MARKET SOLUTIONS FOR DEVELOPMENTMARKET SOLUTIONS FOR DEVELOPMENT: Frontiers in Infrastructure Finance Mansoor Dailami Lead Economist, World Bank Institute September 8, 2015

1 PSD Competition Infrastructure Finance FY 2002 Regulation Market Solutions for Development FY 2001 FY 2000 FY 1999 where we were……where we are now… Governance MS4D: Consolidation of 4 earlier programs

2 What is the logic behind MS4D? Reliance on the potential power of market mechanisms and private initiatives to promote a favorable investment climate: Better distribution of risks between public and private sector Infrastructure investment and the supporting institutional changes are a core component of WBG poverty alleviation programs It does not exclude the role of government in establishing sound regulatory systems and protecting property rights

3 MS4D: What is it? Learning program focusing on: Policy, regulatory, governance, and poverty aspects of PPI and PSD, for market-led growth Policy services and implementation processes, using a holistic and cross-sectoral approach Filling market gaps in learning and capacity building What it does not do: Focus on some sectoral issues (we do not cover education or oil & gas for instance) One-off activities Crowd out private sector and other content providers including academics

4 MS4D: Content/Design The rigorous incorporation of Governance concerns and equity/poverty aspects of growth, e.g. Transparency in infrastructure concessions PPPI and the Poor A modular design, that will allow us to share and draw upon other relevant programs within and outside WBI Emphasis on : Research and data that provide the intellectual and empirical basis for our learning activities; Scaling up through the GDLN and distance and e-learning Frontiers in knowledge, best practices, and emerging issues

5 Infrastructure Finance u to finance: Defined by Webster’s Dictionary as “to raise or provide funds or capital for” u Infrastructure Finance: to raise or provide funds for greenfield or divestiture projects (in power, water, telecom, and transport) u Options a)Government finance (management contracts, supply and civil work contracts) b)Private sector finance  PPP (BOT, estimated at $907 billion planned and funded since 1985)  PFI (£19 billion since inception in 1992)

6 Key Objectives u Balancing the need of financers/promoters for long-term off-take contracts with buyers’ desire for flexibility to meet changes in market demand u Designing a financing package to minimize the cost of capital consistent with the project’s risk profile u Devising strategies for equitable sharing of risk u Capitalizing on market innovation: merchant financing, targeted insurance guarantees, new trading markets

7 Expanding the possibilities for efficient infrastructure provision through public-private sector partnership: Community of interest Government Private Sector Partnership Investments that are socially beneficial

8 Private Sector Participation: A Continuum of Options Technical assistance contracts PUBLICPRIVATE Supply and civil works contracts Sub- contracting Management contracts Leasing BOT and concession BOODivestiture Of particular importance

9 Evolution of Private Participation in Infrastructure: An Historical Perspective 1970s U.S. deregulation of airlines, gas, rail, and telecommunications Deregulation and privatization in the UK Russia and Brazil crises South East Asian financial crisis 1980s 1990s 2000s Decade of 1990s: Liberalization and opening up of emerging market economies to private sector 1991 Launch of UK Private Finance Initiative (PFI) Transformation of U.S. electric industry EU Electricity Directive opens market to competition 2001 California Power crisis

10 u Private activity declined in 1998 from a high in 1997, falling most in East Asia and in energy. Annual Flows to PPI Projects in Developing Countries 1999 $USBn $125.1 $97.3 $65.4 Total: US$573.5 Bn

11 by Sector Total: US$573.5 Bn by Region Total Flows, u Telecommunications and energy have been the leading sectors in private participation. Latin America and East Asia the leading regions.

12 Main Characteristics of the Infrastructure Project Finance Market I. Complex contractual arrangements II. Dominant use of project financing techniques III. Risk management strategies and techniques IV. Project financing mix depends on tariff charged

13 Major Parties to an Infrastructure Project Security of Debt Payment and Collateral (concession agreement) Build, Operate, Raise Finances to Provide Infrastructure Services Concession Rights, Fiscal Incentives, Guarantees Government Creditors Project Promoters Security and Assurance of Debt Repayment Term Debt Capital  Each party maximizes its own objectives subject to the constraints set by others’ willingness to participate.

14 u Sponsor holds a residual claim, after the payment of contractual claims u Financing mixes depend on “negotiated tariff” rate for infrastructure services u Reasonable return on investment u Limited recourse structure Incentives/Objectives of Project Sponsors

15 u Have a claim to fixed contractual payments from the project’s cash flows independent of the borrower’s income u Good credit risk u Sufficient and secure cash flows u Managerial capability u Credit support, guarantees u Want to maximize the probability that their loans will be paid on time. Incentives/Objectives of Creditors

16 u Serve Public Interest u Low Tariff Rate u Quality of Services Incentives/Objectives of the Government

17 u Up-front, specific, risky, and long-term u Examples: power plants, bridges, roads which can not be moved u Lock-in equity capital for a long time u Incentive system of contracting parties changes once the investment is sunk Infrastructure Investment: Why Long-Term Contracting?

18 Forms of Contracts Ô Long-term formal contracts: three classes of contracts are important: u Concession agreements stipulating a property rights transfer from the government to the project company. u Performance contracts between the project company and contractors and operators. u Loan contracts between creditors and the project company.

19 As a result: u Investors are hesitant to make investments without adequate contractual protection, leading to special contracting and risk sharing problems. Features of Private Infrastructure Investment

20 Incomplete Contracts u It is difficult to write complete contingent contracts that will cover all future circumstances, including: Ô Exogenous shocks Ô Unanticipated changes in operating costs and conditions u Market innovation: Merchant plants in the power sector

21 Emergence of Project Financing: u Appropriate techniques for projects with high capital requirements and a complex risk profile u Payouts are based only on the projects’ own assets and cash flows stream u Creditors rely on the ability of the project for repayment of related debt obligations, non- recourse debt u Multi-source financing: syndicated commercial banks, bonds, ECAs, multilaterals

22 Project Financing: Uses of Cash Flows Revenue Streams Depreciation & Interest Taxes Principal Payments Depreciation O & M, Insurance Expenses Dividend to Shareholders  Governed by a hierarchy of claims and by the prevailing tax codes

23 Power Plant Key Parameters % ,000 26MMBTTU/ton Characteristics of the plant u Capacity (MW): u Capacity factor: u Plant investment cost ($/kw) u Plant investment cost ($million) u Heat rate (BTU/kwh) u Heat content

24 Power Plant Key Parameters 70% debt 30% equity 20 years 8.5 % 40% Financial Assumptions u Capital structure: u Term of debt: u Interest rate: u Income tax rate:

25 ROE Depends Critically on the Tariff Rate

26 Must address the needs of a broad cross- section of people and communities Environment - complying with global standards Right investment climate — institutions, political stability, credibility of government commitments Adequacy and security of cash flows Summing Up: Criteria for Success

27 I.What is driving the infrastructure finance market? 1.Changes in country and risk profiles 2.Technological advances, changes in regulatory policy 3.Government support, guarantees, tax incentives, credit enhancements, and political insurance II.What are the implications of globalization / consolidation of infrastructure industries? III.What are the implications for developing countries? What are the requirements to restore investor confidence? What type of financing best fits different countries’ needs, priorities, and local financing conditions? Emerging trends at the turn of the millennium