The World Bank Guarantees

The World Bank Guarantees Leveraging Private Finance for Emerging Markets Financial Solutions Unit Finance, Economics and Urban Development Department 1 Sustainable Development Network Vice-Presidency

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Contacting the Unit Financial Solutions Unit Finance, Economics & Urban Development Department Sustainable Development Network Vice-Presidency The World Bank 1818 H Street, NW, Washington, D.C. 20433 USA Phone: +1 202 458 2801 Fax: + 1 202 522 0761 Email: guarantees@worldbank.org Website: www.worldbank.org/guarantees 3

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World Bank (IBRD & IDA) Guarantees catalyze private finance for emerging market countries by mitigating the risk of default by Governments on their obligations. World Bank guarantees (or Bank guarantees) help catalyze private capital flows to emerging market countries by mitigating critical Government performance risks that private lenders are reluctant to assume. The World Bank (or Bank) is uniquely positioned to bear these risks given its experience in developing countries and its long term relationship with its member countries, which reinforces the incentive for Governments to perform on their obligations. The World Bank provides three kinds of guarantees. Partial Risk Guarantees (PRGs) cover private lenders against the risk of the Government or a Government-owned agency failing to perform its obligations vis-à-vis a private project. These guarantees can be particularly effective in catalyzing private financing for infrastructure projects or to enhance investor response for privatizations. Introduction to Guarantees Bank guarantees require a counter-guarantee from the sovereign Government. If a guarantee is called and paid out, the member country concerned is obligated to repay the World Bank. If the country fails to do so in accordance with the agreed terms, such failure would entitle the World Bank to suspend all lending to the country in accordance with the World Bank s policies. Only 25 percent of Bank guarantee exposure is counted against the country s World Bank exposure limit, increasing the leverage of Bank resources. Projects supported by Bank guarantees have to comply with applicable Bank policies, including those pertaining to environment and social impact. Procurement procedures for investment operations must meet economy and efficiency standards. Partial Credit Guarantees (PCGs) cover private lenders against all risks for a specified portion of debt service payments. They are offered mainly for public investments in IBRD countries, to extend maturity and improve market terms for loans and bond issues. Policy Based Guarantees (PBGs) extend the Bank s partial credit guarantee instrument to Government borrowings for fiscal support. While both PRGs and PCGs cover debt for investment operations, PBGs cover debt for public budgetary needs. As of March 2010, the World Bank had approved 36 guarantees, with a cumulative Bank guarantee amount of $3.8 billion in 28 countries. 5

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Partial Risk Guarantees cover Government non-performance of specified obligations to private projects Partial Risk Guarantees (PRGs) can be provided in both IBRD and IDA countries. PRGs cover specific obligations of the Government (including public entities) to a private project. These guarantees ensure payments in the case of default on a private debt obligation resulting from the non-performance of such Government obligations. The nature of these obligations varies depending on project, sector, and country circumstances. PRGs can be structured flexibly to fit these circumstances. A counter-guarantee is provided by the sovereign, giving the Government an additional incentive to meet its obligations to the project. PRGs mitigate investors perception of Governmental risks, including policy reversal, regulatory failure, and concerns for the creditworthiness of Government contractual counterparties. PRGs can help catalyze long-term private financing in projects at improved terms, with beneficial impact on tariffs. Availability of a PRG may be cited in bidding documents as an option, so that bidders may reflect such risk mitigation in their bid price. These Bank guarantees can cover a variety of Government risks, including Government or parastatal contractual payment obligations; availability and convertibility of foreign exchange; changes in law; expropriation and nationalization; licenses, approvals and consents; obstruction in the process of arbitration; non payment of a termination amount or an arbitral award following a covered default. IBRD provides Enclave PRGs for certain private sector projects in IDA-only countries. To be eligible, projects for example generate foreign exchange revenues (e.g. through exports). This eligibility criterion has been extended recently to projects that do not themselves generate foreign exchange but have clear economic and financial benefits with strong financial flows in local currency through an off-take to a creditworthy party with dedicated foreign exchange debt service payment account arrangements. The Enclave PRG does not count against the country s IDA allocations. PRGs can complement instruments offered by MIGA and IFC. When Bank, MIGA and IFC instruments are deployed together, efforts are made to coordinate due diligence and processing among these agencies. Loans covered by PRGs can also be complemented by funding from (or loans covered by) export credit agencies and other multilateral and bilateral sources. Partial Risk Guarantees 7

