AFRICAN DEVELOPMENT BANK AFRICAN DEVELOPMENT FUND OPERATIONAL GUIDELINES FOR NON-SOVEREIGN GUARANTED LOANS TO PUBLIC SECTOR ENTERPRISES

Transcription

1 AFRICAN DEVELOPMENT BANK AFRICAN DEVELOPMENT FUND OPERATIONAL GUIDELINES FOR NON-SOVEREIGN GUARANTED LOANS TO PUBLIC SECTOR ENTERPRISES SEPTEMBER 2003 SCCD: N.G.

2 TABLE OF CONTENTS ACRONYMS AND COMMON TERMS Page 1. INTRODUCTION Background Rationale for Extending Non-Sovereign Guaranteed Loans to Public Enterprises Objectives of the Guidelines 2 2. DEFINITIONS Non-Sovereign Guaranteed Public Sector Operations Middle Income Countries (MICs) 2 3. POLICY FRAMEWORK 3 4. ELIGIBILITY CRITERIA FOR PUBLIC-SECTOR NSGLs Country Eligibility Eligible Sectors Enterprise Eligibility 5 5. MODALITIES FOR BANK FINANCING Types of Instruments Exposure Limits Terms and Conditions for Public-Sector NSGLs Loan Security GOVERNMENT SUPPORT Privileges, Exemptions and Immunities Other Forms of Support BANK POLICIES AND PROCEDURES Procurement Policy Environment Policy Credit Risk Rating Provisioning for Losses Loan Cancellation Countries Under Sanctions IMPLEMENTATION Project Processing Project Monitoring Annual Audits RECOMMENDATION 17

3 i ACRONYMS AND COMMON TERMS ADB ADB Group ADF ALCO AUDT Bank Group CODE CSP EUR EURIBOR FFCO FFMA FTRY GCEL JIBAR JPY LIBOR LOC MIC MSME NSGL NTF PEN POPR PPRU PSOC PSDU OPSD RMC SCN SPV UA USD ZAR African Development Bank Comprises of the ADB, ADF and NTF windows African Development Fund Assets and Liabilities Committee Internal Audit Department [of the Bank Group] ADB Group Committee on Operations and Development Effectiveness Country Strategy Paper Euro Euro Area Inter-Bank Offered Rate Financial Control Department [of the Bank Group] Financial Management Department [of the Bank Group] Treasury Department [of the Bank Group] General Counsel and Legal Department [of the Bank Group] Johannesburg Inter-Bank Agreed Rate Japanese Yen London Inter-Bank Offered Rate Line of credit Middle Income Regional Member Country Micro, small, or medium scale enterprise Non-Sovereign Guaranteed Loan [or Lending] Nigeria Trust Fund Preliminary Evaluation Note Operations Policies and Review Department [of the Bank Group] Procurement Unit [of the Bank Group] Private Sector Operations Committee Poverty and Sustainable Development [of the Bank Group] Private Sector Department [of the Bank Group] Regional Member Country Summary Credit Note Special purpose vehicle Unit of Account: a Bank Group monetary unit; equivalent to the Special Drawing Right (SDR) set by the International Monetary Fund United States Dollar South African Rand

4 OPERATIONAL GUIDELINES FOR NON-SOVEREIGN GUARANTED LOANS TO PUBLIC SECTOR ENTERPRISES 1. INTRODUCTION 1.1 Background Senior Management, at the request of the Board of Directors, created on 29 January 2001 a Task Force on Enhancing ADB Lending in Middle Income Regional Member Countries (MICs) 1. The Task Force was charged with the responsibility to reflect on the constraints, challenges and prospects for ADB operations in the regional MICs and make recommendations on the appropriate and most effective strategies to boost the operations. The Task Force produced a report, which was presented to the Board of Directors at a meeting held on 4 September Several measures were recommended, including the provision of advisory services, and the design of new and more appropriate instruments of intervention in order to make the Bank more relevant to MICs, thereby increasing ADB lending in the countries Notably, the Task Force recommended that the Bank should consider, on a case-by-case basis, the provision of loans to commercially oriented public enterprises in MICs without requiring a sovereign guarantee, among a range of possible innovations and strategies. The Board agreed, in principle, with the broad thrust and orientation of the proposal and directed Management to prepare the guidelines for the implementation of this recommendation for consideration by the Committee on Operations and Development Effectiveness (CODE), and subsequent approval of the Board of Directors. 1.2 Rationale for Extending Non-sovereign Guaranteed Loans 3 to Public Entities One of the reasons for the low level of Bank lending operations in several MICs is the reluctance of the Governments in those countries to provide guarantees for the borrowings of their public-sector enterprises, after restructuring and transforming them into corporations with legal, financial and management autonomy. The position of these governments is that the continued provision of sovereign guarantees is incompatible with and/or undermines this corporate autonomy. The objective of publicsector reforms is the re-orientation of the role of the State towards the provision of appropriate macroeconomic environment and regulatory frameworks geared to facilitating economic growth, away from direct involvement in the productive sectors and public utilities management. The Governments have thus made representations to the Bank to explore appropriate mechanisms whereby Bank loans can be provided to financially strong autonomous public enterprises without requiring their sovereign guarantee The Bank, on its part, recognizes the existence of a distinct group of public enterprises on the continent that are commercially run, following the implementation of these reforms in a number of RMCs. Due to the financial and managerial autonomy granted to these enterprises, governments have some justification in their reluctance to accept commercial risks on behalf on these enterprises. These enterprises are indeed an important customer segment, which is expected to increase as the reform process advances in several MICs. 1 The concept of Middle Income Countries is defined in section 2. 2 Proposal for enhancing the Bank operations in Middle-income countries - reference: ADB/BD/WP/2002/47. 3 Loans as used in this report refers to all of the Bank s lending instruments, including lines of credit, guarantees, etc.

