World Bank

Infrastructure Funds and Facilities in Sub-Saharan Africa

Final Report

BY CENTENNIAL GROUP HOLDINGS, LLC

2600 Virginia Ave Suite 201 Washington DC 20037 USA www.centennial-group.com

May, 2009

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ACKNOWLEDGEMETNTS We are deeply appreciative for the time and attention given us by the more than fifty fund managers, investors and other experts in the field of public private infrastructure finance with whom we interacted. We are also appreciative of the help we received from the World Bank team led by Michael Fuchs, and comprising Jeff Delmon, Iain Menzies, Peter Mousley, Ada Karina Izaguerre, and others. They provided invaluable guidance to our work and detailed comments on the reports from which we greatly benefited. We also wish to thank our Senior Advisors for their ideas and direct assistance in preparing this report: Ryan Orr, Suman Babbar and Everett Santos. Finally, Liem Nguyen and Bogdan Prokopovych of the University of the Rhode Island School of Business deserve special recognition: the development of the EMIFFI would have been impossible without their persistent efforts. Thomas H. Cochran Michael de Angelis Johan Kruger Anthony Pellegrini March 2009

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Table of Contents1. 2. Purpose of the Study .................................................................................................... 17 The Sub-Saharan Africa Context ................................................................................ 192.1 Levels of infrastructure in Sub-Sahara Africa (SSA) lag other regions. ............................. 20 2.2 Gaps in infrastructure along with a high cost structure for infrastructure services are affecting country competitiveness ............................................................................................... 21 2.3 The total amount of financing needed to bridge infrastructure gaps in SSA has been estimated at $800 billion ............................................................................................................. 22 2.4 Private infrastructure investment in Sub-Saharan Africa is low ........................................ 23 2.5 Several factors contribute to the low levels of private infrastructure investment in SSA .... 23 2.6 Reforms to deal with the above constraints to private investment are being taken seriously by SSA governments ................................................................................................................... 32 2.7 While the level of private infrastructure investment is SSA is low, it has been on a rising path 32 2.8 Both the types of investors and the risk profile of investors in SSA infrastructure are changing ..................................................................................................................................... 33 2.9 IFIs, including bi-lateral institutions, play a large role in infrastructure finance in the region. China is becoming an important player. ........................................................................ 36 2.10 The current global financial crisis is having an impact on infrastructure funds and facilities in SSA ........................................................................................................................... 38

3. Key Characteristics of Existing infrastructure Funds and Facilities in Emerging Markets and Specifically in SSA ........................................................................................ 443.1 Preparation of the inventory of Funds and Facilities in Emerging markets ........................ 44 3.2 The methodology used for the preparation of the inventory of infrastructure funds and facilities in emerging markets. .................................................................................................... 44 3.3 The number of infrastructure funds and facilities has risen rapidly on a global basis and has been followed in recent years by growth in funds and facilities operating in SSA ................. 45 3.4 General characteristics of existing infrastructure equity funds in SSA............................... 48 3.5 General characteristics of infrastructure facilities in SSA .................................................. 53 3.6 National political stability is an investment criterion for both private funds and for private facilities, but managers of private funds and facilities with experience in SSA believe that political risks are manageable ..................................................................................................... 54

4. Recommendations for the Design of New Funds and Facilities Intended to Concentrate Investment on Core Infrastructure in SSA......................................................................... 554.1 More aggressively develop domestic capital markets.......................................................... 56 4.2 Support new funds and facilities with the objective of significantly extending investor exit time horizons .............................................................................................................................. 58 4.3 Build skills and develop human capital .............................................................................. 60 4.4 Reform the Institutional Framework ................................................................................. 61 4.5 Financing solutions should match project scale. ................................................................. 76 4.6 Initial geographic focus of newly formed funds and facilities should be on a limited number of countries. ................................................................................................................................ 78 4.7 Where a multi-country fund or facility is established, a strategy is needed for country and sector deal identification. ............................................................................................................ 78 4.8 Special consideration should be given to local currency debt and mezzanine facilities in SSA 80

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4.9 A format without a fixed end date may be appropriate for new debt facilities and guarantee facilities that concentrate on core infrastructure ........................................................................ 82 4.10 Review opportunities for the use of pooling mechanisms to efficiently finance projects of small and medium scale. ............................................................................................................. 83

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Recommendations for IFIs in Supporting Specific Funds and Facilities ..................... 905.1 Participate in infrastructure equity funds with the objective of extending the closing date of the funds and facilities. (See recommendation 4.2) ...................................................................... 90 5.2 Expand use of partial risk and partial credit guarantees, put options, liquidity facilities and other techniques in support of locally denominated, longer tenor debt and equity. ..................... 91 5.3 Adopt a policy of seeking to maximize the leverage of IFIs own funds when setting up funds or facilities .................................................................................................................................. 94 5.4 Support mezzanine finance either directly in projects or through new facilities that offer mezzanine finance ....................................................................................................................... 96 5.5 Support debt facilities and pooled finance facilities ............................................................ 98 5.6 Support the public sector with significant additional funding of project preparation and associated technical assistance. ................................................................................................... 99 5.7 Ensure that IFI participation does not crowd out the private sector .................................. 99

Annex 1 ............................................................................................................................ 100 List of Funds and Facilities in Inventory .......................................................................... 100 Annex 2 ............................................................................................................................ 108 Characteristics of funds and facilities from inventory ...................................................... 108 Annex 3 ............................................................................................................................ 115 Philippine Water Revolving Fund -- Description of the MDFO Stand-by Credit Line .... 115 Annex 4 ............................................................................................................................ 118 MFI K-Rep Bank in Kenya loans to small water enterprises ........................................... 118 Annex 5 ............................................................................................................................ 124 List of persons interviewed............................................................................................... 124 Annex 6 ............................................................................................................................ 128 Interview Template .......................................................................................................... 128

