FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 Total Assets 9,170 10,034 31,368 38,857 53,794 78, ,594 Loans advanced 6,577 7,625 19,423 27,929 44,526 70, ,512 Total Liabilities & Equity 9,170 10,034 31,368 38,857 53,794 78, ,594 Borrowings 4,384 5,129 5,855 7,122 20,389 43,656 77,670 Equity 4,786 4,905 25,513 31,735 33,405 35,063 36,924 Total Income Financing & Investments Advisory Project Development Net Profit Key Ratios Net Interest Margin 4.73% 4.21% 2.10% 5.98% 4.79% 3.00% 2.50% Net Margin 40.93% 40.06% 45.85% 55.62% 46.75% 27.82% 21.79% Return on Equity 5.38% 5.72% 2.02% 4.19% 4.54% 4.00% 4.69% Return on Assets 2.67% 2.68% 1.61% 3.28% 2.69% 1.71% 1.44% Debt to Equity Ratio 86.75% 99.91% 22.05% 21.68% 60.28% % % Source: CRIS analysis from business plan projections provided by PT SMI 6. Capital Adequacy. SMI is not required to compute and provide for capital adequacy, as the OJK regulation on non-banking infrastructure financing institutions does not require so as yet. However, SMI has initiated the process of computing CAR and it is understood that as of now the CAR stands at ~65 percent. 7. Non-Performing Loans. An asset quality policy was introduced in January 2015, in line with standard banking practice to recognize asset quality and provide for non-performing loans (NPLs) and CAR. There are a few NPLs and accordingly the annual financial statements provide for loan impairment. In relation to the PIP portfolio transferred to SMI, it is understood that there aren t any NPLs and that the risk of NPLs is expected to be low given the MoF guarantee to intercept mechanism to be in place in the implementing regulations for transferring PIP to SMI. As per SMI s monitoring report of September 2015, the NPLs stood at IDR billion, constituting 3.27 percent of the loan portfolio excluding IIF loan and constituting 2.24 percent of the loan portfolio if we include the IIF loan. SMI s NPLs are within the average range (~3.5 percent as per BI s banking statistics for September 2014) of Indonesia bank s infrastructure lending portfolio and similar international institutions like IIFCL, India and KDB, South Korea (~2-4 percent). SMI has been closely monitoring its NPLs and is following up with its sluggish borrowers. Given the sluggishness of the Indonesian economy, SMI would continue to closely monitor its NPLs and plan for adequate provisions in line with financially prudent practices. 8. Asset-liability mismatch. It is understood that as SMI s assets and liabilities are mostly long term in nature, it has government equity and is borrowing on a long term basis from international institutions, and therefore has not experienced any significant ALM mismatch. The recent bond 15 Includes commitment fee of IDR 1 billion 70

72 issuance, series A of ~ US$7.41 million with maturity of 3 years and series B of ~ US$66.67 million with maturity of 5 years (using 1 USD = IDR 13,500), would have some impact on ALM but it is not expected to be substantial. Corporate governance structure 9. SMI s corporate governance structure is consistent with a professionally managed financing company. Pursuant to SMI s Articles of Association, the company s oversight and management is conducted by three major organs namely, the Shareholders, the Board of Commissioners and the Board of Directors. 10. The Board of Commissioners (BoC) supervises the management of SMI s business activities, and is responsible for supervising and providing direction to the BoD and to assure that SMI has implemented Good Corporate Governance (GCG). In addition, the BoC submits its supervisory report on the management of the company by the BoD to shareholders. 11. To support these three key organs, there are several committees, such as an independent Audit Committee to BoC that is chaired by an independent commissioner. The Audit Committee assists the BoC for effective supervision of the company and is governed by the Audit Committee Charter. Key responsibilities of the Audit Committee include ensuring the effectiveness of the internal control system and the effectiveness of the internal and external auditors performance, reviewing activities and audit results of Internal Audit Division and external auditor; reviewing any financial information that is to be released to public and/or authority such as, financial statements, projection reports, and any other reports related to the company s financial information, reviewing the risk management implementation programs by the BoD, reviewing any complaints regarding the accounting process and financial reporting of the Company, and providing recommendations to BoC regarding the appointment of accountants on the basis of independency, scope of work, and fee. 12. The Board of Directors (BoD) is responsible for managing SMI and to ensure business continuity. The BoD reports its management to the shareholders within the General Meeting of Shareholders. The Board of Directors comprises of the President Director, Director of Financing and Investment, Director of Project Development and Advisory and the Director of Risk Management, Finance and Support. 