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Examples of Partial Risk Guarantees Albania Power Distribution Privatization In 2009, IBRD provided a 60 million (US$78 million equivalent) Partial Risk Guarantee (PRG) in support of the privatization of the Energy Distribution System Operator (OSSH) in Albania. The Government of Albania (GOA) sold 76 percent of shares in OSSH to a strategic investor, CEZ, the power utility company of the Czech Republic. Given the heightened investor sensitivity to regulatory risk in distribution privatizations (primarily due to tariff adjustment issues), the PRG was a critical precondition to the effectiveness of the Privatization. The PRG backstops the obligation of the GOA to compensate OSSH in the event the Electricity Regulatory Entity (ERE) or GOA fails to implement the pre-agreed regulatory framework which forms part of the Privatization Agreements. A breach of the Regulatory Framework would entitle OSSH to draw upon an irrevocable, revolving, standby Letter of Credit (L/C) issued by Citibank Hungary on behalf of the Albania s Ministry of Finance for any losses of revenue resulting from such a breach. The PRG would guarantee GOA s reimbursement obligation to Citibank Hungary for the amounts drawn, plus accrued interest, under a Reimbursement and Credit Agreement concluded between the Bank and GOA. The PRG is expected to help catalyze around 240 million in investments over the next five year period. Uganda Bujagali Hydropower: In 2007, IDA provided a US$115 million Partial Risk Guarantee (PRG) in support of the Bujagali Hydropower project in Uganda. The project is a run-of-river power plant and has an installed capacity of 250 MW. The project is being developed by Bujagali Electricity Limited (BEL), whose sponsors are Industrial Promotion Services (Kenya) Limited, and SG Bujagali Holdings Ltd, an affiliate of Sithe Global Power, LLC (USA). At the time, it marked one of the largest private-sector financed project in Sub-Saharan Africa, and the first Independent Power Producer (IPP) arrangement in Uganda. The total financing requirements for the project were US$798 million of which US$627 million was financed with debt. The debt facility consisted of a commercial loan of US$115 million covered by the IDA PRG for a period of 16 years matching the loan maturity. The rest of the financing came from other multilaterals, such as IFC, the European Investment Bank, AfDB and a group of European DFIs. The IDA PRG guaranteed commercial lenders against debt service payment defaults resulting from the Government s failure to meet its payment obligations as stipulated under the Implementation Agreement and the Government Guarantee between BEL and the Government of Uganda (GOU). IDA PRG is non-accelerable; therefore, principal and interest on the IDA Guaranteed Facility between the commercial banks and BEL would be paid by IDA only as they become due. IFC provided US$100 million A loan and US$30 million C loan. MIGA provided an equity investment guarantee of up to US$115 million for a 20 year period. The project came at a time when Uganda was facing major power shortages, constraining its industrial growth. The IDA guarantee improved the terms of the commercial bank loan to the project company BEL, resulting in lower costs, to be passed on to end users via lower tariffs. 9