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ABBREVIATIONS

AIG AKFED CABEI CCI CEE CEO CFA COMESA DBSA DBP DCA DFI EAIF ECP EMIFFI EMP EPC EU FMO GoTN GPOBA GDP GNI ICICI IDFC IFIIMF INCA JBIC KIEF LAPEF I LGUGC LIBOR LIF MDFO MENA MIIU MWRMD NEPAD NPL NWCPC -

American International Group Aga Khan Foundation for Economic Development Central American Bank for Economic Integration Climate Change Investment Central and Eastern Europe Chief executive Officer Currency used by fourteen African countries Common Market for Eastern and Southern Africa Development Bank of Southern Africa Development Bank of the Philippines Development Credit Authority of USAID Development Finance Institution Emerging Africa Infrastructure Fund Emerging Capital Partners The Emerging Market Infrastructure Funds and Facilities Inventory Emerging Markets Partnership Engineering Procurement and Construction European Union Netherlands Development Finance Company State Government of Tamil Nadu Global Partnership for Output-Based Aid Gross Domestic Product Gross National Income The Industrial Credit and Investment Corporation of India Ltd Infrastructure Development Finance Company IFIs International Financial Institution International Monetary Fund The Infrastructure Finance Corporation of South Africa Japan Bank of International Cooperation Kagiso Infrastructure Empowerment Fund Latin American Private Equity Fund I Local Government Unit Guarantee Corporation London Interbank Offered Rate Leverage India Fund Municipal Development Fund Office Middle East and North Africa Municipal Infrastructure Investment Unit Ministry of Water Resources Management and Development New Partnership for Africas Development Non-performing Loans National Water Conservation and Pipeline Corporation

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OBA output-based aid OECD Organization for Economic Cooperation and Development OPIC Overseas Private Investment Corporation PIDG Private Infrastructure Development Group PPP Public Private Partnership PPIAF Public Private Infrastructure Advisory Facility PROPARCO - Promotion et Participation pour la Coopration conomique PWRF Philippine Water Revolving Fund SACU Custom Union of Southern Africa SEASAF South East Asian Strategic Assets Fund SFC State Finance Commission SMEs small and medium-sized enterprises SSA Sub-Sahara Africa SRI Socially Responsible Investment TCX The Currency Exchange Fund TNUDF Tamil Nadu Urban Development Fund TUHF Trust for Urban Housing Finance ULB Urban Local Body USTDA US Trade Development Administration WSPWater and Sanitation Program WSPFWater and Sanitation Pooled Fund

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DEFINITIONS USED IN THE REPORT

Closed investment vehicle refers to an investment vehicle that is no longer issuing shares or accepting new investments because it has reached its target size. (See open investment vehicle below) Core infrastructure is a term that refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Infrastructure is a term that refers broadly to fixed, physical assets in the telecommunications, power, transport and water and sanitation and other sectors Infrastructure facilities are separate legal entities set up for the commercial financing of infrastructure assets whose resources are accessible to project sponsors whenever project financings are ready to be taken to market and hence facilities raise capital continuously as needed.. Instruments can be broad and include debt, guarantees and other risk mitigation instruments provided by private and public institutions, including development banks. Facilities generally do not have a closing date and often have permanent staff. Infrastructure funds are separate legal entities set up for the commercial financing of a limited number of infrastructure assets, typically with money committed upfront. Funds typically have a limited number of financing instruments, have a pre-determined, finite lifespan, and are subject to minimum return expectations by investors. Infrastructure funds are often managed by an asset management company. Infrastructure facilities (see above) more typically have permanent staff. Junior Debt refers to subordinated debt (see below) Leverage can be defined as the ratio of: the amount invested (or set aside as a capital charge or reserve) by one financier e.g. equity fund, debt facility, or guarantee facility to the total project capital mobilized Liquidity Facility is a term that refers to a legally binding commitment to provide funds to purchase securities or other debt that have been tendered to the issuer or its agent but which cannot be immediately remarketed to new investors. The provider of the liquidity facility, typically a bank, purchases the securities (or provides funds to the issuer or its agent to purchase the securities) until such time as they can be remarketed. Mezzanine financing refers to a type of finance that sits between common equity and secured debt. Mezzanine debt (or preferred equity) represents a claim on company's assets which is senior only to that of common shares. Mezzanine financings can be structured either as debt or preferred stock. In the event of default, mezzanine financing is less likely to be repaid in full than senior obligations such as secured debt. Non-core infrastructure is a term that refers to infrastructure that is considered less essential to basic human needs. It generally refers to telecommunications, but could involve a road, gas line

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or water treatment plant dedicated to a specific industrial operation rather than to providing general service to a population. Open ended investment vehicle refers to an investment vehicle which does not have restrictions on the amount of shares or amount of money that can be raised. Pooled financing means any bond or other debt instrument the proceeds of which are

to be used directly or indirectly to make or finance loans to 2 or more ultimate borrowers.Put Option is a term that refers to a financial contract between two parties, the seller and the buyer of the option. The buyer acquires the right, but not obligation, to sell the underlying instrument at an agreed price and/or within an agreed time frame. If the buyer exercises the right granted by the option, the seller has the obligation to purchase the underlying asset. In exchange for having this option, the buyer pays the seller a fee (the option premium). Subordinated debt refers to debt that has a lower priority in repayment than that of another debt claim on the same asset (also called junior debt.) .

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EXECUTIVE SUMMARY

1.