5 In response to the interest expressed by the MIC Governments, with a view to furthering the goals and objectives of public-sector reforms in these countries, as well as the catalytic role and expected positive impact of ADB financing on increasing access to public services, supporting socio-economic development and promoting poverty reduction, Management recommends for Board s consideration and review, the Guidelines on Non-Sovereign Guaranteed Loans (NSGLs) to public enterprises. 1.3 Objectives of the Guidelines The purpose of these Guidelines is to set out the scope of Bank support for non-sovereign guaranteed public sector loans with regard to underlying policy framework, eligibility, financing instruments, modalities of the Bank s intervention, and the required government support. They also outline the relevant policies and implementation procedures, which will guide the Bank staff and beneficiaries. 2. DEFINITIONS 2.1 Non-Sovereign Guaranteed Lending Operations to Public-Sector Enterprises For the purposes of these Guidelines, Non-Sovereign Guaranteed Lending Operations to Public- Sector Enterprises (Public-Sector NSGLs) are defined as the provision of loans, lines of credit, agency lines or guarantees to public enterprises that meet the eligibility criteria defined in Chapter 3 of these guidelines, without the requirement of a sovereign guarantee by the host government The Bank currently provides loans without sovereign guarantees through two means: (i) the private sector window, and (ii) enclave projects. Neither of these two avenues would be appropriate for the Public-Sector NSGLs proposed in the MIC Report. As the envisaged enterprises are those that will have majority to full government ownership, they would not ordinarily be eligible for financing through the private sector window of the Bank 4. Equally, it will be difficult to accommodate such loans within the current framework for enclave projects. This is because the spirit of the Bank Policy Guidelines on Financing Enclave Projects is to make the Bank resources available to viable public-sector projects in ADF-only countries. Secondly, the policy on enclave projects requires eligible projects to be exportoriented, with assured foreign market for its products and services. On the other hand, Public-Sector NSGLs would only be available to countries eligible for accessing the Bank resources, while eligible projects would not be limited to only export-oriented projects. 2.2 Middle Income Countries (MIC) The credit policy adopted by the Board of Directors in 1995 classifies the Bank s regional member countries (RMCs) into three categories as follows: i) Category A (ADF-only) Countries: those countries eligible only for concessional ADF resources; 4 The private sector policy does allow, on exceptional cases, the financing of majority government owned enterprises, provided that the Bank s involvement is consistent with the basic objectives of private sector development and foreign direct investment.

6 ii) iii) Category B (Blend) Countries: those countries which are eligible for both ADF and ADB resources; Category C (ADB-only) Countries: those countries eligible only for ADB resources. They are deemed creditworthy for non-concessional financing For the purpose of these Guidelines, Middle Income Regional Member Countries (MICs) are the countries considered sufficiently creditworthy to be eligible for non-concessional ADB resources. These countries comprise Category C and Category B countries, which have relatively more developed economies and higher per capita income than the lower income Category A countries. The MICs are heterogeneous, varying significantly in the size of their economies, in terms of real GDP and per capita income, population, as well as access to international markets and foreign capital flows. 3. POLICY FRAMEWORK 3.1 The Public-Sector NSGL instrument is an outcome of the Bank s resolve to increase and diversify its operations portfolio in the MICs. It provides one additional channel to increase Bank lending by responding to those enterprises that have indicated a need to access Bank resources without the provision of states guarantees. The range of problems that must be overcome in order to increase Bank lending to MICs, however, needs a comprehensive approach beyond one new instrument. Thus, the Bank will continue to search for additional new lending instruments and approaches aimed at enhancing dialogue with development partners and stakeholders, streamlining procedures, refining risk analysis and management methodology, reducing transactions costs, strengthening the competitiveness and improving the attractiveness of Bank resources in the evolving development context of the MICs. 3.2 In extending resources to the MICs through Public-Sector NSGLs, the overarching goal is to provide catalytic support to investments that contribute to the reduction of poverty, improve the standard and quality of living of the population at large, and support sustained growth of labour employment and productivity, thereby contributing to raising the rate of economic growth. The Public-Sector NSGL operations, therefore, will be closely aligned to the medium- to long-term development strategies of the middle-income RMCs whose public-sector enterprises wish to tap Bank resources under the terms set out in these Guidelines. These interventions will also be guided by the Bank s Vision and strategic objectives, and relevant operations policies and guidelines approved by the Board of Directors. Public- Sector NSGL operations will also be related to the development strategy outlined in the Country Strategy Papers (CSPs) of client middle-income countries. In implementing this lending instrument, however, flexibility will be exercised, in view of the autonomous financial, management and legal personality and commercially competitive orientation of the clients (quite apart from being majority owned by the State). 3.3 Public-Sector NSGL operations will support poverty reduction through strengthening development in key production sectors of MIC economies notably, agribusiness, industry, infrastructure and public utilities (e.g., energy, power, telecommunications, water, transport, etc), and finance where majority state-owned corporations still play an important catalytic role. The new Bank lending outlined in these Guidelines is calibrated to support the goals and objectives of MIC public sector reforms, especially concerning the restructuring of public enterprises into autonomous and financially viable corporate entities, which may be a step in the direction of privatization. Indeed, by fostering the commercial orientation of their operations and strengthening their profitability, the Bank s non-sovereign guaranteed