13. The BoD is supported by four committees that assist in the decision making process by providing their recommendations. These include, the (i) Credit and Investment Committee, which provides recommendations to BoD on financing transactions; (ii)project Development & Advisory Committee, which provides recommendations to BoD on the mandated activities and project preparation activities; (iii) Information System and Technology Committee, which formulates the annual strategy for technology and information management activities; and (iv) Risk and Capital Committee, which is responsible for ensuring the alignment of main business strategy in fulfilling SMI s mission and achieving annual targets. The Committee is also responsible for ensuring that any risk related to SMI s activities has been managed effectively and prudently according to its pre-defined capital ownership and risk appetite. 14. In addition, the sub-committees to the Risk and Capital Committee manage specific areas of risks as mentioned below: 71

73 (a) Risk Management sub-committee sets the risk management framework and establishes policies (guidelines, procedures, and limits) in response to the recommendations of risk-taking divisions and/or the Risk and Capital Committee. (b) ALM sub-committee formulates SMI s asset and liability management (ALM) strategy, sets pricing (range) of lending interest rate and treasury interest and funds rate. The sub-committee is also responsible for providing recommendations on changes in ALM. (c)target and Monitoring sub-committee formulates annual strategy on the allocation of corporate resources and recommend changes in policies of business processes. It is also responsible for providing relevant decisions on asset quality, such as restructuring, the sale of completed financing assets, or litigation decisions. Corporate governance policies 15. The Company s corporate governance practices are based on its Good Corporate Governance Charter, Code of Conduct, the Audit Committee Charter and the Whistle-blowing system. SMI has implemented Good Corporate Governance (GCG) based on the implementation outline provided by the Ministry of State Owned Enterprises Decree No. PER-01/MBU/2011. The principles underlying the Company s Good Corporate Governance are Transparency, Accountability, Responsibility, Independence and Fairness. In order to fulfil the principles of GCG, the Corporate Secretary Division (DSP) has been disseminating and monitoring the implementation of the Code of Business Ethics and Conduct. The ethics guideline of the Company details the ethics to be maintained by the Company personnel and staff (the Board of Commissioners, Directors and employees of the Company) in interacting with the stakeholders. The Ethics Committee monitors the Company s working environment and reports to the President Director on official complaints or on any alleged violation of the Code of Ethics and Conduct submitted to the Ethics Officer of the Corporate Secretary Division. 16. SMI has put in place a whistle-blowing System. Frauds and deviations against regulations, unethical/immoral behaviours as well as other actions performed by the company s employees and management, which may impact the company and its stakeholders, can be reported independently and confidentially by the whistle-blower. Reports can be submitted through telephone, fax, letter mail or . The whistle-blower reports an incident through the company s website. Identity of the whistle-blower is protected in accordance with the regulations applicable in the company. The whistle-blower s report is managed by a Whistle-Blowing System (WBS) officer. Internal Audit staff have been appointed as Whistle Blowing System officers. The officer will have an obligation to periodically report the results of the WBS management at least once a month and submit it to the person-in-charge. In case of a complaint against members of the Audit Committee or Board of Directors, the IAD forwards report to the BoC. When a complaint is related to the financial reporting process or things to be acted upon by the Board of Commissioners, IAD will be forwarded the report to the audit committee. For any complaint, the report is submitted to the President Director. 72

