1 Foreign Exchange Liquidity Facilities World Economic Forum - Financing for Development Workshop Tuesday, October 26, 2004 São Paulo, Brazil

2 Conceptual Structure of a Foreign Exchange Liquidity Facility: Basic Assumptions Project Structure –Revenues are received in local currency –Revenues are contractually committed to increase with the host country’s inflation rate –The project will promptly convert all local currency cash available for debt service into US dollars at the then-current exchange rate Financing Structure –Project is financed with US dollar-denominated long-term debt –Debt is fixed-rate or floating, swapped to fixed

3 Conceptual Structure of a Foreign Exchange Liquidity Facility: Draws and Repayments Coverage is based on purchasing power parity, rather than hedging changes in nominal exchange rates The coverage establishes a “floor” for the value in US dollars of the company’s cash available for debt service Draws may be made when the project’s cash available for debt service, converted into US dollars, is below the floor value and is insufficient to pay scheduled debt service Draws from the liquidity facility will give rise to claims against the project, evidenced by a loan subordinated only to the project's senior lenders, repaid as soon as free cash flow allows Draws are subject to a maximum facility amount; recoveries through the subordinated loan mechanism will be available for payment of future claims

4 Conceptual Structure of the Devaluation Coverage: Currency vs Operational Risk Coverage is structured to separate currency risk from operational risk Changes in the real exchange rate are measured by valuing the project’s expected cash available for debt service based on actual inflation and current exchange rates, rather than the projected (PPP) values used to create pre- closing proformas Value of the project’s cash available for debt service is measured on a per-unit- of-output basis A proforma calculation is performed to determine the extent to which a cash shortfall is a result of fluctuations in currency values (which give rise to a draw under the liquidity facility) versus negative operational results (which do not give rise to a draw under the liquidity facility) Senior lenders are exposed to all operational risks, just as if the liquidity facility were not in place

5 Basic Structure of a Foreign Exchange Liquidity Facility Line 2: 67% Line 1: 100% Value in US$ Debt Service Coverage Ratio 1.50 Line 3 Time (in years) 015 Debt service shortfall amount to be paid from Liquidity Facility Amount repaid to Liquidity Facility Line 1: Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection) Line 2: Annual debt service requirements in US$ (principal and interest) Line 3: Actual value in US$ of cash in local currency, indexed to host country inflation rate 1.0

6 Sizing a Foreign Exchange Liquidity Facility Appropriate size of a foreign exchange liquidity facility depends upon: –The historical volatility of the real exchange rate of the project’s host country –The project’s debt service coverage ratio Exposure created by historical volatility of the real exchange rate of the host country depends upon where the floor value is established for an individual transaction (i.e., how far the real exchange rate must decline before the project is eligible to draw from the liquidity facility) The debt service coverage ratio for a project can be increased by: –Improving the project’s economics, e.g., by charging more for the project’s output –reducing the amount of debt in the project’s capital structure –Lengthening the tenor of the project’s debt (which is likely to occur as a result of the use of a liquidity facility)

7 Reduction in Exposure as a Project’s Debt Service Coverage Ratio Increases Line 2: 67% Line 1: 100% Value in US$ Debt Service Coverage Ratio 1.50 Line 3 Time (in years) 015 Line 1: Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection) Line 2: Annual debt service requirements in US$ (principal and interest) Line 3: Actual value in US$ of cash in local currency, indexed to host country inflation rate Line 4: Line 3 shifted upward to illustrate a higher DSCR than that of Line Line 4

8 Establishing the Floor Value for a Foreign Exchange Liquidity Facility If the floor value were to be established at a level equivalent to a 1.0 debt service coverage ratio, a small operational problem could cause the project to default –Liquidity facility provider would reduce its exposure to project operational risk, but –Fixed-income investors and rating agencies would put little value on the structure (it would resemble a US project with a 1.0 debt service coverage ratio) The floor value should be established at a level sufficient to provide an adequate margin for deviations of operational performance from the performance levels projected at closing

9 Structure of a Liquidity Facility with a Floor Value Equivalent to a DSCR of 1.20 Line 2: 67% Line 1: 100% Value in US$ Debt Service Coverage Ratio 1.50 Line 3 Time (in years) 015 Debt service shortfall amount to be paid from Liquidity Facility Amount repaid to Liquidity Facility 1.0 Line 4: 80% 1.20 Potential amount to be paid from Liquidity Facility (payments at this level of real exchange rate will be made only if necessary to pay debt service; i.e. only if the project is operating below projections) Line 1: Projected value in US$ of cash in local currency, indexed to host country inflation rate (base case projection) Line 2: Annual debt service requirements in US$ (principal and interest) Line 3: Actual value in US$ of cash in local currency, indexed to host country inflation rate Line 4: A line showing the level of cash at which the project has a debt service coverage ratio of 1.20 (“Floor Value”)

10 Status of Liquidity Facilities as a New Financial Product The concept has been successfully implemented in one transaction (AES Tietê) in one country (Brazil): –US$300 million issue, 10 year average life, 15 year final maturity –Rated Baa3 by Moody’s, BBB- by Fitch –First electric power project financing in a below-investment grade country to achieve an investment-grade rating –Longest tenor ever achieved by a Brazilian corporate issuer –Priced at a level equivalent to 237 bp less than Brazilian sovereign debt (vs. 150 bps for the 7-year Petrobras transaction which priced one week earlier) However, –AES Tietê has been downgraded for as a result of conditions in the Brazilian electric sector and the effect of macroeconomic factors on its ability to distribute cash –Further use of liquidity facilities within the Brazilian electric sector was impeded by the rationing which occurred in

11 Status of Liquidity Facilities as a New Financial Product The initial transaction utilizing a foreign exchange liquidity facility received favorable press coverage and industry awards: –Infrastructure Journal: Global Deal of the Year –Project Finance: Latin America Deal of the Year –Project Finance International: Latin America Deal of the Year –Euromoney: Best Structured Bond, Latin America Rating agencies have recognized the enhancement provided by coverage Report of the Panel on Financing Global Water Infrastructure (the Camdessus Panel) endorsed the use of foreign exchange liquidity facilities as a means of facilitating financing for the water sector