7 - 4 - lending will make public enterprises more attractive for privatization. In line with the particular strategic objective of promoting private sector development, during the preparation of Public-Sector NSGLs, the Bank will engage MIC governments in deeper dialogue on strengthening the corporate governance, financial sustainability, productivity and competitiveness of public enterprises and parastatal agencies, including exploring critical performance targets and/or time-frames towards possible privatization. 3.4 Private sector development will be promoted especially through Public-Sector NSGL financing facilities (e.g., lines of credit, agency lines, guarantees, etc) extended to majority state-owned financial institutions (banks and non-banks) that will be used to finance short-, medium-, and long-term lending to micro, small and medium scale enterprises (MSMEs). Thus, the NSGL instrument will provide the Bank an opportunity to open dialogue on the promotion of MSMEs with key financial sector agencies in the MICs. In addition, Public-Sector NSGL operations may create new sub-contracting opportunities for the small and medium scale enterprises. 3.5 In appraising Public-Sector NSGL opportunities, the Bank will pay close attention to issues pertinent to strengthening competition in the domestic markets of client MICs, in line with the goals, objectives and targets of macro- and micro-economic policy reforms, sectoral restructuring, and institutional reforms. The Bank, as one of the co-financiers of such reforms (past, on-going, or prospective) through its policy-based lending operations, has a stake in reinforcing the outcome of these reforms. As a matter of principle, but also from a stance of risk aversion, the Bank will not extend NSGL financing if the financial viability of a public enterprise client or project is found to require the suppression of competition or the indefinite postponement of domestic market opening. 4. ELIGIBILITY CRITERIA FOR PUBLIC-SECTOR NSGLs 4.1 Country Eligibility Eligible countries for Public-Sector NSGLs will be regional MICs as defined in section of these Guidelines. These are Category C countries, currently Algeria, Botswana, Egypt, Equatorial Guinea, Gabon, Mauritius, Morocco, Namibia, Seychelles, South Africa, Swaziland and Tunisia, 5 and Category B or blend countries, currently Nigeria and Zimbabwe. Regional Member Countries that subsequently graduate from Category A to either Category B or C will automatically become eligible for Public-Sector NSGLs. The resources provided by NSGLs will normally be used to finance projects promoted by eligible parastatals of MICs As the Bank will be assuming normal commercial risks in connection with Public-Sector NSGLs, it will take into account the economic circumstances prevailing in the country concerned in making its investment decisions with respect to these loans. The Bank will, therefore, not provide assistance where: (i) (ii) the political, micro- and macro-economic circumstances and/or the policies of the government are such that the project for which the Bank is providing support is unlikely to succeed; and the overall legal, regulatory and judicial conditions are likely to place the servicing or recovery of the loan at significant risk. 5 Libya Arab Jamahiriya, one of the MICs, is a non-borrowing regional member of the Bank Group.

8 4.2 Eligible Sectors Under NSGLs operations, the Bank, guided by the development strategy and priorities of the middle-income RMC as outlined in its CSP, may provide assistance to a public sector enterprise engaged in activities in any sector, including, but not limited to, manufacturing, infrastructure, extractive industries, energy, and other productive activities, as long as the Bank s intervention shall benefit the economy of the host country, and provided that the enterprise meet the eligibility criteria defined in section 4.3 below. However, as stated in the policy framework, candidate operations for Bank financing will be screened, retaining only those that have no detrimental effect on competition in the domestic market and safeguarding progressive widening of the space for private-sector entrepreneurial activities in the MICs. With respect to eligible sectors, general policies of the Bank Group apply. 4.3 Enterprise Eligibility Ownership Public enterprises to be considered for NSGLs would reside principally in the public sector. The share capital of these enterprises is majority (i.e., over 50%) owned by the Government or by corporations the capital of which is majority owned by the Government of an MIC, including cases of full (or 100%) ownership. Until the introduction of the NSGL facility, these enterprises have been able to borrow from the Bank only against the sovereign guarantee of their host governments. Management Eligible enterprises for NSGLs will be those assessed to be managed autonomously from the host government and financially sustainable. The instrument of establishment of such enterprises (e.g. legislation, memorandum and articles of association, etc.) will be scrutinized by the Bank to ensure that such autonomy is adequately entrenched in the corporate instruments. Legal Form Eligible enterprises must have been duly established, validly existing and operating under the applicable laws of the country in which they are organized. As a general rule, these enterprises must have a distinct legal personality and capacity to sue and be sued, as well as incur debts on their own account. The Bank will verify the fulfillment of these basic requirements from the entities statutory documents. In the event that some of the legal attributes are lacking, the candidate entities may still be considered for financial assistance on the condition that, prior to loan approval or, as the case may be, effectiveness, they obtain the right to sue and be sued and also the ability to borrow Furthermore, eligible entities will be those not protected by immunities, for example, from legal process, seizure, attachment or execution of judgment. Where such immunities are enjoyed by an eligible public enterprise, the waiver of such immunity for the purpose of the NSGL will be required. To that end, it shall be necessary for the Bank to determine, by way of preliminary legal due diligence, (i) the necessary procedures that have to be taken to effectively waive legal immunity of the enterprise under the laws of the host country, and (ii) the extent to which the waiver of immunity gives protection to the Bank loan.