74 Risk management processes 17. Risk management frameworks and processes are in early stages in SMI. The project risk rating tool based on S&P s Capital IQ templates has been recently introduced in SMI. This tool is in line with international practice. SMI is using the tool for new investment applications and is yet to update its entire portfolio with this tool. This would also need to be integrated into the annual appraisal and rating review of its existing project portfolio and then the output of the rating tool would need to be integrated with its future processes related to decision making, risk management, portfolio management and capital adequacy provisions. In the context of appraisal and internal rating of financing local government projects, SMI with assistance from local credit rating agency PEFINDO has developed the local government rating tool. This procedure has been finalised in early A risk register and a risk control matrix tool is under development with assistance from E&Y. It is anticipated that this would get implemented in Safeguard standards 18. It is understood that at present SMI is focusing on ensuring that the national standards are implemented. As on date, in projects where SMI has co-financed with international agencies, the international safeguard standards have been applied. SMI s Environmental and Social Management System (ESMS) has two components. (i) The ESMS project has adopted national laws and regulations pertaining to land acquisition and environmental management, and applies to projects funded from SMI s own financial resources. (ii) The ESMS multilateral has adopted national laws and regulations as well as some international standards, and applies to projects financed by multilateral agencies. SMI currently uses the ESMSs in its current operations, mainly PPP projects, whereby social and environmental safeguards due diligence is undertaken once a subproject is defined as eligible for financing based on the financial and investment assessments. A Corrective Action Plan to meet ESMS requirements is prepared based on gaps identified in the due diligence assessment, and its implementation is covenanted in the loan agreement between SMI and the borrower. Moving forward SMI aspires to adopt international standards (from 2017 onwards). One of the example is the establishment of ESMF for RIDF project that follows World Bank Safeguards Policies. 19. For the RIDF project, an Environmental and Social Management Framework (ESMF) has been prepared that is consistent with the World Bank policies. The ESMF includes a Resettlement Policy Framework (RPF), Process Framework (PF), and an Indigenous Peoples Planning Framework (IPPF), as well as Grievance Redress Mechanisms and Disclosures and arrangements for monitoring the implementation of social safeguards instruments (such as a Resettlement Plan, A Plan of Action, and an Indigenous Peoples Plan). The draft ESMF was disclosed in SMI s website on June 15, 2016, and submitted for disclosure through the Bank s Infoshop on June 17, Consultations with stakeholders on the draft ESMF were held on June 21 and 22, The revised version of the ESMF incorporating relevant inputs from the stakeholder consultations has been approved by the Bank and has been disclosed on SMI s website and the Infoshop. 20. Moving forward, SMI s staff would need training on implementing safeguard standards and increasing staff strength. SMI will need to undertake capacity building of its ESMS unit to enable it to cope with the increased project load that would arise from the PIP and RIDF activities. 73

75 Human resource management 21. Human resource management strategy. SMI s human resource management strategy involves activities to improve staff capabilities, through trainings, workshops, seminars, discussion forums as well as other development programs. These capability enhancing initiatives span the entire spectrum of SMI s businesses: financing, project development, advisory and other supporting programs and improvement of soft skills. Besides, these initiatives, SMI also incentivises its best employees through promotions and developing a pay and benefit strategy based on fairness and competitiveness. SMI also undertakes routine job reviews based on which employees are engaged and retained. With its expanded mandate, SMI is in process of enhancing the skill sets of its staff as also the staff strength. 22. Staff Strength. As of 2015, SMI had 167 employees, of which 40 are under the Finance & Investments directorate, 28 under the Project Development & Advisory directorate, 60 under the Risk Management, Finance and Support Directorate, 7 in Strategic Planning & Business Development, 11 in legal division, 6 in internal audit division and 15 in the corporate secretary division. In line with its medium term business plan, SMI is focusing on human resource capacity augmentation both in terms of increased manpower and also training of its existing resource base. In 2016, SMI proposes to add another 100 employees. The maximum employee additions are proposed in Financing & Investments, Project Development & Advisory and Risk Management directorates. The staff strength in RMD, including the ESMS unit, will be doubled in to cater to increased business activities of SMI due to expansion of its mandate. Besides manpower expansion the Risk Management Division along with its ESMS unit would require skill development in order to cater to a larger and more diverse portfolio that will include PIP and RIDF projects. Future Outlook 23. GoI s expectations from SMI are high. Its transformation journey over the