Lao PDR Nam Theun 2 Hydropower: In 2005, IDA provided a US$42 million Partial Risk Guarantee (PRG) to the Nam Theun 2 (NT2) hydropower. This was the first Bank PRG to support a hydropower development. NT2 is 1070 MW hydropower plant, which supplies both Thailand and Lao PDR with electricity. It was the largest ever foreign investment in Lao PDR, the largest cross-border privately financed, project financed hydropower project, and the largest Independent Power Project in Asia after the 1997 financial crisis. The project was implemented by Nam Theun 2 Power Company Limited (NTPC), whose sponsors are Electricité de France (EDF) of France, Italian-Thai Development Public Company Limited (ITD) of Thailand, and Electricity Generating Public Company Limited (EGCO) of Thailand. The IDA PRG covers a commercial debt tranche provided to NTPC by nine international dollar lenders with door-to-door maturity of 16.5 years. It backs debt service default on the covered tranche resulting from a limited set of activities and actions that are under Government of Lao s (GOL) control. IDA also provided a grant of US$20 million to support GOL s equity investment. MIGA provided political risk insurance (PRI) for a US$42 million loan. The total project financing was US$1.4 billion, with 72:28 debt equity ratio. Debt financing was a combination of a US dollar and a Thai Baht tranche. Mozambique Southern Africa Regional Gas Pipeline: In 2003, IBRD provided its first Enclave Partial Risk Guarantees (PRGs) to Sasol Petroleum Temane Limitada (SPT) and Republic of Mozambique Pipeline Investments Company (ROMPCO). Both companies were set up by SASOL of South Africa and are jointly owned by SASOL and Government of Mozambique. IFC owns about 5 percent of shares in SPT and Government of South Africa owns 25 percent of ROMPCO. The PRGs provided risk coverage for commercial financings led by SCMB: R140 million for SPT and R70 million for ROMPCO. The Bank exposure is capped at US$20 million and US$10 million for SPT and ROMPCO respectively out of the total project cost of about US$1.1 billion. MIGA also provided similar cover for US$27 million and US$45 million respectively. The PRGs would cover debt service defaults resulting from a breach by GOM of specified obligations as set forth in the Petroleum Production Agreement (PPA) and the Pipeline Agreement (PA). This is a joint Mozambique-South Africa natural gas development and pipeline project. The project comprises two individual but fully integrated sub-projects. Firstly, the development of the Pande and Temane gas fields in Mozambique and the construction of a central processing facility, together the upstream project operated by SPT, and secondly, the construction of the 865km pipeline to transport the gas to Sasol s Secunda plant in South Africa, the pipeline project, operated by ROMPCO. The project met the requirement for an enclave project, as an export-oriented, commercial project expected to generate foreign-exchange outside of Mozambique, an IDA-only country. This is also the first guarantee applied to a cross-border transaction and denominated in South African Rand. 10

Partial Credit Guarantees cover a portion of private loans or bonds against all risks. These guarantees facilitate commercial borrowing for public projects. Partial Credit Guarantees (PCGs) are available for countries eligible for IBRD lending. PCGs typically assist the commercial borrowing of Governments and public-sector entities to finance public sector investment projects. These guarantees encourage extension of maturity, lowering of interest rate costs and/or improvement in market access by covering a part of a financing. PCGs are flexible instruments. Different structures have been used and explored to meet clients needs, such as guarantee coverage of principal for bullet maturity bonds; rolling (non re-instatable) coupon and principal guarantees; and the guarantee of later maturity principal payments of amortizing syndicated loans etc. PCGs are usually applied in cases where client countries have limited access to medium and long-term capital or commercial loan markets; and when there is a financing gap for public sector investment projects. By guaranteeing the later debt service payments of a bond or a loan, the PCG extends maturity of the debt beyond what the market would otherwise accept. The lengthening of maturity, as well as significant reduction in borrowing costs as a result of the PCG, substantially improves the commercial borrowing terms and usually results in more affordable tariffs in the case of infrastructure projects. Partial Credit Guarantees 11

Example of Partial Credit Guarantees Botswana: In 2009, IBRD approved a Partial Credit Guarantee (PCG) in support of commercial borrowing by Botswana Power Corporation (BPC), a state-owned utility, to finance the Morupule B Power Station. The Botswana power sector was in dire need of new investment at the time, requiring a significant amount of financing. The IBRD PCG of US$243 million guarantees the lenders of the US$825 million 20-year bank loan, which was arranged by the Industrial and Commercial Bank of China Limited (ICBC), a commercial bank based in China. The PCG guarantees the payment of the scheduled outstanding principal amount and one accrued interest payment falling due and payable after the 15th year. The maximum guaranteed principal amount of the US$243 million stands for 29% of the loan facility amount. The guarantee is callable only during the last 5 years ( IBRD Callable Period ); and is accelerable during such a callable period. This transaction marks the Bank s first co-guarantee operation with a bilateral agency, namely, China Export & Credit Insurance Corporation (Sinosure). The PCG improved the terms of the commercial bank loan to BPC, by extending maturity from 15 to 20 years. The longer maturity significantly lowers BPC s revenue requirements, benefitting power consumers and the economy in general. It helped mobilize a substantial amount of long-term debt despite the financial crisis. The PCG leveraged IBRD resources significantly. IBRD s initial exposure under the PCG (i.e., the present value of the guarantee) is about US$121 million, which represents a leverage of about 7:1 against the commercial debt mobilized of US$825 million. 12