9 Types of Enterprises In addition to the criteria detailed in paragraphs to above, eligible public enterprises for NSGLs shall have the following attributes: The public enterprise is incorporated in a middle-income regional member country or countries; Be financially and commercially viable entities, with full control over their funding, budgeting, investment, and pricing policies; Have a track record of good operational and financial performance; Have adequate accounting and cost control arrangements and management information systems, and must be subjected to annual audits by independent auditors acceptable to the Bank; Have sound management and corporate governance systems that: (i) provide effective protection of the interests of all investors (shareholders and creditors); and (ii) maintain an environment that is favourable and conducive to efficient and sustainable growth of the public corporation; and Have demonstrable developmental impact through their activities, and demonstrable contribution towards poverty reduction in the RMC In the particular case of special purpose vehicles (SPVs) (i.e., corporate entities established for the specific purpose of operationalizing special capital projects), a track record of operational and financial performance might not be available. In lieu of this, however, due diligence process will involve gathering relevant information on the entities sponsoring the SPVs, assessing their financial perspective and operational track record, evaluating the reliability of their guarantees for the SPV, and ascertaining the level of their control and involvement in the decision-making processes of the SPV. In addition, the SPV should have good prospects for meeting all its financial obligations and generate adequate surpluses to sustain its long-term viability Public enterprises wishing to apply for NSGLs will be encouraged to seek a credit rating from one of the major international credit rating agencies, or a reputable local rating agency. Having obtained such a rating will be an added advantage in the Bank s consideration for NSGLs. Project Soundness, Profitability and Development Impact A project proposal by a public enterprise will be eligible for NSGLs if it is satisfactory on each of the following eligibility criteria: The project proposal is conceived on the basis of a sound concept that is consistent with the member country s or countries economic and/or social development objectives; It is financially viable, and has good prospects of generating a satisfactory financial rate of return for the public enterprise;

10 - 7 - It is well planned, realistically costed and has an adequate and reliable financing plan; The enterprise has a market for products and/or services resulting from the project; and The project is intended to have desirable economic and social impacts, such as contribution to creating new jobs and/or sustaining existing ones, use of significant amounts of domestic raw materials thereby providing market outlets for local produce, strengthening the country s external accounts, etc; and It meets Bank environmental standards. 5. MODALITIES FOR BANK FINANCING 5.1 Types of instruments Bank financing for NSGL projects of MIC public-sector enterprises will be primarily provided in the form of direct term loans, lines of credit, agency lines and guarantees. Additional assistance such as advisory services and risk management products will also be considered on a case-by-case basis. The types and conditions of the Bank s assistance to a particular enterprise will depend on the risks involved, the profitability of the project as well as the characteristics of the corporate entity through which the Bank s assistance is being provided. The assistance will be subject to operational limits outlined in section 5.2 below. Management will review these limits periodically. Loans The Bank may make direct term loans to enterprises meeting the eligibility criteria outlined in Chapter 4 above. The Bank may provide loans to eligible enterprises in one or several currencies approved as lending currencies. These currently are the United States Dollar (US$ or USD), the Euro ( or EUR), the Japanese Yen ( or JPY), and the South African Rand (ZAR). The Bank will take no foreign exchange risk in connection with its Public-Sector NSGL operations. Therefore, loans must be serviced in the same currency in which they are provided. In particular cases, the Bank may consider lending in other currencies, including local currencies, if it can fund itself efficiently in those local currencies and if there is sufficient demand for such local currency. Lending in local currencies will be possible only after the Bank has developed appropriate mechanisms for borrowing in those currencies. Lines of credit (LOCs) Lines of credit to creditworthy public-owned financial institutions represent a major instrument to provide credit to eligible sectors and SMEs in member countries. Such financial institutions should demonstrate sound corporate governance, managerial autonomy from the government, competent financial and business management, adequate capitalization including risk provisioning, and the fulfillment of applicable fiduciary and prudential regulations. It should also have knowledge and experience of local market conditions, gained from public-private collaborations with local businesses and entrepreneurs.

