The World Bank Group Infrastructure Economics and Finance Department

1
The World Bank GroupInfrastructure Economics and
Finance Department
Capital Markets Instruments Financing
Infrastructure Development IDB Business Seminar
Series 2004, Capital Markets for Development,The
Role of the Private Sector, Washington DC, June
4th, 2004
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Contents

• Overview of Bond Markets
• Capital Markets and Infrastructure Development
• Infrastructure Needs
• Local capital markets
• Local currency debt instruments
• Guarantees
• Definition
• Options under Consideration
• Guarantee Liquidity Facility
• Capital Markets in the Region

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Size Structure of the Bond Markets (LATAM)

• Capital Markets still represent a very small
  of GDP (except Chile) average 11 (est. 2001).
• Average holdings of sovereign risk by investors
  is relatively high (70 to 85)

4
Relative Size of local Capital Markets
 
Table 2 Capital Markets Capitalization as a of
GDP for selected countries, Year 20011 (equity
and bond markets) 1
  Source World Bank Financial Structure Data
Base (using FIS)
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Infrastructure Needs LATAM (2005-2010) /1
Source World Bank, Working Paper 3102,
Fay-Yepes, 2003
Note /1 Does not include rehabilitation,
deferred past maintenance and upgrades
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Infrastructure Needs LATAM (2005-2010)

• LATAM infrastructure needs are estimated at US
  71 billion per year (it was close to US 60 back
  in 1995). Of this close to 45 is represented by
  maintenance.
• The most demanding sector in the Region will
  appear to be the Telecom Sector (US 32.5 billion
  per year or 46 of the total), with the mobile
  sub-sector alone demanding US 25 billion
  annually. Following Telecom will be Electricity
  (mainly generation) with US 25 billion per year,
  and toll roads with US 7 billion per year.
• In the golden years of infrastructure finance in
  the Region (1996), total amount of financing
  raised was closed to US 30 billion. This figure
  is probably now in the US 8 to US 10 billion at
  best. These demand figures do not include a stock
  of deferred investments and maintenance. If we
  add the weak foreign capital flows into LATAM
  infrastructure during the last years (and
  immediate future), the outcome is a pressing need
  for new financing options
• Redesign of the government role (from regulator
  to partner, PPPs)
• Development of risk mitigation products that can
  addressed the FX risk
• Development of local currency debt instruments

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Real Investment in Infrastructure Projects with
Private Participation in Developing
Countries(1990-2002)
Source PPI Data Base (IEF, WBG)
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New Agenda Connect Infrastructure with private
financial markets

• Transparent and efficient rules to determine
  future returns and risks with clear enforcement
  and dispute resolution mechanisms (economic
  regulation, judicial reform,investment climate)
• Development of local capital market
  development (local currency financing) and
  hedging instruments against currency risk.
• Development of risk-mitigation products to
  support financing instruments capable of dealing
  with credit, fx, contractual and regulatory
  risks.
• Enable and support access of municipal
  governments, sub-sovereign entities and public
  utilities to private financial markets via
  improvement of corporate governance, credit
  worthiness, and initial financial backing.

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Local Capital Market Development

• Financial des-intermediation is a key component
  of a sustainable economic development strategy.
• Support of good quality credit rating private
  sector instruments as a way to diversify
  investors portfolio (e.g., pension fund
  development in LATAM increased sovereign risk
  cases of Argentina, Uruguay, Brazil, Colombia)
• Develop local currency funding instruments that
  could mitigate cross-border risk (FX risk).
  Projects that are typically local currency
  generators Water sanitation, toll roads,
  irrigation, etc. will have a tough time getting
  finance in the US markets (even with the best
  build-in contracting clauses for US tariff based
  there is a tolerance to FX adjustments in a
  particular economy)

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Development of local currency debt instruments

• Matching of revenue generation (productive
  assets) and liabilities for private corporations.
  
• Mitigation of economic regulation framework under
  volatility scenarios (I.e., US based tariffs in
  utilities public services)
• Development of local savings capacities (I.e.,
  diversification from investments in government
  related securities).
• Incorporation of local debt holders as stake
  holders in infrastructure projects (mitigate
  regulatory risk)
• Introduce market performance benchmarks to
  improve risk return remuneration for local
  savings (domestic investment)

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Guarantees Overview

• Political Risk Guarantees (US debt instruments)
• sovereign (transfer convertibility) and
  selected non-commercial risks (contract
  frustration) for infrastructure development in
  the Region. Streamlined approval process (3
  months).
• Could include selected non-commercial risk
  regulatory risks such as breach of contract by
  the grantor of the concession (e.g., San Pedro de
  Macoris, IPP, Republica Dominicana).

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Guarantees Overview

• Financial Guarantees, partial credit guarantees
  (local currency debt instruments)
• credit enhancements to improve credit risk
  profiles of local issuers to enable them to
  access market financing under better conditions
  (tenor and pricing).
• Instruments mechanism that cover or protect
  debt service payments to institutional investors
  (bondholders).
• Products can be structured to guarantee an
  specific layer of credit risk,in order to elevate
  the risk profile of the overall transaction and
  thereby attract investors. By guaranteeing an
  intermediate part of the debt (I.e., guaranteeing
  to pay a portion of the obligation after the
  internal cash reserves or sponsor support has
  been exhausted) the local investor maybe more
  willing to put its capital at risk for the
  remaining exposure.