Purpose of Study

The purpose of this study is to review the experience of infrastructure funds and facilities that have been set up in emerging markets and based on that experience, to develop principles that would apply to new funds and facilities to finance infrastructure in Africa. As part of this study, an inventory of emerging market infrastructure funds and facilities was created, The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI). The inventory contains information on 262 funds and facilities that are currently operating or in the process of raising funds. The inventory covers all emerging market regions including Eastern and Central Europe, Latin America, South and East Asia and Africa. It includes purely private, publicprivate and donor supported infrastructure funds and facilities. The inventory is available as a separate document. (See EMIFFI Inventory.xls) Some 53 senior managers were interviewed to gain information on lessons learned. These were selected from the funds and facilities in the inventory, project sponsors and others that have offices in Washington DC, New York, London and Johannesburg. These interviews along with a literature review of infrastructure financing in Africa, were used in the formulation of recommendations. The interview template is shown in Annex 6. The list of the funds and facilities covered in the Inventory is presented in Annex 1. Annex 2 provides information on the characteristics of the funds and facilities in the Inventory. Based on these results, key principles and recommendations for the design of infrastructure financing solutions for Africa were developed. Several definitions are important for this report: Infrastructure refers broadly to fixed, physical assets in the telecommunications, power, transport and water and sanitation and other sectors Core Infrastructure refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Infrastructure facilities are separate legal entities set up for the commercial financing of infrastructure assets whose resources are accessible to project sponsors whenever project financings are ready to be taken to market and hence facilities raise capital continuously as needed.. Instruments can be broad and include debt, guarantees and other risk mitigation instruments provided by private and public institutions, including development banks. Facilities generally do not have a closing date and often have permanent staff.

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Infrastructure funds are separate legal entities set up for the commercial financing of a limited number of infrastructure assets, typically with money committed upfront. Funds typically have a limited number of financing instruments, have a predetermined, finite lifespan, and are subject to minimum return expectations by investors. An asset management company often manages infrastructure funds. Infrastructure facilities (see above) more typically have permanent staff.

. Other definitions of technical terms are listed following the Table of Contents. 2. Sub-Saharan Africa Context The SSA region generally lags behind other regions in all the sectors of public infrastructure required to promote economic development. The regions shortfall in infrastructure and the relatively high cost for infrastructure related public services leads to supply bootlenecks, communications problems and logistical troubles that seriously undermine international economic competitiveess. The total infrastructure financing needs in SSA over a ten year period has been placed at almost $800 billion. The factors that contribute to the low level of private infrastructure investment in SSA include: the lack of locally denominated long term capital due the underdeveloped domestic capital markets; the poor state of the business environment; low incomes that affect affordability; small country size that affects economies of scale and service delivery costs; and weak institutions, and lack of skills. Because of limits in budgets, SSA governments have been encouraging private investment in infrastructure as part of the overall reform process. Private investment of infrastructure in Africa has in recent years been increasing consistently from a low base. Several Africa infrastructure fund managers expressed a strong belief that a consensus about the need for consistent macro-economic policy and sector reform now exists in most countries of Sub-Saharan Africa. They believe that the launching of such initiatives as the NEPAD and the African Peer Review mechanism are evidence of this and expressed confidence that the basic commitment to reform was durable. . In the SSA region, donor aid comprises a far larger, more influential component of the financial landscape of recipient countries than it does in other regions. This places a greater burden on IFIs in Africa. China has become a major player in Africa infrastructure development. Much of Chinas recent official economic aid and loans to Africa are backed by natural resource commitments and many are targeted at infrastructure projects aimed at development of the petroleum and mineral extraction industries. By 2003, Chinese investors had established 602 businesses in 49 African countries.

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The global financial crisis is beginning to affect Africa. African banks generally did not invest in sub-prime markets or related derivatives. However, because international banks need to reduce risks, the region is seeing a decrease in private investment flows that will negatively affect the financing of many infrastructure projects.

3. Characteristics of existing funds and facilities in emerging markets and specifically in Sub-Saharan Africa

The rate of growth of infrastructure funds/facilities in emerging markets has accelerated sharply in recent years. However, most investments supported by existing funds and facilities in Africa have focused on telecoms. This is because of the relatively short and uncomplicated process of project preparation in comparison with other sectors and the relatively short payback period offered in the telecom sector. Very little private investment from funds and facilities in Africa has taken place in the sectors of transportation, water supply and electric power. Equity fund managers throughout the developing world including in Africa have been most successful investing in telecommunications. Relatively little private equity investment, especially in Africa, has taken place in the core infrastructure sectors of transportation, water supply and sanitation or even power. This has significance when considering the development impact of funds and facilities. It also suggests that IFI involvement in funds and facilities should aim at shifting investment to the basic sectors of transportation, water supply and sanitation and power. Finance by construction and operating companies is far greater than by independent infrastructure funds. The reason for the dominance of construction and operating companies may have to do with differences in the cost of capital. Private equity funds that are not leveraged at the fund level are likely to have the highest costs of equity capital defined by the return expectations of the limited partners and other contributors of equity. Construction firms, nonregulated power project developers and operators, and transportation concession operating companies have often been able to lower the actual cost of the equity capital which they are expected to contribute to projects through the use of debt raised on a corporate finance basis, e.g. shareholder subordinate debt from commercial lenders or bond issues the proceeds of which are used to make equity investments at the project level. Equity funds exceed debt facilities by a wide margin in all regions. Equity fund managers operating in Africa believe that equity is far easier to raise than debt. They see a significant role for IFIs in using their funds to extend the tenor of domestic debt. They believe that this would increase the attractiveness of investments in core infrastructure. Mezzanine financing is sparingly used - especially in Africa. Most infrastructure equity funds rarely use mezzanine financing as part of the funds own capital structure because of high carry costs and only opportunistically provide mezzanine financing for project investments. While a good many equity funds are allowed by their mandate to provide mezzanine financing to individual projects - yield considerations are a deterrent. Most only provide mezzanine financing if they see a reasonable chance of equity-like returns on the mezzanine commitment.

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Sovereign risk per se did not seem to be a significant concern to experienced Africa fund and facility managers. A number of them pointed out that the global investor community is still perceives Africa as a continent filled with sovereign risk. However, one manager expressed the view that this perception provides his fund with a distinct competitive advantage as it suppresses competition he would otherwise face if the true level of sovereign risk were more broadly understood.

