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Initial Research Deliberations: Testing the Broad Themes of the Project’s

Emerging Recommendations

Richard Samans & Barbara SamuelsWorld Economic Forum Financing for Development

Initiative

22-23 June 2005WEF FfD Workshop

New York City

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Agenda

• Meeting Objectives & Structure • The Imperative for Mobilizing Private Investment: Twin

Financing Gaps– Cited Evidence of Insufficient Official Sector

Effectiveness – Measures of Decline: 1997 - 2004– Cited Constraints & Impediments

• Summary of Initial Themes & Priorities Cited by Study Participants

• Open Discussion: How to refine & sharpen emerging priorities & themes?

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Meeting Objectives & Structure

• Objective: Develop specific concrete proposals that serve to stimulate private investment (domestic and international) in developing countries

• Focus: How to better leverage official sector resources & enhance financial governance?

- Crisis: Huge financing gap & insufficient ODA/ local government funding

- Historic Opportunity: Widespread political recognition that action is required; potential for win-win partnerships

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Meeting Objectives & Structure

• Deliverable: Recommendations to be presented to International Community– UN General Assembly meetings on Financing for

Development in Fall 2005– World Economic Forum Annual Meeting in Davos

2006– Other high-level exchanges

• Methodology: To insure open brainstorming, “off the record” consultations with experts & practitioners

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The Imperative & FfD Challenge:Twin Financing Gaps

• Infrastructure Financing - precondition to growth & meeting Millennium Development Goals

• Provision of Affordable Long Term Local Currency Financing - precondition to development of private sector companies, especially small & medium- sized companies (SMEs)

• Challenge at Multiple Geographic Levels: Regional, National, and SubSovereign

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The Case of Infrastructure Financing: Demand,Supply & Current Role of Guarantees

Demand

• Total Annual: $ 465-650B

• Examples:

-East Asia: $ 1T (over next 5 years)

-Brazil PPP Program: $65B

-Mexico: $100B Energy,$ 6B water (public sector investment fallen from 12% GDP in 1981 to 2% in 1998)

Supply

• Total Annual:– Private Sector: declined to

$48B (high of $128B in ‘97)– ODA: $66B– Major IFI Guarantees: $2B– Bilateral Guarantees: $0.3B (.5% total aid)

• From 2001-3 only 14 infrastructure project covered for breach of contract ($976MM), 6 MDB credit guarantees ($800MM)

Sources: World Bank & ADB working papers; Winpenny, 2004

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Cited Evidence of Insufficient Official Sector Effectiveness

• Declining demand for multilateral loans & services, especially from middle-income countries

• Declining participation of private sector in official sector risk mitigation programs (especially water & energy)

• Widening gap for infrastructure & other financing needs, especially with decentralization to states and municipalities

• Insufficient progress in increasing employment & economic growth & MDBs

• Unmet expectations of improved living standards (terrorism!)

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Debt Flows to Developing Countries

Source: Global Development Finance 2004, The World Bank, 2004

-40

-20

0

20

40

60

80

100

1997 1998 1999 2000 2001 2002 2003

Net Annual Flow (in billions of US$)

Official Creditors Private Creditors

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Bank Lending and Capital Markets Financing for Developing Countries

Source: Global Development Finance 2004, The World Bank, 2004

0

20

40

60

80

100

120

140

160

180

1997 1998 1999 2000 2001 2002 2003

Gross Annual Volumes (in billions of US$)

Bank Lending Capital Markets

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Measures of Infrastructure Finance for Developing Countries

• IFC’s A Loan / B Loan program has seen a consistent decline in B Loan participation since 1998

• IDB’s A Loan / B Loan program has experienced an even more dramatic drop in both A Loans (since 1999) and B Loans (since 2000)

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International Finance CorporationA Loan / B Loan Lending Program

0

2000

4000

6000

8000

10000

12000

FY 1998 FY 1999 FY 2000 FY 2001 FY 2002 FY 2003

Annual Loan Volume (in millions of US$)

A Loans B Loans

Source: International Finance Corporation

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Inter-American Development BankA Loan / B Loan Lending Program

0

100

200

300

400

500

600

700

800

900

1999 2000 2001 2002 2003

Annual Loan Volume (in millions of US$)

A Loans B Loans

Source: Inter-American Development Bank

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Constraints & Impediments at Multiple Levels

• Country-Level

• Multilaterals

• Bilaterals

• The Gap: Market Requirements for Greater Mobilization

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Country-Level: Reported Constraints and Impediments