next 5 years to evolve into a national development bank will place several challenges on the relatively small institutional set up of SMI. 24. From a business perspective, SMI would need to quickly diversify its client base from a few large infrastructure players to a more regionally dispersed and disparate clientele that would include sub-national governments, SMEs, SOEs and private sector. To ensure that operating costs are under control, SMI would require cost-effective ways of business network expansion. It will need to enhance its financial intermediation. By raising both public and private resources and channel them to a diverse set of projects national priority projects, local government projects, state-owned entities (SOEs), small and medium sector enterprises (SMEs) and private sector projects. Moving forward, SMI would need to institutionalize national and international best practices in safeguards, risk management and corporate governance, to achieve high performance standards as a national level financial institution comparable to the world s best. To achieve the above, SMI will require financial support and technical assistance in strategic planning, organization change & growth, execution excellence and performance management, safeguards 74

76 risk management and corporate governance, legal and regulatory reforms, advocacy and programmatic project preparation at both national and sub-national government level. 25. From the perspective of the limited role of channeling the Bank s sovereign loans to IIF, SMI has instituted satisfactory internal controls and procedures to transparently and efficiently manage the continued on-lending operations under IIFF Additional Financing Project. Certain suggestions on strengthening the coordination between MOF, SMI and IIF in relation to financial management standard operating procedures have been made by the financial management specialists in the Task Team. These are in the process of being socialized and finalized. Other than this, the overall performance of SMI as the executing agency has been satisfactory. There are several indications that the GOI support to SMI will continue in coming years and that SMI will continue to implement capacity strengthening policies to manage its performance on par with applicable national and international standards. 75

77 ANNEX 6. SAFEGUARDS 1. Assessment of IIF s institutional capacity, development and systems to implement IIFF AF vis-à-vis safeguards has been carried out. The WB safeguards team assessed IIF safeguards institutional capacity, development, and systems using criteria as shown in Table 6.1. In addition, the P-D-C-A approach (Plan-Do-Check-Review) was used to assess the Social and Environment Management System (SEMS) of PT IIF to implement IIFF-AF. Background. 2. Since October 2012 the WB safeguards team has participated in 7 formal implementation support missions. The team has visited three IIF subprojects and participated in three informal missions. In addition, a team from RSS Washington has also met with IIF Managing Director/Chief Risk Officer and had an intensive discussion about safeguards implementation and conducted site visit during the safeguards thematic review of Indonesia portfolio in February In Q1 2015, World Bank s IAD (Internal Audit Department) also conducted audit to IIF operations. The objective of the audit was to assess the adequacy of risk management processes in consideration of the unique characteristics of FIF projects. Specifically, it focused on the effectiveness of the Safeguards framework. Overall, the review results were positive and this exercise has become an opportunity for IIF to show their good performance in implementing safeguards frameworks in their project. Institutional Capacity and Development of Social and Environment (S&E) Safeguards 3. A fully dedicated Social and Environmental (S&E) Management Unit had been established at IIF since The Chief Risk Officer (CRO) is the ultimate responsible position for safeguards. A new S&E manager position had been created and filled since 2015, to support the CRO. The unit has now 3 full time safeguards staff to maintain a portfolio of 15 projects under implementation and 11 projects in the pipeline with total commitment of Rp trillion (about US$ 332 million equivalent). A staff fully dedicated for Health and Safety aspects has recently joined the team. 4. This S&E unit has also conducted training programs and workshops/seminars related to S&E topics involving IFC, ADB and WB. All S&E specialists have undertaken some trainings or workshops, among others: Risk Management and World Bank Safeguards Policies (May 2013), IFC Performance Standards and Green House Gases Management (March, April 2015); Stakeholders Engagement Training (October 2015) and Environmental Analysis (October 2015). IIF has partnered with eight Indonesia-based international and national consulting firms 16 to support SEMS implementation or to produce safeguards instruments such as SEDD, EIA, and LARAP that had also improved the capacity of IIF s S&E. 5. Since 2015 IIF has carried out SEDD in-house for projects having moderate risks such as telecommunication projects, solar power, and renewable energy. WB has provided a sample of in-house SEDD for the Gorontalo Solar Power Energy, and noted that it is satisfactorily done in 16 PT ERM Indonesia, PT EnviroSolutions and Consulting, PT Delta Prima Mitra Manajemen, PT AECOM Indonesia, PT BERI, PT Hatfield Indonesia, PT Lorax Indonesia and PT Hatch Indonesia. 76