4. Recommendations for the design of new Funds and Facilities in SSA intended to concentrate investment in core infrastructure Three key themes relevant to Africa emerged in discussions with infrastructure fund and facility managers and others that represent key challenges to infrastructure financing. The recommendations of the report follow the key themes . Theme 1: The domestic capital market and financial environment The underdeveloped domestic capital markets in Africa leads to difficulties in provision of long-term finance denominated in domestic currency, especially debt finance. Recommendations: Aggressively develop local capital markets Domestic finance of infrastructure is preferred when feasible because it avoids currency mismatches. Portfolio managers of domestic contractual savings pools in most countries welcome the appearance of wellstructured securities issued by prudently managed public and private entities providing infrastructure services because these instruments can provide both a positive yield spread above similar maturity sovereign securities and enough safety to meet stringent fiduciary guidelines and other relevant regulatory requirements. Substantial effort is being devoted by governments throughout Africa in a range of initiatives intended to encourage the emergence and growth of capital markets. This effort should be continued and substantially expanded. This often goes hand in hand with the reform of the locally domiciled commercial banking, pension fund and insurance sectors. Support newly created equity and debt infrastructure funds and facilities with the purpose of extending exit time horizons Some international investors with longer time horizons e.g. developed country pension funds, insurance companies, sovereign wealth funds, philanthropies have been interested in the higher yields associated with emerging market investments. However, the global financial crisis will increase perceived risks and will affect the readiness of international investors to come forward. Give special attention should to establishment of facilities that provide debt and /or guarantees of debt. Managers of equity funds in Africa indicated that the lack of longer tenor local debt financing was an important factor that led them to favor telecom projects over investments requiring a longer payback period. There appears to be space for

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additional debt facilities such as revolving loan facilities, bond banks, and guarantors of debt, particularly those focused on single countries that would make more use of indigenous pools of long term savings, e.g. domestic pensions funds, military pension funds, insurance companies, etc. for investment in infrastructure. Generally debt facilities and guarantee facilities concentrating on core infrastructure should not have fixed exit dates. Infrastructure facilities with no fixed exit date may be an appropriate institutional structure for providing longer-term debt to infrastructure projects. The open-ended character of such facilities is far better suited to the origination of relatively long-dated lending for infrastructure, than are the structures with a fixed end date of ten years that are seen in most equity funds.

Theme 2:

Institution building and skills development

At the project analysis level, there is a need for improved development of project proposals with sound technical, economic and financial analysis and with an appropriate risk sharing structure. At the level of management of institutions, there is a need for better systems and procedures and timely decision making based on sound policies; and at the level of frameworks there is the need for credible legal and regulatory frameworks. Recommendations: Reform the legal and regulatory frameworks to improve the environment for core infrastructure finance A major factor determining whether investment can be successfully developed is the policy, legal and regulatory framework governing business formation, operation and taxation. A simple, clear, and coherent set of policy, legal and regulatory frameworks lowers project preparation and financing costs as uncertainty is reduced in areas such as (i) profit repatriation, (ii) tax regimes, (iii) regulatory and judicial corruption, and (iv) the effectiveness of investors recourse in the case of problems. The sector environment must be aligned with the business environment to facilitate international or local private sector investment rather than constrain and inhibit it. This involves reexamining sector policies and sector structures, legal system issues, regulatory issues, PPP frameworks and fiscal issues. Many fund managers emphasized that legal/regulatory frameworks and tax systems set the conditions for prudent infrastructure finance that attracts skilled private sector managers and investors. Improve the intergovernmental framework that governs sub-national functional responsibilities and their fiscal resources. Governments need to improve the legal and regulatory framework that controls sub-national service delivery, financial resources and debt. Develop a larger, more robust pipeline of bankable core infrastructure projects. Infrastructure agencies and project preparation facilities in SSA are not developing a sufficient number of well prepared core infrastructure project opportunities that are of interest to private investors.

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To improve the development of project pipelines, governments should: o Develop systems within each sector agency for project selection, screening and prioritization: o Clarify the bidding and competition processes: o Make Project Preparation Facilities more user friendly for private project sponsors/financiers. o Ensure staff has relevant technical qualifications. o Use outside financial advisory staff o Include funding in agency budgets for experienced transaction advisors o Adopt clear processes for annual budgeting of funds for the facility. o Encourage more end-to-end funding of project preparation o Test systems to recover the costs of project preparation o Develop strong links to agencies o Develop projects in conjunction with explicit PPP frameworks

Review and change, as necessary, laws, regulations and tax codes that constrain the use of pooling mechanisms to efficiently finance projects of small and medium scale. Pooled debt funds and facilities can be useful in the local currency financing of the many small and medium sized core infrastructure projects needed in any country. Pooled debt facilities have been employed in a number of advanced economies in the world including the USA, Canada, and Europe and are being developed in India, Mexico, Columbia, and Poland. The Tamil Nadu Urban Fund Pooled Bond Facility is and interesting example as is The Infrastructure Finance Corporation of South Africa (INCA) Develop VGF policies for PPP projects. Ideally, projects should be financially viable on their own, but government financial support is often necessary make a project viable. Such support should be limited, transparent, affordable, properly accounted for and managed to serve priority objectives. With limited resources, a formal prioritization mechanism with clear criteria is important. Develop data and information systems permitting more reliable service demand projections and other key analytic activities necessary to develop sound project financing plans. The absence of reliable information is seen by some fund managers as inhibiting the design, appraisal and successful closure of core infrastructure transactions. Information deficiencies cover the entire spectrum from the most basic demographic and national macro economic data to basic information on service delivery and demand, even the location of underground facilities. Adopt proven management principles to increase the probability of success. Key principles include: o Ensuring good country knowledge on teams o Developing competitive compensation to attract staff with proper expertise

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o o o o

Combining deal origination and portfolio management in same teams Proactive deal origination especially for equity funds Use of well-established, credible local partners Governance, investment decision-making, and portfolio management practices in conformance with international standards o Investment guidelines that give strong guidance to staff but are flexible enough to permit new opportunities which conform to the basic risk/reward profile originally intended o Control over key decisions in project entities o A formal strategy to minimize severity of loss in projects that go sour Develop local institutional and individual capacity to support core infrastructure project development, finance, operations, and maintenance. Many of the fund managers indicated that building skills and developing human capital to improve the quality of indigenous project preparation and governmental decision-making is vitally important. It will be a long and difficult process requiring the sustained commitment and cooperation of IFIs, donors and host government

Theme 3: economies.