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Guarantees Extending tenors for required longer
maturities.

• A Partial Credit Guarantee (PCG) can guarantee
  debt service for specific periods

150 million
Example China Ertan Power Project
50 million
0
3
6
9
12
15
Average financing term for
World Bank
Additional uncovered
China without
risk taken by
Guaranteed
World Bank Guarantee
commercial banks
Total risk assumed by commercial banks
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Guarantees PCG applications under development
Application of Partial Credit Risk Enhancements
to potential PPP projects in infrastructure
Design the optimal partial credit enhancement
for a given project in order to improve its
credit risk profile enough to capture private
capital on adequate terms conditions

• Mezzanine Guarantee (local currency instruments)
• Pool Guarantee (local currency instruments)
• Guarantee Liquidity Facility

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PCG applications under development

• Mezzanine Guarantee
• A credit loss protection enhancement with the
  WB providing a guarantee for a specified
  mezzanine layer of credit risk, thereby elevating
  the overall transaction to investment grade on
  the local currency scale.
• Illustration For a project bond supporting PPP
  investments in electricity distribution, the WB
  could provide a partial credit guarantee to
  support electricity payments by government
  related clients to project.

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Mezzanine Guarantee (energy distribution co.)
Transaction (Receivables Securitization )
Mitigation of the lower credit risk quality and
improving the transaction rating attracts
participation of Monoline Insurers to provide a
wrap on the whole transaction, improving
further the transaction credit rating.
Project Revenues (High Credit Risk Quality
Layers)

• Transaction Reserves
• Over-collateralization
• Project Debt Service Reserve Account
• Liquidity Reserve (sponsors recourse)

Partial Guarantee (a portion of the credit loss
on the transaction, -- debt service)
Layer of Lower Credit Risk Quality
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PCG applications under development

• Pool Guarantee for Asset-Backed Securities
• A partial credit enhancement product with WB
  providing a PCG for a portion of principal and
  interest sufficient to offset potential losses
  resulting from non-performing assets within the
  underlying collateral pool. The Pool Guarantees
  amount will be calibrated for each transaction to
  improve the projects credit rating in a manner
  sufficient to attract targeted local investors.
• Illustration A utility company may pledge
  credit receivables as collateral to repay a bond
  issue. Although the collateral enhances the
  bonds credit quality, the information on the
  collateral in emerging markets may not be
  adequate (e.g. incomplete records of past
  performance) and as such, the collateral may not
  be sufficient to attract local investors to
  purchase the bond. The WB could further enhance
  the bond with a partial credit guarantee in order
  for the bond to achieve a credit quality
  sufficient to interest targeted local investors.

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Pool Guarantee CBO, for Illustrative purposes
Source Rating Agencies Methodology (Case Example)
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PCG applications under development

• Liquidity Facility
• A form of project support that is funded in a
  separate escrow account, or available on a
  contingent basis from a third party and that
  maybe utilized under defined circumstances.
  Liquidity Facilities are intended to assist the
  project in coping with problems that are believe
  to be temporary.
• The liquidity facility will be repaid over a
  number of years through (a) phased tariff
  adjustments to return tariff to a cost recovery
  level, or (b) a special levy on consumers. /1

• /1 Foreign Exchange Risk Mitigation for Power and
  Water projects in Developing Countries, World
  Bank, Energy Discussion Papers, Matsukawa,
  Sheppard and Wright, December 2003

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PCG applications under development

• Guarantee Liquidity Facility (GLF)
• A partial credit enhancement product with the WB
  providing a liquidity guarantee to cover a
  specified number of interest and/or principal
  payments, on a rolling forward basis i.e. the
  guarantee is in place throughout the life of the
  bond or until depletion.
• The guarantee could be predetermined as an lump
  sum amount of the debt service covering a rising
  share of remaining debt service (on a mortgage
  style payment), or the guarantee could be
  designed as to cover only a predetermined of
  principal throughout the life of the bond.

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GLF (transmission and distribution PPPs)
Outstanding Principal
Debt / Service Coverage Ratio
DSCR
1.5
1.0
Guarantee Liquidity Facility
Years
N
N I
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Liquidity Facility Guarantee FX mitigation
Product currently under development
Projected Cash-Flows
Real Cash-Flows (after FX adjustment)
Local currency Project Cash-flows expressed in
real US (going exchange rate)
US cash shortfall
US cash shortfall
Years
N
N1
N2
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Liquidity Facility Guarantee FX mitigation
Projected Cash-Flows
Product currently under development
Real Cash-Flows (after FX adjustment)
Local currency Project Cash-flows expressed in
real US (going exchange rate)
DSCR
US cash shortfall to cover DSRA
US cash shortfall to cover DSRA
Years
N
N1
N2
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Liquidity Facility Guarantee FX mitigation
Projected Cash-Flows
Product currently under development
Real Cash-Flows (after FX adjustment)
Local currency Project Cash-flows expressed in
real US (going exchange rate)
DSCR
Liquidity Facility covers short fall up to debt
service payment
Liquidity Facility covers short fall up to debt
service payment
Years
N
N1
N2
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Capital Markets in the Region