78 accordance with the revised SEMS. A small note for IIF to improve the future SEDD is to include the assessment of the potential impacts on the access road to the project location during and post construction. 6. IIF S&E staff carried out a knowledge sharing session in September 2015, whereby IIF s S&E Principles and SEMS were socialized to all of the IIF employees. Furthermore, in November 2015 IIF conducted safeguards workshop for clients on Benefit and Best Practice of Doing S&E Principles in addition to one-to-one explanation to the potential clients. IIF has been invited by BCA and other financial institution to share its safeguards experience. IIF believes that S&E is now becoming a strength rather than a liability. IIF has also provided safeguards advises to its public and private clients under its Advisory Services business line. 7. Social and Environment Management System (SEMS). The ESSF as the environment and social safeguards management framework of the project has been fully adhered to and the already established SEMS (Social Environment Management System) in now fully implemented. The SEMS is used to screen and evaluate proposed sub-projects and to monitor S&E implementation for active sub-projects and shall also be used to screen project s pipelines in the future. The SEMS is tailored to manage safeguards risk for all range of financial products that IIF offers, from fund based to non-fund based and guarantees. Progress has been made in establishing IIF s operational procedures (SOP), for the business operation 17 and safeguards management. The Social and Environmental SOP highlights working arrangement and relationship with other sections in the form of a flow chart diagram (high level process flow) followed by 4 operating SOPs Assessment of SEMS Implementation. In assessing SEMS implementation of IIF the Plan- Do-Check-Review approach is used to gather evidence of management system implementation and to assess IIF S&E capacity in implementing the commitments made in the SEMS. Plan IIF has developed the Social and Environmental Policy, consisting of seven commitments to be applied during sub-project selection, preparation, construction and operations to ensure the compliance to S&E regulatory requirements and international best practices. SOP for sub-project screening has been established and criteria for social and environmental assessment has also been set in the SEMS. Continual improvement of the SEMS is assured by the application of the Corrective Action Plan system. S&E Policy was stipulated in the SEMS. Do- Environmental and Social Assessment has been applied by the application of SEDD (Social and Environment Due Diligence), IEE (Initial Environmental Examination), or EIA/EMP as outlined in their SEMS to screen all proposed sub projects and to determine appropriate mitigation measures and safeguards instruments needed. During missions WB found evidence of SEDD report for PT Garuda Maintenance Facility s project, Grievance Mechanism Monthly Report, EIA documents and ESMP for PT LMS project - completed 17 Investment, credit risk, insurance policy/guidelines, internal audit, credit operation, procurement, accounting, tax, treasury and HR. 18 The SOPs regulate pre-approval of sub projects (greenfield and brownfield project), approval process, post approval process ( client/developer duties and S&E officer duties) and the completion phase SOP (the production of ICR) supplemented by the check list for site visits, templates for environmental and social assessment, regular reporting and project appraisal memo. 77

79 with international standard sub-plans. A fully dedicated Social and Environmental (S&E) Management Unit has been established, as previously explained, to ensure that this happens. Various trainings and workshop/seminars have been held, which helped built the capacity of the S&E Management Unit and also its clients. The S&E SOP that clarifies responsibility, workflows and decision making process of the units responsible for S&E aspect was also found. Check- IIF has demonstrated a satisfactory monitoring scheme by the implementation of CAP (Corrective Action Plan) to address all the gaps found during project s due diligence survey for all subprojects. Intensive communication and reporting system with developers (sub-projects) have been established in ensuring SEMS application. For example, IIF has received separate 36 reports from PT LMS in one single calendar