Financial solutions corresponding to the size and scale of African

The large number of countries and small size of many, leads to a need for a variety of types of financing structures and vehicles to accommodate projects of small medium and large scale. Initial geographic focus of newly formed funds and facilities should be on a limited number of countries There are substantial differences among the 48 countries of SSA. A detailed understanding of how the infrastructure systems operate within each country and good relationships with both majority and opposition leaders in each country is essential to making successful investments in core infrastructure. This means that at least the initial geographic focus of new funds and facilities should be on only one or a few countries. A framework should be applied for country and sector deal identification for multicountry funds or facilities Once a fund or facility targeting multiple SSA countries has become operational, the identification and origination of a pipeline of bankable core infrastructure transactions becomes the critically important priority. A starting point would be to adopt a country-differentiated approach. One useful way is to distinguish between countries where a largely reactive approach to deal origination will likely be most cost-effective and those where a more proactive plan is warranted Measures to improve the affordability of civil works and the financial capital which pays for them should be adopted and steps taken to reduce the annual cost of capital Measures to reduce the cost of capital by re-examining equity vs. debt ratios, using credit enhancements to reduce spreads in senior debt, using mezzanine debt and possibly equity

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markets, and extending tenor to reduce annual principal amortization burdens, etc. all must be considered. Consider pooling

5. Recommendations for IFIs in Supporting Specific Funds and Facilities IFIs can play a key role in supporting the development of infrastructure funds or facilities in SSA. This is especially true in the aftermath of the financial crisis. Recommendations for IFIs in support of funds and facilities include: Participating in infrastructure equity funds with the objective of extending the closing date Expanding use of partial risk and partial credit guarantees, put options, liquidity facilities and other techniques in support of locally denominated, longer tenor debt facilities and equity funds, and local guarantee facilities Adopting a policy of leveraging IFI funds Supporting new facilities that offer mezzanine finance. Supporting debt facilities and pooled loan facilities Supporting technical assistance and training on international best practice to encourage sound fund/facility management techniques, particularly vital when funds/facilities are local/small regional. Ensuring that IFI support does not crowd out commercial financing.

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MAIN TEXT

1.

Purpose of the Study

The purpose of this study is to review the experience of infrastructure funds and facilities that have been set up in emerging markets and based on that experience, to develop principles that would apply to infrastructure finance in Africa. The project: Analyzed the experience with existing infrastructure funds and facilities in emerging markets in different regions, and Developed principles and options for improving infrastructure-financing mechanisms for Africa.

The project is motivated by the fact that the level of infrastructure investments in Africa that is needed to support economic growth and development is too large to be met solely through public resources. Private sector infrastructure finance can play a complimentary role to public finance in improving access to infrastructure services. Private investment funding for infrastructure is needed in the form of both long-term debt and equity capital. In recent years infrastructure funds and facilities backed by private capital have emerged as important investment vehicles in many regions, primarily in developed countries but increasingly in emerging markets. A number of funds and facilities have been established in Africa. As part of this study, an inventory of emerging market infrastructure funds and facilities was created, The Emerging Market Infrastructure Funds and Facilities Inventory (EMIFFI). The inventory contains information on 262 funds and facilities that are currently operating or in the process of raising funds. The inventory covers all emerging market regions including Eastern and Central Europe, Latin America, South and East Asia and Africa. It includes purely private, publicprivate and donor supported infrastructure funds and facilities. The inventory is available as a separate document. (See EMIFFI Inventory.xls) Some 53 senior managers were interviewed to gain information on lessons learned. These were selected from the funds and facilities in the inventory, project sponsors and others that have offices in Washington DC, New York, London and Johannesburg. These interviews along with a literature review of infrastructure financing in Africa, were used in the formulation of recommendations. The interview template is shown in Annex 6.

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The list of the funds and facilities covered in the Inventory is presented in Annex 1. Annex 2 provides information on the characteristics of the funds and facilities in the Inventory. Based on these results, key principles and recommendations for the design of infrastructure financing solutions for Africa were developed. Definitions of technical terms used in the report are provided after the Table of Contents. Several definitions are particularly important. Infrastructure is a term that refers broadly to fixed, physical assets in the telecommunications, power, transport and water and sanitation and other sectors. Core Infrastructure is a term that refers to assets in the power, transport and water and sanitation sectors that provide what might be called essential basic public services. Infrastructure facilities are separate legal entities set up for the commercial financing of infrastructure assets whose resources are accessible to project sponsors whenever project financings are ready to be taken to market and hence facilities raise capital continuously as needed. Instruments can be broad and include debt, guarantees and other risk mitigation instruments provided by private and public institutions, including development banks. Facilities generally do not have a closing date and often have permanent staff. Infrastructure funds are separate legal entities set up for the commercial financing of a limited number of infrastructure assets, typically with money committed upfront. Funds typically have a limited number of financing instruments, have a predetermined, finite lifespan, and are subject to minimum return expectations by investors. An asset management company often manages infrastructure funds. Infrastructure facilities (see above) more typically have permanent staff.

. .

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2.