11 Guarantees Guarantees will enable the Bank to play a catalytic role and respond to the needs of eligible public-sector corporations to finance profitable projects, by increasing their access to larger amounts of financial resources on longer term than would normally be available to them. With guarantees, these clients may be able to lower their cost of funding, access new attractive sources of funding, and secure larger amounts or longer maturities than otherwise available. The Bank may provide partial credit guarantees. These guarantees may cover the payment of principal and/or interest on instruments such as bonds, commercial paper, facilities, and medium term notes. 5.2 Exposure Limits Public-Sector NSGL operations will be determined within the framework of exposure limits that the Bank observes to ensure the development of any adequately diversified credit portfolio. Consistent with the Bank s practice of distinguishing between sovereign and non-sovereign credit risks, Public- Sector NSGL operations will be subject to the same limits normally applied to all non-sovereign exposures 6. The principal limits are summarized below: Total risk capital 7 used for non-sovereign operations, including Public-Sector NSGLs, shall not exceed 20% of the Bank s total risk capital. Risk capital for public and private sector non-sovereign guaranteed operations used in any single country shall not exceed 15% of the Bank s total risk capital available for non-sovereign operations. Risk capital for all non-sovereign guaranteed operations used in any single sector / industry shall not exceed 25% of the total risk capital available for non-sovereign operations. Given the inherent diversification, the sector limit for financial intermediaries is 35%. Risk capital for all non-sovereign guaranteed operations used in any single enterprise (obligor) normally shall not exceed 4% of the total risk capital available for non-sovereign operations. This limit may be exceeded in exceptional circumstances such as in the case of public enterprises deemed to have particularly strong credit enhancement from a well-rated sovereign state. The Bank s participation in any single NSGL operation should not exceed 33% of the total cost of the project; and facilities to financial institutions should not exceed 50% of shareholders net worth at any time Principal responsibility for understanding and applying the Bank s non-sovereign exposure limits rests with the Task Manager leading each transaction. The Credit Risk Working Group monitors the various exposure limits and reports to the Asset and Liability Management Committee (ALCO) on compliance through the quarterly credit risk report. 6 Credit Risk Management Guidelines for Non-Sovereign Operations, June Risk capital comprises the Bank Group s paid-in capital, accumulated reserves and general provisions.

12 Terms and conditions of Public-Sector NSGLs Pricing policy: The financial assistance to Public-Sector NSGL operations will be provided under a risk-based pricing mechanism. Accordingly, the lending margin for each NSGL will be determined on a case-by-case basis after a comprehensive credit assessment process, taking into consideration the assurances and/or undertakings provided by the host Government and the residual risk assumed by the Bank, so as to determine the credit risk rating for the facility. The pricing of NSGL operations will be guided by the principle of flexible cost recovery. For each level of credit risk, the pricing will cover the cost of provisioning (to cover expected losses) and the cost of risk capital (to cover unexpected losses), plus administrative, legal and technical fees outlined in the paragraphs below. On a case-by-case basis, the Bank will negotiate the pricing of each NSGL with a view to recovering the cost of extending the Bank s risk-bearing capacity, within the constraints of the competitive market. The aggregate all-in margin, expressed as a nominal interest rate (in terms of basis points (bps), where 100 bps = 1.00%), will be added to the market reference interest rate in the loan currency (i.e., LIBOR for USD, Yen, EURIBOR for Euro, and JIBAR for the South African Rand) Public-Sector NSGL operations will be subject to other financial charges, listed below, the possible ranges of which are provided. Flexibility will be exercised, on a case-by-case basis, in determining which fees and their levels to apply, depending on the size, complexity and intensity of technical expertise required to prepare and appraise these operations. It may be noted that these fees are the same as those charged by the Bank on its private sector lending operations. 9 The possible range of fees includes: Commitment Fees. The commitment fee rate for Public-Sector NSGLs will be between 0.5% and 1% per annum and will be calculated on un-disbursed loan balances. The commitment fee will start to accrue, at the latest, 60 days after loan signature. When market conditions warrant, the commitment fee may accrue at a different date and /or be set outside the range of 0.5%-1% per annum. The Board shall decide on the eligibility for a special commitment fee based on the recommendation by Management. Front-end fee. The front-end fee is designed to partially compensate the Bank for the costs associated with processing a loan request and preparation of the documentation for loan approval. It is only charged on an approved project. It is not reimbursed if the project is subsequently cancelled. As in the case of other lending operations financed from the ADB window, the frontend fee for NSGL operations will be set in the range of 0.5% 1% of the loan amount. When market conditions warrant, the front-end fee may be waived altogether or set outside this range. The fee shall be payable before or at a date not later than the date of the loan signature. However, when market and/or other conditions warrant, the Bank may allow the front-end fee to be paid after loan signature or as agreed among co-financiers in co-financed projects. 8 For the meaning of these terms see the Table of Acronyms and Common Terms on page (ii). 9 All the fees and penalties indicated hereafter are those currently applied to private-sector non-sovereign guaranteed lending operations, as provided for in the present and subsequent Policies and/or Guidelines of the Bank, such as (but not limited to) Guidelines for Private Sector Loans (Bank document No. ADB/BD/IF/2001/239); Policies for Lines of Credit, Agency Lines and Guarantees to Private Sector Financial Institutions (Bank document No. ADB/BD/WP/98/37/Rev.2); Credit Risk Management Guidelines for Non-Sovereign Operations (reviewed informally at a Board seminar in July 2004 but not yet submitted for approval), and other related documents.