year and have received 7 reports regularly of the CAP report, monthly contractor reports for safety health and environmental aspect, ESMP implementation report, environmental noise monitoring report, EMP report for government (RKL RPL), Resettlement Action Plan report, Grievance Mechanism Report and GHG inventory report and Monitoring & Evaluation Report.. Implementation of CAP is formally bound as a legal covenant in the loan agreement between IIF (and / or syndicate lenders) and its clients or in a side letter agreed by two parties. At the project level, clients have to submit a quarterly, bi-annually or annual monitoring report on the implementation performance of CAP. S&E monitoring are carried out under the Risk Management Directorate through: (i) periodic review of CAP; (ii) Quarterly Risk Management Report (QRMR); and (iii) Annual S&E Safeguards Monitoring Report that are shared with the Bank. They have also developed 3 (three) performance indicators for safeguards 19 to be reported in the QRMR. In addition to this, IIF has also the regular project review that is carried out by the Directorate for Investment. First, the Semi Annual Review, particularly for green field project, which includes performance of the company in terms of credit risks and compliance of the S&E requirements; second, is the Annual review for COD project which consists of the performance of the company in terms of credit risks and also compliance of S&E requirements. Review- the SEMS also regulates the preparation of the Project Implementation Completion Report to describe the lessons learnt for future project s improvement. In addition, during Annual Shareholder meeting issues related to social and environmental safeguards are also discussed. The S&E unit prepares the Annual S&E Performance Reports to strategic investors. The formal Bank s supervision mission is also part of the SEMS review process. Implementation support has included (i) regular meetings at all management levels to review overall project implementation; (ii) site visits (iii) meetings and capacity building training and workshop/seminar for capacity building; and (iv) formal placement of an S&E specialist at IIF. 19 The three parameters are: outstanding S&E CAP that is percentage number of projects with outstanding and incompliance CAP in the last quarter divided by total number of projects; number of S&E claims cases that is claim cases in the last quarter divided by total number of projects; and number of negative publications in the last quarter with regard to S&E issues of the project. 78

80 Safeguards Implications and Approach towards the Proposed IIFF-AF 9. The IIFF-AF will provide an additional loan in the amount of about US$200 million following successful implementation of the Indonesia Infrastructure Finance Facility (IIFF) Project (P092218). The products outlined in the AF are covered under the types of IIF s financial products and types of possible sub-projects for financing (refer to SEMS page 8 and 9 and Annex W 20 for safeguards assessments for financing types). 10. The current SEMS can still be used for the IIFF-AF purpose for the following reasons. Firstly, the operating procedures stipulated in the SEMS for all possible project types are still applicable for the proposed financing products. For example, if the take out financing is triggered, the IIF will apply the current due diligence procedure (section 3.2 para 19) to mitigate potential reputational risks or to address legacy issues or liabilities from the sub-projects. Secondly, based on the assessment to the current SEMS using the Environmental and Social Policy and Procedural Guidelines for Projects Financed Jointly by Bank, IFC, and/or MIGA dated January 21, 2009, the SEMS still satisfies the requirement from IFC Performance Standards and World Bank OPs. 11. During the assessment, it was found that for some aspects the IIF S&E Principles are even more conservative than the IFC PS or WB OPs. The World Bank OP requirements are used for the subprojects that involving private sectors. For example, the definition of project area of influence is using both the IFC s and also the Bank s definition. Also for natural habitats aspect, the SEMS has put all together two requirements from IFC and WB (section and of the SEMS Vol. I into its IIF S&E Principles. For the initial screening of project impacts, IIF will undertake this screening process by themselves following the WB practices (section 3.2 of the SEMS Vol. I) while IFC standards allow the clients to do by themselves. Also, another good thing about this SEMS is that the project categorization has been based on the potential adverse environmental and social impacts of the project and not be influenced by any technical threshold or government regulations to determine safeguards instruments required. The disclosure policies are also strictly adhered and applied (section 3.3). In general, the IIFF-AF still can use the current SEMS. 12. Indeed, there are