The Sub-Saharan Africa Context

This section of the report discusses the infrastructure gaps in Sub-Sahara Africa and the current level of private investment in infrastructure. It discusses the factors that affect private investment in Africa including the lack of long term domestic capital, underdeveloped domestic capital markets, poor business environment, low incomes affecting affordability, small project size, and weak human capacity. It discusses recent trends in private investment including the global financial crisis and the role of the IFIs. Africa faces a number of economic, financial, institutional and technical constraints that reinforce each other and affect infrastructure finance. Figure 1: Financial, institutional and structural constraints facing Africa

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2.1

Levels of infrastructure in Sub-Sahara Africa (SSA) lag other regions.

The SSA region generally lags behind other regions in all the sectors of public infrastructure required to promote economic development and create opportunities for private investment. The following graph clearly illustrates this gap compared to other developing regions. Figure 2: Infrastructure Access in SSA vs Other Developing Regions

In addition to deficiencies in physical infrastructure noted in the above figure, supporting business infrastructure is also lacking. A traveling businessperson may not find convenient access to the Internet outside the capital city of many countries. Spare parts or skilled repair technicians may be difficult to find. The composite satellite photograph below, of electric light usage at night, illustrates the stark differences in the levels between most of the SSA region and all other densely populated parts of the world.

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Figure 3: Africa by night

Source: Econobrowser Technological development is extremely dependant on the availability of electricity at reasonable costs. The SSA regions deficit in power generation and transmission is a contributing factor to its lagging rate of development in sectors ranging from manufacturing to social services such as healthcare and education. In manufacturing, this means that less value is added to the few finished products that are consumed locally or exported. In agriculture, it means that commodities are seldom turned into food products suitable for export. And in mining, it means that little beneficiation takes place downstream in the production process before export. In healthcare, it imposes limitations on everything from refrigeration to use of diagnostic equipment; and in education, a lack of residential electricity limits the hours during which students can prepare for classes while lack of electricity in schools limits everything from lighting to the ability to use computers. 2.2 Gaps in infrastructure along with a high cost structure for infrastructure services are affecting country competitiveness

A comparatively expensive cost structure for most public services persists in many Sub-Saharan African countries. This has been attributed to factors such as the relatively small scale and

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inefficient technologies used in projects.1 The comparison with other developing regions shown in Figure 4 underlines this disparity. The regions shortfall in public infrastructure and relatively high cost structure for public services leads in turn to supply bootlenecks, communications problems and logistical troubles that seriously undermine international economic competitiveess. For example, a rubber tire manufacturer in Nigeria was forced to close down as a result of the inability of the power supplier to guarantee an uninterrupted supply. For the many land-locked countries in SubSaharan Africa in particular, the costs imposed by poor infrastructure are extraordinarily high. The World Bank estimates that to transport a container from Baltimore in the USA to Tanzania would cost about US$1,000, but to transport that same container from Tanzania to neighboring Burundi would cost about US$10,000.

Figure 4:

Cost of infrastructure services Africa vs other developing regions Unit SSA 0.02 - 0.46 0.86 - 6.56 0.04 - 0.14 2.6 - 21.0 0.44 -12.5 6.7-148.0 Other Developing regions 0.05 -0.10 0.03 - 0.60 0.01 - 0.04 9.9 2.0 11.0

Power Tariifs Water Tariifs Road Freigt Tariifs Mobile telephony International telephony Internet Dialup

$/KWH $/Kl $/ton-km $/Month $/Minute $/Month

Source: Vivien Foster & Cecilia Briceo-Garmendia, Meeting Africas Infrastructure Needs: The Twin Challenges of Financing and Sustainability, Presentation to AICD, October 9, 2008

2.3 The total amount of financing needed to bridge infrastructure gaps in SSA has been estimated at $800 billion The total amount of infrastructure financing needs in SSA over a ten year period has been placed at almost $800 billion. This is allocated by sector as shown in Figure 4. Figure 5: Sector ICT Power1

Annual infrastructure financing needs for Sub-Sahara Africa by sector Capex 0.8 23.2 Opex 1.1 19.4 Total 1.9 42.6

See: Vivien Foster & Cecilia Briceo-Garmendia, Meeting Africas Infrastructure Needs: The Twin Challenges of Financing and Sustainability, Presentation to AICD, October 9, 2008

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Transport WSS

10.7 2.7

9.6 7.3

20.3 10.0

Figures in $ billion per annum over 10 year period Source: Vivien Foster & Cecilia Briceo-Garmendia, Meeting Africas Infrastructure Needs: The Twin Challenges of Financing and Sustainability, Presentation to AICD, October 9, 2008

The needs vary considerably by country and sector with the needs in the Democratic Republic of Congo representing 70% of GDP while in Cape Verde they represent only 1% of GDP. It is important to note that current actual spending on infrastructure is on average, about half the requirement. Of this amount, on average, approximately 50% of expenditures is mobilized internally through taxes, fees and other means 2.4 Private infrastructure investment in Sub-Saharan Africa is low

Because of limits in budgets, SSA governments have been encouraging private investment in infrastructure as part of the overall reform process. A recent analysis of the PPI database 2 indicates that Africa had the smallest historical share of all regions in private investment in infrastructure over the period 1983-2004, at 5% of the emerging market total. Total private spending on infrastructure in SSA over this period was estimated at just over $28 billion3.