13 Appraisal fee (External Consultancy fee). This fee is based on the cost pass-through principle. Accordingly, when project appraisal contains a large advisory component such as external legal, engineering or financial consultants for due diligence, the Bank shall charge an appraisal fee. The fee will be set in order to fully recoup the Bank s costs during appraisal and will be payable even in cases where the project is, for whatever reason, not approved. The appraisal fee shall be settled at a date not later than first disbursement, or as agreed among co-financiers in co-financed projects. Other fees and penalties. The Bank shall charge prepayment fee on fixed and variable rate loans; the prepayment fee shall reflect the Bank s cost of redeployment of the prepaid funds. Late payment fees of 2% per annum above the interest rate on the loan may also be charged on the overdue amount Loan maturity and grace period: NSGLs shall have a maximum duration of up to fifteen (15) years, inclusive of a grace period of up to 5 years. In exceptional cases, viable projects of long gestation periods and/or with financial return streams drawn over extended lifetimes (such as is typical of infrastructure and public utility facilities) that are supported by strong cash flows may be considered on a case-by-case basis for maturities exceeding 15 years. Duration restrictions, however, may apply to certain currencies and product types depending on market conditions Loan repayment terms including prepayment: Public-Sector NSGLs will be repaid in line with the Bank s principal repayment terms, which provide for the payment of equal installments of principal, after the expiration of the grace period. The Bank will consider client proposals for other principal repayment terms notably, annuities, bullet repayment and step-up or step-down amortization subject to satisfactory justification of project requirements by the client. Interest and any other charges on the Bank s loans will be payable semi-annually. However, the Bank will allow monthly, quarterly, and annual payment frequencies (except in the case of variable rate loans), subject to suitable justification by the client. In accordance with the asset-liability matching and cost pass-through principles, any additional costs that the Bank incurs in order to offer these features will be passed on to the Borrower. 5.4 Loan Security The Bank will require borrowers requesting Public-Sector NSGLs to provide it with suitable security. Where required, the client will offer to the Bank security consisting of one or more forms from a range of acceptable arrangements including but not limited to mortgages, fixed and/or floating charges over the assets of the borrower, as well as pledges. The Bank shall appraise the security offered and ascertain its adequacy to cover the risk exposure. As a matter of preliminary legal due diligence, the Bank shall, establish that the borrower has the capacity to grant security, or will obtain such capacity, as a condition for the NGSL. In cases where there are other co-financiers of the project, the Bank shall require that its own security is of a rank pari passu with that of the other co-financiers. No security granted by the borrower to any other party shall have priority over the Bank s security. The Bank may enter into security sharing agreements with other project co-financiers. All charges shall be duly registered in accordance with applicable laws In addition, the Bank may require adequate guarantee to cover its loan exposure, including commercial bank guarantees and/or guarantees issued by other corporate entities acceptable to the Bank.

14 The Bank may accept a central bank guarantee if offered by the NSGL client, provided it is determined that such a guarantee is, firstly, legally callable, and, secondly, does not constitute a sovereign guarantee. As yet other alternative forms of security, in particular cases, the Bank may request the establishment of (i) foreign or domestic escrow accounts that will have on deposit a certain amount of project revenues, which could be used for debt service repayment, (ii) support agreements under which third parties would undertake to cure defaults of the borrower to the Bank and or (iii) any other mechanisms that the Bank, in consultation with the borrower, deems necessary and appropriate under specific project circumstances. Guarantees, escrow and support arrangements may cover a specified period (e.g. project construction) or the entire duration of the Bank s loan Loan agreements will, where necessary, contain covenants fully or partially restricting the borrower s creation of additional liens on its assets. In cases where no security or guarantee is taken, such as in the case of lines of credits, the Bank shall reinforce its position through the use of negative pledges and pari passu clauses, which would restrain the borrower from granting security to other financiers or, in the event of such a grant, would require the borrower to place the Bank in an equal position with such financier. Attention will be paid, during legal due diligence, to previous negative pledge arrangements of the borrower, to assess the effect of such negative pledges to the proposed NSGL. 6. GOVERNMENT SUPPORT 6.1 Privileges, Exemptions and Immunities Government s role is a critical factor in the financing of public-sector projects. The Bank will bear the commercial risk; but it may require that the host Government provide general comfort commitment as evidence of its recognition of the potential benefits of the project, to protect the Bank against government decisions and actions that may adversely affect the sustainability and success of the project, and also reassure co-lenders and even the project sponsors. In the same regard, the Bank may require the host Government to provide undertakings, such as not to revoke the corporate autonomy of the client public enterprise, alter tariffs, or change laws and regulatory provisions that affect commercial operations of the public enterprise To facilitate its non-sovereign guaranteed public-sector lending operations, the Bank will seek prior confirmation concerning the privileges, exemptions and immunities of the Bank, including exemption from taxes, unrestricted repatriation of loan principal repayments, interest and any other income from sale proceeds of Bank s investment or security held in the country as well as any other privileges and immunities accorded to the Bank under the Bank Agreement Therefore, the Bank will not undertake Public-Sector NSGL operations in a MIC if that country has not signed a Letter of Assurances confirming the privileges, exemptions and immunities of the Bank in respect of such operations To-date all MICs have signed a private-sector letter of assurances. Such a letter is good for NSGL operations as well, since it covers any loan that is not given to or guaranteed by the governments.