• Unprofitable projects (e.g., too risky, insufficient profitability & scale, high upfront expense)

• Inadequate legal and regulatory frameworks (especially at regional and subsovereign levels; issue with local banking provisions for guarantees)

• Unacceptable cross-border risk & insufficient access to local funding (government crowding out, pension funds restrictions, government fiscal constraints)

• Weak local partners (e.g., operators, government)

• Unrealistic public expectations

• Difficulty/expense coordinating with multiple official donors

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Multilateral Level: Reported Issues & Constraints (1)

• Limited resources & suboptimal utilization (e.g., existing private sector portfolio limits)

• Bias toward lending to public sector (e.g., skill base, operations, policies, culture, backlash with unsuccessful privatizations & lack of success)

• Charter interpretations (e.g., restrictions on private sector, subsovereign, involving nonmember countries, etc)

• Concern with losing AAA ratings, tendency to emulate private sector risk management processes (competing with private sector rather than absorbing unacceptable risks)

• Unwillingness to openly engage private sector, concerns with avoiding perceptions of collusion (e.g., how to score guarantees, devise regional & country infrastructure plans)

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Multilateral Level: Reported Issues & Constraints (2)

• Slow, bureaucratic & politicized procedures (rigidity of Board approval process, fear of innovation, politically-based decisions)– One-off deals– Lack of new programs/services (unresponsive to market

requirements)– Politicization of work-outs & recovery processes

• Reduced faith in umbrella value (e.g., IFC default rate on B loans up from 1% pre-Asian crisis to 17% June 2003; Argentina deals)

• Lack of “coherence” with IMF fiscal policies (inadequate differentiation of expenditure vs. investment)

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Bilateral Level: Reported Issues & Constraints

• Sometimes more innovative & flexible than multilaterals, but lack scale

• Political focus, often bureaucratic (resistance to new programs)

• Often anti-business culture, fear of collusion

• Lack of sufficient coordination with other official sector entities (in some cases many chasing same deals)

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The Gap: Market Requirements forGreater Mobilization

• Credit requirements: 100% confidence that unacceptable risks covered with timely payouts, transparency of recovery and workout procedures (without politicization)

• More relevant & credible guarantee products (covering equity, regulatory risks, cross-border risk, demand risk, etc)

• Reduction of project development costs (e.g., official support to governments in project identification and structuring)

• Open business participation in development of country and regional development plans, regulatory & legal frameworks, etc (without being precluded from deals)

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Financial Market Impediments

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Impediments to Infrastructure Financing for Developing Countries

• Sponsors are now reluctant to make new equity investments

• Commercial banks have retreated from project finance in both developed and developing countries

• International capital markets investors avoid developing country issues to finance infrastructure

• Local capital markets in developing countries are hesitant to bear both the commercial and financial risks of infrastructure

• Multilateral institutions have been unable to replace or attract new private funding

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Sponsor Reluctance to Make New Developing Country Investments

• Previous developing country investments have produced disappointing returns because:

– Regulatory risk has frequently reduced expected local currency cash flows

– Devaluation has often reduced the US dollar value of local currency cash flows

• Difficult conditions in sponsors’ home markets require that attention be given to sponsors’

– Credit ratings

– Balance sheet improvement

– Share prices

• Sponsors’ avoid new investments because:– They fear regulatory risk and devaluation will adversely affect new investments

– They do not want to make decisions which appear to increase the risk profile of their firm to rating agencies or shareholders

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Reasons for Retreat By Commercial Banks

• Commercial banks do not view provision of infrastructure financing to developing countries as an attractive standalone product:

– Project financing is provided only if commercial bank clients demand it

– Other, easier transactions are used by sponsors to reward banks which provide support for difficult project financings

– Sponsors’ avoidance of new investment ends pressure on commercial banks to continue to provide infrastructure financing

• Commercial banks wish to present a lower risk profile to shareholders

• Current banking strategies emphasize:

– Fee income transactions, not transactions requiring assets to be held for long periods

– Mergers & acquisitions and equity business, rather than traditional debt products

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Why International Capital Markets Investors Avoid Developing Country Infrastructure

• Capital markets investors are very conscious of the risk of downgrades:

– Many international infrastructure transactions which initially carried an investment-grade rating were downgraded to below investment-grade

– Linkage between sovereign rating of host country and transaction rating worries investors

• Capital markets investors were particularly disillusioned by Argentina’s default

– Investor’s have a heightened awareness of devaluation and regulatory risk, which they see as linked