2.5

Several factors contribute to the low levels of private infrastructure investment in SSA

The factors that contribute to the low level of private infrastructure investment in SSA include: the lack of locally denominated long term capital due the underdeveloped domestic capital markets; the poor state of the business environment; low incomes that affect affordability; small country size that affects economies of scale and service delivery costs; and weak human capacity. These are discussed below. 2.5.1 Lack of locally denominated longer term capital

The availability of long-term debt at reasonable interest rates is vitally important to the efficient financing of infrastructure. Private investors in infrastructure need to be able to leverage their own investments in projects with debt that is well protected from foreign exchange risk. With thinly traded currencies such those of most SSA countries, the best foreign exchange risk2

Private Participation in Infrastructure data base maintained by Public-Private Infrastructure Advisory Facility (PPIAF) and managed by the World Bank3

Annez, Patricia Clark Urban Infrastructure finance from private operators: What have we learned from recent experience? World Bank Policy Research Working Paper 4045, November 2006

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protection is the use of locally denominated debt in the first place. If debt is to be denominated in local currency, that debt will ultimately have to be some form of domestic savings. The formal structures for aggregation of savings into sizeable pools available for significant investment have not yet been well established in most African economies. Substantial domestic savings are diverted into informal burial societies, savings clubs and other alternative mechanisms. An estimated 80% of Africans do not have bank accounts. Country gross domestic savings in the region averaged about 18 per cent of gross domestic product (GDP) in 2005, compared with 26 per cent in South Asia and nearly 43 per cent in East Asia and Pacific countries.4 There are many reasons for Africa's low voluntary savings rates. First, low incomes leave less of a surplus for savings after basic needs expenditures. But in addition, there are other reasons including (i) inadequate financial services provided by commercial banks, (ii) physical distance from banking institutions, (iii) high minimum deposit and balance restrictions complicated by overly complex documentation requirements, (iv) very low savings interest rates offering little or no incentive to save, and (v) traditional indigenous lifestyles. Most savings use simple passbook accounts. The use of certificates of deposit exceeding one year maturity is very rare. This means that banks cannot normally offer the long-dated debt instruments to public or private infrastructure project developers that would be most suitable for the delivery of reasonably priced essential public services. There has been a recent growth of deposit-led micro-finance institutions and mutual building societies such as K-Rep and Equity Bank in Kenya that suggests that such institutions could become increasingly important aggregators of savings in Africa and potential sources of capital for infrastructure. As the savings accumulate more rapidly than micro-loan originations, these institutions are finding that they must broaden their array of credit products well beyond microloans and a few are finding that basic community infrastructure can be an attractive lending opportunity. The full description of this initiative, including details on the roles being played by each institutional participant is attached as Annex 4. The CEO of Equity Bank, another Kenyan micro finance institution (MFI) and the managing director of Micro-Credit Ratings International both indicated that other MFI institutions are beginning to include community-level infrastructure finance (e.g. small scale water projects) in a broadened array of credit products, alongside of such products as small and medium-sized enterprise, mortgage and homeimprovement loans, etc. In most SSA countries some form of banking reform has been undertaken in the last decade as part of more comprehensive reform programs. One of the most dramatic examples is the Nigerian banking reform which created a strong and relatively highly capitalised banking sector. However, the degree of consolidation and sophistication varies considerably from country to country.

4

See for example Efam Dovi, Boosting domestic savings in Africa in Africa Renewal, Vol.22 #3 (October 2008), page 12

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The pension and insurance industries are important sources of long term savings. They present a very similar picture to the banking sector but with reform lagging slightly behind banking sector reform. The pension fund and insurance industries are building assets under management to sizes which are now or soon will be theoretically capable of providing debt and equity for infrastructure. However, regulators in many Sub-Saharan African countries like those in most other developing countries with relatively small pension fund sectors -take a conservative enough approach to prudential standards for credit quality that in the absence of wide-spread use of third party credit enhancement, the use of fixed income securities to mobilize these funds for indigenous infrastructure is still rare outside of South Africa. For example the pension fund industry in Nigeria has the potential to invest $3 billion in infrastructure if transactions can be structured to meet the stringent standards imposed by the pension fund regulator. To date, no infrastructure investments have met that standard. The weakness of the indigenous insurance sector also deprives the local capital markets of an important potential source of institutional demand for infrastructure debt and equity. The whole and term life sectors of the insurance industry are still in an infant stage in most SSA countries. Further pension fund and insurance reform will be critical to the development of pools of locally denominated capital. This in turn should create demand for a diversified array of relatively safe mid- to long-term fixed income investments such as bonds or syndicated loans with predictable long benefit pay-out schedules that are capable of match-funding obligations such as annuities and guaranteed investment contracts from pensions and insurance companies.

2.5.2

Under-developed capital market institutions

Local currency financing in the emerging markets appears to have embarked on a period of secular growth. According to various sources, the compounded annual growth rate of local currency financing from 2000 to 2004 in Mexico was 18%; in Chile, 35%; and in South Africa, 54%. There are a substantial number of developing countries where locally denominated financing is becoming an increasingly attractive option, displacing foreign currency financing, and creating an environment where local investors are seeking well-structured private sector fixed income securities as an alternative to central government treasury bills. Among the countries where members of our team have witnessed this trend are Indonesia, Vietnam, South Africa, Chile, Brazil, Poland, and Ukraine. Most countries with sovereign ratings in the BB to A range have established or are making strides toward establishing reasonable legal and regulatory frameworks for local capital markets, and a sufficiently promising macro-environment to permit local currency infrastructure investments. A number of lower-rated countries are also moving in the same direction. The lack of long term domestic financing is leading to strong interest in reform of domestic capital markets in Africa as well. African economies generally have a need for significant further development of market institutions including stock exchanges, broad based bond markets, securities trading and