15 Before approving a Public-Sector NSGL operation, the Bank will formally notify the government so as to provide an opportunity for the government to provide its non-objection to the proposed Bank intervention, in accordance with the provisions of Article 17(1) (b) of the Agreement Establishing the African Development Bank. 6.2 Other Forms of Support In addition to the letter of non-objection, the host Government of a Public-Sector NSGL operation may be required to give further undertakings and assurances by way of letters of assurances or letters of comforts, including commitments to undertake specific macro-economic and/or sectoral reforms or institutional changes deemed essential for project success and sustainability of the project. The undertakings and assurances would be tailored to protect the Bank from non-commercial risks, such as regulatory risks, currency transfer risks, moratorium, nationalizations or other forms of taking In addition, a Public-Sector NSGL agreement will outline the rights, privileges and obligations of the Bank as a preferred creditor, in the event of a firm decision to restructure or privatize the public sector enterprise beneficiary of an outstanding Bank non-sovereign guaranteed loan. 7. BANK POLICIES AND PROCEDURES 7.1 Procurement Policy Funds provided by the Bank may be used for foreign currency or local currency expenditures to acquire fixed assets, meet a portion of working capital requirements or finance intangible assets. Funds provided by the Bank must be spent in a member country of the Bank on goods and services produced in a member country, in accordance with the Bank s Procurement Policy The Bank generally will need to satisfy itself that clients are making their capital investments in a cost effective manner. Where appropriate, the Bank will recommend to its non-sovereign guaranteed public-sector clients to resort to open competitive bidding, especially for large contracts. In order to do this, the Bank will reach an agreement with these borrowers, at the time of project appraisal, on the provisions relating to the most suitable advertising mode and media, bid preparation time and bid evaluation criteria that the borrower should retain. In particular, the Bank and the borrowers will agree, where appropriate, on the possibility of competitive shopping through ways other than those leading to the preparation of bidding documents (shopping by telephone for example) The mode of procurement shall be adapted to the approach defined in the Bank s policy document, Private Sector Operations Policies 11 and paragraphs 3.3 to 3.5 of the Bank operational guideline document, Guide for the Procurement of Goods, Works and Services within the Context of Private Operations 12. It will be essential to ensure that the procurement procedure is carefully planned and reflects the public-sector enterprise s particular needs. More specifically, it will ensure that, in this phase, (i) bid packages or the sets of bid packages are well defined; (ii) the procurement procedures are Revised Private Sector Operations Policies (Bank document number ADB/BD/WP/94/127/Rev.2) submitted to the Board of Directors on 7 March 1995, and Proposals for a Revision of the Private Sector Operations Policies (document number ADB/BD/WP/98/148) submitted on 18 December Bank document number ADB/BD/IF/99/01, submitted to the Board of Directors on 14 January 1999.

16 determined so as to obtain competitive prices; and (iii) detailed planning of procurement is prepared in compliance with the project implementation schedule. In all cases, the Bank will agree with the borrowers on appropriate procurement methods, which will ensure selection of goods and services in a cost-effective manner. 7.2 Environment Policy Relevant Bank environmental policies will apply to non-sovereign guaranteed public sector operations. In this regard, each operation will undergo an environmental review process to ensure that it is fully consistent with the appropriate Bank guidelines. The environmental review will be initiated at an early stage of the project cycle to determine whether environmental experts need to be involved in processing the project and whether an environmental impact assessment needs to be prepared. 7.3 Credit Risk Rating In assessing the credit risk rating of non-sovereign guaranteed lending operations both to private and public enterprises the Bank will employ a ten-point credit risk rating scale to measure the expected loss of each credit facility 13 over the tenor of the facility, as described in the Bank s Credit Risk Management Guidelines for Non-Sovereign Operations. The credit risk ratings, as a measure of expected loss, integrate assessments of both the default probability 14 for each borrower as well as the estimated loss from default for each specific credit facility The Bank s ten credit risk ratings can be summarized under five generic risk classes, from very low risk to very high risk, that correspond broadly to the international credit rating scales as shown in Table 1, below. Table 1. ADB Credit Risk Rating Scale 15 Risk Rating Description Expected Loss Risk Score Risk Class 1 Excellent 2% >79 Very Low Risk BBB/Baa 2 Strong 3% Low Risk BB/Ba 3 Good 4% Fair 6% Acceptable 9% Marginal 15% Special Attention 30% Substandard 50% Doubtful 80% Expected Loss 100% <35 Moderate Risk High Risk Very High Risk International Equivalent 16 B/B CCC/Caa CC-D/Ca-D 13 A borrower or client may have different facilities or transactions at the ADB window. 14 Default is said to have occurred if payment is more than 30 days overdue. 15 See the Bank s new Credit Risk Management Guidelines for Non-Sovereign Operations. 16 Rating scales used by Standard & Poors, Fitch, and Moody's Investors Service.