– Investors now give less credence to co-participation by multilateral agencies in infrastructure financings

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Why Local Capital Markets Have Not Filled The Gap Left By International Institutions

• Limited understanding of the risks of structured financings for infrastructure projects

• Limited market capacity (average transaction sizes for local currency financings are much smaller than for US dollar-denominated financings):

– Government regulatory restrictions on the financial sector frequently hamper investment in local infrastructure financings

– Many countries do not have adequately developed long-term savings institutions– Local commercial banks may not be able to obtain long-term funding, thus creating asset/liability

mismatches if they provide infrastructure funding

• Macroeconomic policies (both current and historical) often make local investors prefer:

– Short-tenor transactions– Floating, rather than fixed-rate debt

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Why Multilateral Agencies Have Not Replaced or Attracted New Private Financing

• Role is to supplement and facilitate private financing to substitute for it - especially in current climate of privatization

• Lack of new investment by private sponsors has created fewer potential transactions in which they can participate

• More comfortable with commercial bank financing structures than with capital markets structures - but commercial banks participation requires clients as sponsors

• In some cases, reluctant to develop new products: willing to continue to offer old products until market for these products returns

• Culture does not demand or provide incentives for measuring success in terms of volumes of new transactions

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Testing the Broad Themes of the Project’s Emerging Recommendations

• Overall: “Crowding In” Private Sector Investment: Reorienting Multilateral Development Banks & Bilateral Aid Agencies– Urgent need to reposition official sector agencies

– Focus on comparative value relative to private sector• Insufficient financial and expertise to meet the demands

– Shift from being primary providers of funds to being catalysts that “crowd in” the private sector:

• Risk mitigation• Technical Assistance

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Eight (8) Major ThemesParticipant Input to Date:• Risk Mitigation (Themes 1, 2, 3)

– Overall Need to Scale Up– Local Capital Markets– Regulatory & Foreign Exchange Risk

• Project Feasibility Funding (Theme 4)• Financial & Corporate Governance (Theme 5)• Internal Official Sector Challenges (Themes 6, 7)

– Institutional Change in Culture– Redeploying Capital & Amending Charters

• Demand-Based Donor Coordination (Theme 8)

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Theme 1: Scale up Risk Mitigation Products

The new leadership of the multilateral and regional development banks, in concert with bilateral aid agencies, need to commit to launching large-scale risk-sharing programs designed in partnership with private sector companies to enhance aid effectiveness by harnessing domestic and international private sector capital and developing capital markets.

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Theme 1: How to Scale Up Overall Risk Mitigation Instruments?

For immediate large-scale replication by multilateral and bilateral institutions worldwide:

• Guarantee Programs - partial loan guarantees, loan portfolio guarantees, commitment agreements for guarantees (“portable guarantees”) & bond guarantees

• Risk-Sharing Agreements with banks and monolines• Modified and Expanded Political Risk Insurance Programs for

both debt and equity that meet investor needs• Modified and Expanded Supplemental Tariff Payments to

support Infrastructure Projects (Output-Based Aid)• First Loss Provisions in financing agreements • Regional Debt and Equity Funds

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Theme 2: Focus Local Capital Market Enhancement

The leadership of official sector institutions needs to scale up and expand the current programs aimed at developing local capital markets and expanding local sources of available credit in direct collaboration with other official agencies, private sector companies, rating agencies, and government officials at both national and subsovereign levels.

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Theme 2: How to Scale Up Specific Local Market Instruments?

For immediate large-scale replication by multilateral and bilateral institutions:

Local Currency and Tenor Extension Guarantees State Revolving Funds (SRFs) Monolines (Multilateral, Regional, and Country) Swap Funds and Transactions (Country and Regional) Official Sector Counter Guarantees of National Guarantees Global and Regional Diversified Funds (especially in local currencies

and infrastructure) Strengthening and Establishment of Local and Regional Development

Financial Institutions Risk-Sharing Programs outlined in above point (Theme One)

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Theme 3: Regulatory and Foreign Exchange Risk

The most significant impediments blocking the access of developing countries to private sector capital are the unacceptable risks associated with regulatory and currency risk. The leadership of official sector institutions needs to task their expert staffs with urgently designing new financial structures that correspond to market needs in two specific areas blocking mobilization of capital, government regulatory risk and foreign exchange risk.

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Theme 3: How to Enhance Capacity to Mitigate Regulatory and FX Risk?

