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Capital Markets Financing for Developing-Country Infrastructure Projects United Nations

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Capital Markets Financing for Developing-Country Infrastructure Projects United Nations
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  Economic &  S  o ci   al   Af  f   ai  r  s ST/ESA/2003/DP/28 DESA Discussion Paper No. 28 Capital Markets Financing for Developing-Country Infrastructure Projects Robert Sheppard January 2003 United Nations  DESA Discussion Paper Series DESA Discussion Papers are preliminarydocuments circulated in a limited number of copies and posted on the DESA websitehttp://www.un.org/esa/papers.htm to stimulatediscussion and critical comment. This paper has not been formally edited and thedesignation and terminology used do not implythe expression of any opinion whatsoever onthe part of the United Nations Secretariat.Citations should refer to a “Discussion Paper of the United Nations Department of Economicand Social Affairs.” Robert Sheppard Robert Sheppard, a consultant based inCharlotte, NC, is an attorney and former investment banker with twenty years of experience in the field of project finance. As aManaging Director at Bank of AmericaSecurities LLC, he was responsible for ProjectFinance Capital Markets and was previouslyco-head of the Global Project Finance Groupat Bank of America. Prior to the merger of NationsBank with Bank of America,Mr.Sheppard was global head of ProjectFinance at NationsBank. The views expressedin this paper are those of the author and donot necessarily represent the views of theUnited Nations. Comments should beaddressed to the author at the United Nations,c/o Mr. Barry Herman, Room DC2-2120,United Nations, New York, NY 10017 (e-mail:projfin@bellsouth.net). Authorized for distribution by Ian Kinniburgh ,Director Development Policy Analysis DivisionDepartment of Economic and Social AffairsUnited Nations Acknowledgements The author would like to acknowledge thesupport and organizational assistanceprovided by Barry Herman, Chief, Finance &Development Branch, and Krishnan Sharma,Economic Affairs Officer, United NationsDepartment of Economic and Social Affairs, aswell as the leadership of Dr. Dan Bond, FirstVice President of Ambac AssuranceCorporation, who proposed the idea of thisstudy and the independent experts advisorygroup. The assistance of those who took thetime to answer the author's questions duringthe interview process and to contribute bytheir ideas and presence at the expertsmeeting is also gratefully acknowledged.  Abstract This paper reviews risk-mitigating structures to improve the ratings of debt securities issued bydeveloping-country infrastructure projects, with an emphasis on electric power projects. Itreports on the opinions of several important constituencies which were interviewed as part of this study: fixed-income investors, monoline insurers, investment bankers, rating agencies, bilateral and multilateral agencies, and private political risk insurers. Finally, the paper reviewsthree new approaches for promoting increased access to the capital markets for infrastructure projects: structures to encourage local capital markets financing, new uses of partial risk guarantees, and expanded use of expropriation coverage.  Key words: Risk mitigation, capital markets, bonds, infrastructure projects, electric power, project sponsors,financial insurers, institutional investors, investment banks, rating agencies.  JEL classification code: O16, F3, G15, G22, G23, G18, G24, G28.  Contents  Page I.Purpose of This Study. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1II.Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1III.Background on Current Market Practices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Previous Capital Markets Financings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2Structures to Breach the Sovereign Ceiling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Mitigating the Risk of Devaluation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5Local Capital Markets Financing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6Emerging Role of Monoline Bond Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 IV.Market Participants’ Views on Current Practices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Views of Institutional Investors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6Views of Investment Bankers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8Views of Rating Agencies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Views of Certain Multilateral and U.S. Government Agencies. . . . . . . . . . . . . . . . . . . . . . 9Views of Project Sponsors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 V.Using the Capital Markets to Further Economic Development. . . . . . . . . . . . . . . . . 13 Local Capital Markets Financing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13Targeted Risk Guarantees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13Comprehensive Guarantees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 VI.Conclusion and Key Issues Going Forward. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14Notes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15  I. Purpose of This Study This study is an outgrowth of the United NationsInternational Conference on Financing for Developmentheld in Monterrey, Mexico in March 2002. At that meet-ing government officials and representatives of the busi-ness community addressed the need to increase access to bond markets for developing-country infrastructure proj-ects through enhanced risk sharing between public and private sector financial organizations. It was suggestedthat an Independent Experts Advisory Group be estab-lished to study current risk sharing efforts and to proposeways that such risk sharing might be improved. It wasdecided to convene a meeting, which was held October 29, 2002 in New York, to discuss the access of develop-ing countries to this type of financing and the question of the usefulness of such an ongoing Experts Group. To pro-vide a basis for discussions at this meeting, the United Nations funded the preparation of this background brief-ing paper. It has subsequently been revised to incorporatethe views expressed by participants at the meeting.This study examines existing risk mitigation tech-niques employed in capital markets financings for devel-oping-country infrastructure projects and assesses thecurrent market acceptance of these structures. It alsodescribes new initiatives to facilitate capital marketsfinancings and attempts to suggest further enhancementswhich will enable the capital markets to become a reli-able source of financing for infrastructure projects indeveloping countries. The study is based on interviewswith fixed-income investors, monoline insurers, invest-ment bankers, rating agencies, bilateral and multilateralagencies, and private political risk insurers 1 . II. Introduction While at one time most infrastructure projects indeveloping countries were financed by host governmentsout of general government revenues, there has been atrend in recent years for publicly developed facilities to be financed on a project basis or for infrastructure proj-ects to be purchased or developed by the private sector.In such cases financing is usually obtained from the pri-vate sector—in many instances with foreign privateinvestors and creditors playing a major role. Given thehigh initial capital costs of infrastructure projects, long-term financing is essential for privately-owned infra-structure projects to be financially viable. 2 One of themost common forms of financing has been “non-recourse” (or “limited recourse”) financing. This meansthat the income used to repay creditors comes entirely (or  primarily) out of the revenues generated by the projectitself. Creditors have little or no recourse to call upon thecorporate or government owners in the event that the project has inadequate cash flow to service its debt.Historically, the greatest part of the financing for developing-country infrastructure projects has been pro-vided by commercial banks, often in conjunction withofficially-backed export credit agencies (“ECAs”) or mul-tilateral agencies. In the past, commercial banks contin-ued to finance developing country projects, even duringdifficult periods when the capital markets were closed for a particular developing country (although often withtighter structures than previously). Recently, however,commercial banks have, in general, retreated from devel-oping-country project financing. This contraction is basedless on lenders’ credit experience in international lendingthan on changing business strategies within the financialservices industry, but the effect on economic developmentis the same regardless of the motivation.In the context of this strategic redirection by com-mercial banks, the ability of properly-structured transac-tions to obtain financing in the capital markets has become more important. As one on the participants in theOctober 29 th meeting noted, it is unlikely that investorswill quickly forget recent difficulties in emerging marketsand be as willing to provide funding for below-investmentgrade countries. New forms of risk mitigation will be nec-essary if infrastructure projects in such countries are toregain access to the capital markets. The internationalcapital markets are the largest and deepest pool of financ-ing in the world, and in conjunction with local capitalmarkets, which represent an essentially untapped sourceof funds for infrastructure projects, they can make a hugecontribution to economic development, if effective trans-action structures are developed. III. Background on Current Market Practices Infrastructure projects are generally regarded asincluding capital-intensive facilities in the following sec-tors: • Electric power (generation and distribution) • Energy (refineries, pipelines, processing facilities,etc.)
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