some minor revisions required for the SEMS based on several discussions during appraisal, such as to update the obsolete terms and regulations, and other non-substantive revisions. Rather than carry out another cycle of SEMS revision during the IIF AF process 21, the recommendations below can be undertaken later in the next cycle of SEMS revisions: Revise Annex W to include new financial products of IIF. To ensure that the SEMS will always follow the latest national regulations (even though section 1.4, 2.1 and 2.2 about the S&E Policy and Applicable policies have stipulated that the SEMS will always comply to the applicable laws and regulations); the SOP for updating the list of regulations and its regulatory requirements shall be prepared 20 Annex W of the SEMS elaborate approach of the S&E risk management correspond to each type financing products with examples and definition. Recently the SEMS has just been revised to incorporate the new IFC PS 2012 and it took around 1.5 years to get approval from Ministry of Finance, PT SMI and other IIF stakeholders including ADB, DEG etc. 21 During the process of SEMS revision to the incorporate new IFC Performance Standard 2012, IIF need around 1.5 years to get approval from the shareholders among others: Ministry of Finance with its related directorate generals, PT SMI, ADB, IFC and World Bank. 79

81 equipped with the feedback mechanisms to address related implication the SEMS. The review shall be done regularly. 13. S&E Management Strengthening Plan. With the growing portfolio 22 and pipeline, and the intention of doing more in-house SEDD and increasing monitoring activities of the CAP implementation, IIF is planning to recruit another Environmental and Social Safeguards Specialist in In addition, IIF is planning to have various training program such as LARAP training, training on selected infrastructure sector such as renewable energy; and prepare a booklet on IIF s S&E principles. IIF will continue to disseminate its S&E principles and experiences through series of workshops for existing clients, potential clients, regulators or financial institutions. IIF will continue to outsource the SEMS implementation activities to strengthen IIF capacity and to promote partnership learning. Consultation and Disclosure Requirements 14. For Category A sub-projects that require ESIA/AMDAL, the client of IIF carried out consultation and disclosure in compliance with the GoI regulation PermenKLH 16/2012 and SEMS. For LARAP, consultation and disclosure follows Law no 2/2012 and SEMS. For the proposed IIFF-AF, IIF will continue to carry out outreach workshop (e.g. in November 2015) for its clients and potential clients on SEMS including requirement for consultation and disclosure for subproject instruments. IFF has continuously improved its website. The website has disclosed specific safeguards instruments for subprojects financed by IIF such as UKL-UPL, AMDAL/ESIA, and Supplemental RAP. 22 See Annex 3 on IIF Institutional Capacity and Financial Assessment. 80

82 Table 6.1. Checklist for Assessing Institutional Set-up and Working Arrangements with regards to the Implementation of the SEMS/OM for Projects in the Portfolio and Pipeline: 1. Institutional arrangement: e.g. corporate policy, organizational structure, S&E safeguards policies and instruments; business plan; budget for S&E management; internal and external arrangements; communications with clients; documentation and reporting; outreach to clients or potential clients on S&E, avoid or minimize and address potential reputational risks due to E&S, etc. 2. Responsibility, work flows and decision making of the unit responsible for SEMS implementation. 3. Working arrangements with other units that contribute to the decision whether potential projects are proceeded for IIF financing. 4. Operational instruments that have been developed and implemented: e.g., various Standards Operational Procedures pertaining S&E. 5. Staffing: e.g. number and area of responsibilities; recruitment policies; program for development. 6. Staff qualification vs. evolving needs of the IIF: e.g. existing and future recruitment. 7. Scheme for capacity strengthening for S&E staff (e.g. training, outsourcing, expert hiring, etc.). 8. Practice in implementing the SEMS (e.g. work flows and methodologies, how to carry out due diligence, what innovative initiatives/approaches/adjustment have been made; etc.). 9. Self-assessment or review of the SEMS, SOP pertaining S&E, performance of units in charge of S&E, and staffing lessons learned, weaknesses, constraints, and plan of actions that lead for better operations (update SEMS, proposed risk-based approach management for clients flexibility for implementation--, etc. etc.); expected advice and assistance from the World Bank. 10. Approaches, tools and practices in monitoring the compliance of the clients in implementing the agreed action plan; measures adopted to ensure clients meet the agreed action plan. 11. Experiences: description and documentation of process for go projects and no go projects. 12. Other aspects, for instance: the above pointers in relation with ADB and IFC s requirements. 81