Policy Based Guarantees extend the Bank s Partial Credit Guarantee instrument to Government borrowings for fiscal support. Policy Based Guarantees (PBGs) can support well performing IBRD member countries in accessing the financial market. As with PCGs, PBGs cover all risks of debt service default for a portion of commercial loan or capital market borrowings. The PBG can be self-standing or part of a larger IBRD financial support (i.e. through Development Policy Loans or DPLs) to the client country. Example of Policy Based Guarantees PBGs are considered as an alternative or supplement to DPLs. To be eligible for PBGs, client countries should have demonstrated a strong track record of performance and have external financing needs that have important structural, institutional and social dimensions as well as a coherent borrowing strategy for gaining or regaining market access. Policy Based Guarantees. Colombia: In 2001, the Republic of Colombia completed a Notes issuance of US$1 billion, backed by a Policy-Based Guarantee (PBG) of US$158.8 million. The 10-year Notes were structured with mortgage-style, semi-annual amortizations with the Bank s rolling guarantee on the first two debt service payments. Gross proceeds of the Notes resulted in a leverage of about 6.3-to-1 over the Bank s maximum exposure. With the backing of the Bank, Colombia was able to place a large-sized Notes issuance in the US capital market. It allowed Colombia to return to the US market at a time when the US dollar market was essentially closed to Latin American sovereigns, and fulfill its funding needs for 2001. In the volatility surrounding the emerging markets at the time of the issuance, expectations of completion of Colombia s financing needs via the Bank-guaranteed transaction protected Colombia from emerging market contagion effect. Colombian bonds outperformed the broader emerging markets through the period of market volatility, as investors took comfort in the completion of Colombia s 2001 borrowing program and the support of the Bank for economic reforms in Colombia. 13

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Fees vary depending on the guarantee structure. Non-payment of fees causes the guarantee to lapse. IBRD Guarantees IBRD charges a guarantee fee, currently set at 50 bps per annum, on the exposure to the Bank arising from the disbursed and outstanding balances under the guaranteed debt financing. IBRD also charges a standby fee, currently set at 0 bps per annum, on committed but undisbursed exposure to the Bank. The fees remain the same for the term of the guarantee and are charged and collected in advance of each fee payment period under the guaranteed financing. For guarantees with a non-callable period such as the Partial Credit Guarantees (PCG) and Policy-Based Guarantees (PBG), fees are assessed against Bank s exposure where such exposure is calculated as the present value of the guarantee amount from the earliest call date. For capital market transactions, the fee is normally collected up front where the present value of scheduled fees for the life of the guarantee is payable as a lump sum. IBRD charges a front-end fee of 25 bps on the Bank s maximum exposure under the guarantee. It also charges private sector borrowers a one-time initiation fee of 15bps of the guaranteed debt or US$ 100,000 (whichever is higher) as well as a processing fee of up to 50 bps of the guaranteed debt to cover the cost of external consultants and out-of-pocket expenses that the Bank incurs for a transaction. IBRD Enclave Guarantees provided in IDA-only countries IBRD charges a guarantee fee, currently set at up to 200 bps per annum, on the exposure to the Bank arising from the disbursed and outstanding balances under the guaranteed financing. IBRD also charges a standby fee, currently set at 0 bps per annum, on committed but undisbursed exposure to IBRD. A front-end fee, an initiation fee and a processing fee are also charged. IDA Guarantees IDA charges a guarantee fee, currently set at 75 bps per annum, on the exposure to IDA arising from the disbursed and outstanding principal balances under the guaranteed financing. IDA also charges a standby fee, currently set at 0 bps per annum, on committed but undisbursed exposure. The fee remains the same for the term of the guarantee and is collected in advance of each fee period. As in the case of IBRD guarantees, an initiation fee and a processing fee are also charged. Guarantee Fees 15

Financial Solutions Unit Finance, Economics & Urban Development Department Sustainable Development Network Vice-Presidency The World Bank 1818 H Street, NW Washington, DC 20433 USA www.worldbank.org/guarantees April 2010 16