Frameworks for two instruments be developed for immediate large-scale replication by multilateral and bilateral institutions:

Contingent Regulatory Guarantee Facilities at both a country and official sector level, so that country project-specific regulatory guarantees can be counter guaranteed by creditworthy multilateral and bilateral entities; and

Country Foreign Exchange Liquidity Facilities at both a country and official sector level, so that country devaluation liquidity guarantees can be counter guaranteed by creditworthy multilateral and bilateral entities.

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Theme 4: Project Feasibility Funding & Pipeline

A critical bottleneck impeding development finance is the shortage of identified good projects, especially those sized and structured optimally that meet needed performance standards. To remedy this problem, official sector institutions need to pool project feasibility funds and make them easy-to-access, utilizing appropriate experts from across the public and private sectors to identify quality projects and develop acceptable risk-mitigating financial structures.

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Theme 4: How to Scale Up Bankable Project Pipeline?• Set Up Funds with Simplified Access (subsovereign, national, regional,

and global), using technical assistance grants or revolving funds to finance the development costs of projects

• Create Partnerships for Project Development with Experienced Private Sector or Research Entities that can collaborate with federal and state governments in identifying projects & manage the procurement process for operators, service providers, and contractors

• Create and Strengthen Regional and Local Development Financial Institutions that can assist in this process

• Create “Steering Committees” of Experts to oversee the project development process and the development of appropriate policy, legislative, and regulatory frameworks

• Establish Roving SWAT Teams of Experts who can respond quickly to private sector opportunities, help government officials determine how to approach the private sector and structure bankable deals, jump-start the project identification process, and help interested parties quickly access available funding.

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Theme 5: Financial and Corporate Governance

The long-term precondition for developing countries to improve access to private sector finance is to improve their business environments, especially regulatory and legal frameworks as well as the overall skill set and governance of actors across the private and public sectors. To be more effective in these areas, the leadership of official sector institutions needs to refocus and scale up their capacity and institution-building programs of technical assistance to insure greater mobilization of private sector expertise in meeting the overwhelming demand for assistance in these areas.

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Theme 5: How to Scale up Goverance Capacity Building?

• Define Explicit Process for Country-Definition of Priority Needs and Technical Assistance Programs based on Specific Country Needs and Structure, involving a wide spectrum of experts and private sector participants that enables demand-driven technical assistance programs

• Designate Country Technical Assistance Delivery Centers to facilitate donor coordination in assembling an adequate supply of targeted technical assistance against defined priority country needs with decentralized centers of support in local institutions

• Support Existing and Launch New Global and Regional Private Sector Outreach Mechanisms that harness private sector expertise in needed areas such as accounting, auditing, business planning, financial analysis, and legal processes (for example, enable greater reach of Financial Services Volunteer Corps and other like NGOs, support Government-Investor Networks to identify investment impediments and improve business environments, launch new vehicles such as Peace Corps of Financial Experts and SWAT teams to support national and subsovereign governments; expand reach with use of open information portals, tool kits and e-learning)

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Theme 5 continued: How to Scale up Goverance Capacity Building?

• Integrate Technical Assistance into Official Sector Finance Programs and Specific Transactions, facilitating on-the-ground identification of priority problems and linking reforms explicitly to available finance (akin to learning by doing and applied learning)

• Facilitate Creation and Dissemination of Principles, Best Practices, and Tool Kits to governments on national, regional and municipal levels, as well as to business organizations and their members (for example, strengthening bankable property rights)

• Facilitate Public Benchmarking of Enabling Environment Conditions, creating pressure and catalysts for change

• Collaborate with Private Sector and Experts in Creating New Financial Indices, Instruments, and Funds that reward improvements in governance and business environments

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Theme 6: Institutional Changes in Culture

The existing capacity of many official institutions in underutilized due to internal constraints in approving transactions and working effectively with the private sector. Furthermore official sector institutions are often seen as competing with the private sector and each other, all competing for the best projects with no takers for the more difficult transactions and countries. For official sector institutions to partner effectively with the private sector and optimize use of official sector resources, senior management must take the lead in devising new management incentive programs and processes that change the behaviour of officials and processes, and insure a new responsiveness to clients, greater effectiveness, and more competitive practices.

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Theme 6: How to Create Needed Institutional Changes?

• Define the Primary Mission as Catalyzing Private Sector Capital and Expertise in response to Specific-Country Demands, insuring that the official sector takes the risks that are unacceptable to the private sector, including strict rules against direct competition with the private sector (“no compete” rules) and focus on insuring “demand-based services” (rather than “supply-driven services”)

Direct Senior Officials Responsible for Treasury and Risk Management Operations to Modify Internal Processes as Needed to Implement New Primary Mission (e.g., loss reserves, limits, leverage, surveillance, transaction approval processes, etc) in consultation with private sector experts and rating agencies to insure effectiveness and acceptable risk management (to safeguard AAA ratings)

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Theme 6 (continued): How to Create Needed Institutional Changes?