83 ANNEX 7. IMPLEMENTATION ARRANGEMENTS Executing Agency 1. PT. Sarana Multi Infrastruktur (SMI) will be the Executing Agency for the Bank s loan. SMI is a 100% State Owned Enterprise under the Ministry of Finance whose purpose is to invest in infrastructure financing institution(s) or otherwise provide funds for infrastructure financing. SMI holds 40% equity stake in PT IIF and has channeled the earlier IIFF financing from the Bank to IIF. The DG Treasury, Ministry of Finance will be responsible for the execution of the subsidiary loan agreement between the GoI and SMI and for processing and transferring loan funds to SMI. Implementing Agency 2. PT IIF will be the Implementing Agency for the Bank s loan. IIF has established itself as a small but credible player in Indonesia s infrastructure financing market. WB s assistance under the IIFF Project has helped IIF develop unique expertise in Indonesia vis-à-vis project finance and environment and social safeguards management. IIF is now well-positioned to respond to evolving market needs through its range of financial products detailed in its Operations Manual (OM), including senior debt, take-out financing, equity, mezzanine, promoter funding, bridge financing, etc. The IIFF Additional Financing (IIFF-AF) will help consolidate IIF s market position. 3. The Bank s lending instrument for this project is a Financial Intermediary Financing (FIF). The Bank will provide an investment loan to the Borrower. The Borrower will in turn provide these funds to the IIF the sole participating financial intermediary through SMI. The IIF will in turn, use these funds to provide predominantly infrastructure financing to commercially viable infrastructure projects. 4. Drawdowns from the loan will be made on the basis of requests from the IIF to SMI, which in turn will be transmitted to the Government, and the Government will request the Bank for drawdowns. Bank funds will be provided to the GOI, which will on-lend the funds to SMI through a subsidiary loan agreement. In turn, SMI will provide these funds to the IIF through a subordinated loan agreement and/or perpetual/convertible capital instrument, which may be assessed as contributing to the Tier 1 equity capital of IIF, as opposed to the previous treatment of Bank funds as Tier 2 capital. 5. The treatment of part or all of the Bank funds as Tier 1 equity capital will allow IIF to increase its investment portfolio significantly. Given that a major growth impediment for IIF has been its imposed single exposure limit of 25 percent of total capital, 23 the envisaged perpetual/convertible capital instrument is expected to increase both IIF s Tier 1 and 2 capital, thereby broadening its capital base overall and enabling it to continue to fund longer term projects and fund larger size projects. Nevertheless, the World Bank Loan Agreement s financial covenant 23 Total capital equals to the sum of Tier 1 and Tier 2 capital, with the Tier 2 capital capped at a maximum of 50 percent of Tier 1 capital. 82

84 that limits the ratio of subordinated debt to equity at 2.5 will need to be monitored closely throughout implementation. 6. Indonesia will borrow from the Bank in US$ and the GoI will provide equivalent IDR funds to SMI. The Bank funds will be provided to SMI at its standard interest rate for such subsidiary loans (applicable to all state owned enterprises) at an interest rate of borrower s bonds ( SUN ) benchmark series with twenty (20) years maturity. The difference between this rate and the Bank s lending rate to Indonesia effectively represents the premium charged by the Government for taking on the exchange rate risk. SMI in turn will add a spread (0.5 percent) towards its administrative expenses and on-lend these IDR funds to the IIF The subsidiary loan agreement and the subordinated loan and/or capital instrument agreement will contain undertakings by SMI and IIF, respectively, to implement all fiduciary and implementation undertakings made by GoI to the Bank. These requirements are the same as the ones made earlier under the original IIFF project and hence will continue for this IIFF Additional Financing. While the capital treatment of part or all Bank funds will not directly affect the structure of the loan agreement between the Bank and the GoI, it will be necessary to ensure that the Bank s remedies, particularly relating to procurement, social and environment safeguards, and non-eligible investments, are maintained. Figure 7.1: IIFF-AF Funds Flow 24 The net spread charged by SMI to IIFF will be 0.5 percent over the cost of funds that SMI receives from the Government. In addition, the subordinated loan agreement will specify a formula by which SMI will be entitled to recover any actual tax payments that it may incur as a result of the lending to IIFF. 83