Finmedia Conference on Project Finance The Scope for Project Finance

1. Finmedia Conference on Project Finance The Scope for Project Finance Bucharest, Jan.24, 2005 Denis Clarke

2. Outline • Why Project Finance • Why IFIs play a key role • What has been achieved • Lessons • Opportunities and new models

3. Why Project Finance • Large investments needn’t compromise credit rating • A-rated utility in EU could invest in risky country without downgrade • Less critical where host country is Investment Grade • But an EU utility downgraded as Balkans customers exceeded domestic • Project debt can be priced on its merits • Borrowing on sponsor balance sheet subsidizes partners • Finely sliced risk allows higher level of debt • May be only way to get adequate return for risk taken • Allows developers to conceive ambitious projects • Often local, no access to long term debt but key insights and access Most private infrastructure has been financed this way

4. Outline • Why Project Finance • Why IFIs play a key role • What has been achieved • Lessons • Opportunities and new models

5. Overview of Main Project Risks • Completion – typically borne largely by EPC contractor • Fuel / Key inputs: mitigated under supply agreements • Operation & Maintenance: Sponsor typically knows well • Project finance lenders don’t want technology risk – no “pilots” • Market risks: borne by the project co. so lenders share it • Country Risks – element differentiating emerging markets Foreign exchange rate; Convertibility and transfer;Riots and civil strife But country risk also includes • Change of law – including the regulatory & tariff frameworks Weak regulatory frameworks main problem in this region

6. Country Risk and Multilaterals • Countries own the multilaterals – they subscribe to attract investment • Information: investors see IFI has access to data & analysis • So analysis & shared due diligence confirms sponsor’s judgment • Trust: The IFI often cast in role of “honest broker” • IFI involvement with the investor comforts host country politicians • Multilateral’s access to ministers is a comfort for the investor • Mobilizing Finance: facilitated by key privileges • “Preferred debt” excluded from Paris & London club restructuring • Formal commitment to facilitate conversion & transfer • No withholding tax • Country risk reduced: financing terms will reflect this…but limits Country risk: key determinant of when an IFI is required

7. IFIs in Infrastructure, Mining etc. • Capital intensive, long term exposure in country • At interface of public & private: high profile politically • Usually earns local currency to repay hard currency debt • So IFI can make greatest contribution in these sectors • IFC’s portfolio supports this – e.g. excellent results in power • Returns on equity, NPLs, etc. all better than IFC average • Despite sponsors’ poor results in EMs -AES, Enron, El Paso, NRG, • But declined some opportunities where country risk too great Track record in many crises illustrates IFI risk mitigation

8. Outline • Why Project Finance • Why IFIs play a key role • What has been achieved • Lessons • Opportunities and new models

9. PPI:Total Investment 1990-2001 By Sub-sector Total: $754 bn (2,493 projects)

10. PPI: Annual Flows by Region $ billion $128.4 $90.3 $75.6 $46.7 $41.3 $23.2 $16.9 $9.6 $9.7 $5.7 $5.4 $1.5

11. Outline • Why Project Finance • Why IFIs play a key role • What has been achieved • Lessons Learned • Opportunities and new models

12. Some Lessons from the Boom • Private participation brought improvement • Of 2500 private infrastructure schemes • Only 48 have reverted to the public sector • Privatising, competition is a means not an end • Not always necessary; not always sufficient • Transparent legal & regulatory regime is key • Competitive bidding improves contract design • Participation of local financial markets adds strength • Large markets are better: potential NPV not IRR • General economic growth reduces project risk Return to public sector not a credible alternative

13. Key Success Factors* • Political leadership –sector reforms • Political commitment to the project itself • Domestic capital role – debt / equity / cash generation • IFI support; (IFC’s power portfolio remained strong) • In Distribution/ network businesses • Prior tariff increases • Prior improved collections • Investors now seem to be interested in: • Large markets, strong growth prospects & transparent regulation *Based on sample of 20 successful projects in recent Deloitte study for WB

14. IFI’s initial screening questions • Sector fundamentals: tariff levels, pmt.discipline, etc. • Economically competitive: on a sustainable basis • Government committed to meet its obligations • Contractual framework: balanced, transparent • even if incomplete: IFI participation may help complete • Sponsor with adequate funds & expertise • Legal framework which is supportive – and enforceable

15. Outline • Why Project Finance • Why IFIs play a key role • What has been achieved • Lessons • Opportunities and new models

16. Current Context in SEE • Investment needs too large for Governments • Slow earnings growth in EU will draw investors out • Big EU corporates will lead – will hit financial limits • Region is building record of strong economic growth • Missed the PF Boom: no legacy of large losses • Countries in this region are first place to look • Acquisition costs a fraction of what they paid elsewhere • Big progress made on tariffs, regulation etc. Strong grounds for optimism: few projects…

17. Opportunities • Privatisations • EU & higher environmental standards • Water & treatement • Renewables & Co-Gen • Health and Gov. services • Major shifts in trading patterns Recent successes - but still far too few transactions

18. New Models Needed • Where regulatory framework unproven: • World Bank’s Partial Risk Guarantee • Where regulatory framework inadequate: • Concessions with regulation through the contract • Where economic & commercial returns diverge: • PPPs: to reduce risk and/or raise returns to investor • Longer term, incentivised Management Contracts • Where uncertainty is so great required return too high Must change risk / reward balance in some sectors

19. PPPs • Must offer a good economic return to the country • Yet cannot generate commercial returns matching the risk • May be impossible to raise tariffs quickly to level needed • - Cost recovery in the water sector typically below 50% • Experienced private investor with expertise & incentives • Can bring benefits even if tariffs don’t provide a return • Can receive subsidy - & still share the financial risk Essential to launch projects in some sectors - water, heat ? wate

20. Structuring PPPs • Using public funds – need political & public support • Transparency & clear communication essential • If ongoing subsidy, must be fiscally feasible for the future • Should envision transition to full cost recovery • Afffordability for all customer categories – “lifeline” • Service delivery must visibly improve - quickly Combining with public sector IFIs – World Bank, EIB etc. wate

21. Thank You Denis Clarke Chief Investment Officer Dclarke@ifc.org www.ifc.org