Devise and Implement Commensurate Performance Incentives, Measurements, Deliverables and Targets, Decentralized Management Processes, and Open Audits and Client Surveys to enable enhanced local responsiveness and dynamic results-based performance tracking

Establish Capacity-Building Programs to Assist Change in Skill Sets, Attitudes, and Processes, including integrating internal expertise with private sector operations

Support Existing and Establish Ongoing Public and Private Sector Expert Groups that enable ongoing development work with external experts from both official sector development agencies and the private sector aimed at developing new products, services, and processes; more effective investor outreach; and coordination with other donors in improving services and partnering on programs (for example, International Private Water Association, Infrastructure Experts Group, etc)

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Theme 6 (continued): How to Create Needed Institutional Changes?

Explicit Integration of Private Sector Expertise into all Levels of Operation using third-party surveys of investors, private sector “testing” of deals, meaningful broad-based business advisory groups, etc.

Insure Open Dissemination of the Transition Process (for example, surveys, recommendations from private sector, and discussions), to enable market-based pressures to insure successful transition to new organization and processes

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Theme 7: Redeploying Capital & Amending Charters of MDBs

The dominant share of official development institutions retain the structure, charters, and capital allocations for focused emphasis on direct lending and grant making. To enhance capacity and effectiveness in harnessing private sector capital, the capital structures and charters of official sector institutions need to updated and realigned with the specific objective of maximizing the leverage of official sector capital (i.e., the efficiency of each taxpayer dollar in mobilizing additional private capital), as well as the attainment of specific deliverables, such as enhancing infrastructure and improving access to affordable capital for developing country private sector companies.

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Theme 7: How to Proceed with Redeploying Capital & Amending Charters?

Shifting Allocation of Capital to Official Sector Units Responsible for Private Sector, enabling private sector programs to be more effective in their guarantee, insurance, and other risk-mitigating programs aimed at mobilizing private sector capital programs (i.e., capital needs to be increased on global level within the IFC and MIGA; at regional level within private sector departments and entities within regional development banks; and on national levels shifted to bilateral development agencies focused on leveraging private sector capital)

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Theme 7 continued: How to Proceed with Redeploying Capital & Amending Charters?

• Publicly Identifying those Charter Rules that Impede Effectiveness and Begin Process of Amendment - Despite the extremely complicated process of changing the charters of multilateral development banks, participants noted that several charter rules need to be changed (or reinterpreted if appropriate) as they significantly hinder the ability of the official sector to mobilize private sector capital in response to country client needs. Examples cited included charter restrictions on lending to subsovereign entities and insuring equity investments; lengths of tenors too short given payback periods; amounts of financing contributions limited below project needs; inflexible pricing policies; inability to work as needed with other donor entities; specification that beneficiaries must be member states; etc.

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Theme 8:Demand-Based Donor Coordination

The need for donor coordination has been the subject of endless debates, studies, and political resolutions with limited success; yet the imperative remains. To be successful in leveraging official sector capital, these mechanisms for donor coordination need to be explicitly tied to specific programs aimed at mobilizing domestic and international private sector capital and expertise (i.e., implementation of the above recommendations on risk-mitigating instruments and processes for capacity-building and effective delivery).

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Theme 8: How to advance Demand-Based Donor Coordination?

“Public-Private Syndications” of debt, equity, and currency transactions (at global, regional, and country levels employing the above recommended risk-mitigating structures)

“Donor Tables” to enable cost-effective demand-driven donor coordination in support of national development objectives and regional economic integration, involving private sector experts and relevant companies

“Global Sector Capacity-Building Kits” consisting of principles, implementation guidelines, and tool kits that enhance developing country capacity to execute transactions

“Consultative Mechanisms to Build Country Criteria” for official sector entities and key private sector entities to build local capital markets and global competitiveness (i.e., country level working groups including relevant government officials, business organizations, financial institutions, rating agencies, targeted investors, donors, and other key actors)

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Discussion Questions

FOCUS: Enhancing leverage of official sector & financial governance:

– What other impediments need to be identified so we can determine realistic concrete solutions?

– What do we need to understand about these constraints and impediments to construct viable proposals for changing transaction structures and the supporting process and structures?