17 Risk Rating Process As in the general case of non-sovereign guaranteed operations, the risk rating process will begin as soon as a Public-Sector NSGL transaction enters the Bank s project pipeline. The Task Manager from the Private Sector Department (OPSD) 17 will prepare a preliminary evaluation note (PEN) with the information required to make a preliminary rating. After reviewing the PEN and any additional information in the transaction file, a credit analyst from the Credit Management Division of the Financial Management Department will score the facility and assign it a preliminary risk rating. Key elements of the rating, including the impact of the proposed transaction on the Bank s exposure limits, will be described in the credit analyst s summary credit note (SCN). As the appraisal progresses, the risk rating will be adjusted taking into account the assurances and undertakings provided by the host Government and accepted by other parties to the project, until a final facility rating is confirmed prior to final negotiations. The Credit Management Division will assign a final facility rating only be after the credit analyst has verified the audited financials or the project financial model Project selection will also take into consideration the incremental impact of the operation on the overall portfolio risk profile and the Bank s exposure limits. Rating Updates The risk ratings of all active Public-Sector NSGL operations will be reviewed each quarter by the Credit Risk Working Group of ALCO. The Credit Risk Working Group is composed of appointed investment officers, portfolio managers, and legal, accounting, and credit analysts. Updated facility risk ratings will be examined by the Private Sector Operations Committee (PSOC) and submitted to ALCO for endorsement in the quarterly credit risk report on non-sovereign operations. 7.4 Provisioning for Losses While the Bank will seek to protect itself from avoidable losses by carefully selecting and managing its projects, prudent financial management requires the Bank to make provisions for the losses that are statistically probable in its portfolio of projects, in addition to losses that can be reasonably estimated from specific impaired assets. Public-Sector NSGLs will be subject to the same provisioning rules applied to other non-sovereign operations including the private sector 18. Under this framework, a general provision equal to the mid-point expected loss rate will be made for projects rated from 1 to 6 (low risk to high risk) on the Bank s credit ratings scale. For projects rated 7 to 10 (very high risk), a specific provision will be made based on a case-by-case assessment of asset impairment Principal responsibility for understanding and applying the Bank s provisioning policy rests with ALCO. Quarterly, the Credit Risk Working Group prepares a credit risk report that includes provisioning recommendations. These recommendations and the justifications are presented to ALCO for endorsement and implementation of the provisioning rates. In addition, the Financial Management Department 17 In Section 8, the rationale is provided for locating in the Bank s Private Sector Department the overall responsibility for the preparation and management of public-sector NSGL operations. 18 Policy for provisioning for non-sovereign operations, Ref. ADB/BD/WP/98/125, and summarized in the Credit Risk Management Guidelines for Non-Sovereign Operations, June 2003.

18 (FFMA) provides an independent assessment of the adequacy of provisions through the annual nonsovereign portfolio credit risk review. The Public-Sector NSGL operations will be covered similarly under these reviews by ALCO and FFMA, respectively. 7.5 Loan Cancellation Non-sovereign guaranteed public sector loans will be made directly to borrowing enterprises. Loan cancellation will be in accordance with appropriate Bank financial policies and guidelines and/or provisions of the loan agreement. 7.6 Countries Under Sanctions As non-sovereign guaranteed public sector loans will be made directly to borrowing enterprises, the sanctions provisions contained in the Revised Policy on Loan Arrears Recovery relating to sovereign repayment obligations will not apply on Public-Sector NSGL operations already approved and being implemented, as NSGL clients are autonomous of the government. Obversely, the accrual of arrears on any NSGL operation in a MIC will not translate into the application of Bank sanctions provisions on the country as a sovereign borrower, as the government will not be directly responsible for the default on loans extended by the Bank under the Public-Sector NSGL facility. However, where a Government fails to meet or honour its obligations in connection with an undertaking given with respect to a non-sovereign guaranteed public-sector lending operation, such a failure, if not cured, may result in the country being placed under sanctions pursuant to Article 44 of the Agreement Establishing the African Development Bank The Bank, however, shall not approve new operations in a country under general sanctions of the Bank. 8. IMPLEMENTATION 8.1 Project Processing The Bank s non-sovereign guaranteed lending operations to public-sector enterprises are to be processed and managed under the policies, guidelines and procedures applied to the Bank s private sector non-sovereign guaranteed lending operations, with the same level of flexibility, responsiveness, risk awareness, and market competitiveness In view of the different risk profile of non-sovereign guaranteed public-sector lending operations, including lines-of-credit operations to this class of clients, an approach different to the one traditionally used by the Bank for public sector operations with full sovereign guarantees will be required. Compared to the Bank s standard public sector operations, non-sovereign guaranteed operations present different or additional risks for the Bank. To reduce the probability of these risks occurring, therefore, the Bank will apply strict investment guidelines for the selection, evaluation and supervision of non-sovereign guaranteed public sector operations.