25

clearance organizations, secondary trading facilities for fixed income instruments, credit rating agencies, and instruments to facilitate transactions such as hedging instruments and yield curves for benchmarking. In most Sub-Saharan countries, except South Africa, and to a lesser degree Botswana, Nigeria, Namibia and Kenya, both primary and secondary capital markets are still in an early stage of development with little sophistication and tight regulatory oversight. Stock markets or combined bourses have been created in a number of countries as part of the financial reform programs. These are very important to investors in infrastructure funds. Most infrastructure equity funds have an average life of 10 to 12 years. Fund managers typically seek to sell their investment in a project (exit the project) with a profit, after the project is up and running and before the end date for the fund. Stock markets provide a platform for initial investors in infrastructure to exit through Initial Public Offerings (IPOs) and/or bond issuance. However, with the exception of South Africa, the publicly traded equity and debt markets are generally still unsophisticated. Until the recent past the bond capital markets of virtually all SSA countries were largely dominated by central governments using them as a source of locally denominated sovereign debt finance. Corporate bond markets are fairly thin. Because the primary markets are rudimentary, secondary trading of fixed income securities is mostly informally arranged. A strong secondary market, with mark to market prices, can encourage buying of longer tenor securities by investors with a shorter time horizon. As domestic capital markets develop, secondary-trading institutions will be a positive factor in markets beginning to offer longer tenor debt. Formal, independent credit rating processes are un-developed or severally under-developed in all but a few SSA countries. Experience has shown that equity investors place a much lower premium on independent rating reports regarding specific companies or investments than do lenders and bond investors. For example, none of the African-based equity investment funds we interviewed indicated any substantial reliance on credit ratings to guide their investment choices. However, a key hallmark of well-developed local debt capital markets is the establishment of a hierarchy of market based credit spreads for investments with different credit ratings. When credit spreads are based on objective risk criteria as measured by independent analysts, rather than simply the historic relationships between specific borrowers and lenders (name-lending) which characterize less well-developed credit markets, opportunities for a far broader range of passive financial investors such as pension funds and insurance companies which must meet stringent prudential standards in their investment practices to emerge rapidly. Ratings-based credit spreads also facilitate the introduction, rational pricing and use of a variety of third-party risk mitigation and credit enhancement products such as full or partial credit guarantees, partial risk guarantees, and the like. In order to price such products, interest rate savings, increased secondary market liquidity and other benefits to the issuers and investors for using them need to be reliably estimated in advance of the financing. This can be done only in markets that exhibit market based credit spreads. Local capital markets with these characteristics are found in most but not all middle- and upper-income emerging market countries in Latin America, Central Europe, and Asia. SSA, apart from South Africa, has lacked such markets,

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although they are now beginning to emerge in a few countries such as Uganda and Kenya, Nigeria and Ghana. The recent growth in the number of clients requiring ratings is an encouraging indication of the possible future growth of domestic debt markets. In South Africa, credit ratings also play a crucial role in secondary debt market trading operations and portfolio management, assisting portfolio managers to stay within the exposure and concentration limits set by their respective boards. Other developed-world instruments that can be used to encourage investments from nondomestic sources in foreign exchange such as swaps, hedges and related instruments including caps and collars are not yet available in most of SSAs nascent capital markets, although they are in widespread use by both corporate and public sector borrowers in South Africa. Despite the volume of government issues, even basic yield curve benchmarking with government-issued securities has been difficult or impossible. Many central governments in the region prefer to use short-term treasury bills to fund shortfalls. Without benchmark yield curves on which to base credit pricing decisions, credit pricing tends to be arbitrary, with personal relations and marketing skill playing a major role. For example, in a recent potential local bond issue in an East African country of planned 7 years maturity, the yield quoted for a corporatized utility was 10 basis points below the governments Treasury bond yield of like maturity 2.5.3 Poor local business environments

Both general business climate factors and corruption affect private investment. General business climate factors: In Sub-Saharan Africa, the general business environment, already difficult for the business entrepreneur as a result of the lack of infrastructure like telecommunications, broadband, energy and potable water, etc. is further aggravated by governmental bureaucracy, according to Africa fund managers interviewed as part of this study. For example, the World Bank estimates that it takes 47.8 days to start a business in Sub Saharan Africa compared to 22.6 days in Eastern Europe and Central Asia and 32.5 days in South Asia. 5 A further source of concern about Sub-Saharan Africa for an investor considering a regional fund in Africa is the different regulatory and tax frameworks in different countries. The region includes 48 sovereign states varying from the relative giants like South Africa and Nigeria to very small countries like The Gambia and Togo. In addition, many of the frameworks within which infrastructure operators must do business are often still in the midst of transformation from those characteristic of centrally planned economies to current globally accepted standards. The need to understand the highly disparate regulatory and tax environments in up to 48 countries, contrasts with the investor considering South Asiaa region with twice the populationwho has to consider only 8 country regulatory and tax frameworks. Many in the global investment community see the problem of relative governmental fragmentation as being compounded by the multitude of languages spoken throughout Africa.5

http://www.doingbusiness.org/exploretopics/startingbusiness/

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The Africa fund managers regard the fact that little or no policy or regulatory harmonization has taken place on crucial issues like taxes, customs procedures, air traffic control, etc as extremely negative because it hampers the development of large regional projects with significant economies of scale.

Figure 6: Population and numbers of countries by emerging market region Population in Millions Number of Countries 24 26 29 14 8 48 Average population per country (millions) 79.125 17.730 19.172 22.214 187.375 16.291

East Asia & Pacific Europe and Central Asia Latin America & Caribbean Middle East & North Africa South Asia Sub Saharan Africa

1899 461 556 311 1499 782

Corruption: Fund and facility managers see corruption in most of Africa as another important negative factor of the business climate. The heavily regulated utility sectors are a particular source of concern. It is often pointed out that the more governmental bureaucracy there is watching over a sector, the more opportunity there is for corruption. With essentially regulated rates of return to equity in the utility sectors, comparatively thin margins may be compressed further by corruption. Finally, the higher the risk of corruption, the higher the risk of reputational damage to all parties, including equity and debt investors.

2.5.4

Low incomes

Low incomes in SSA affect affordability of infrastructure at the household level and the government level. Providers of essential public services face difficult challenges of affordability due to the fact that most users of the services in emerging market countries have relatively low per-capita income. Full cost recovery tariffs take a far more significant slice of that income than they do in higher income countries. Thus, political leaders, regulators and opinion leaders such as the editors of print and electronic media may find reasons to work to hold tariff rates down. The table below shows regional differences in per-capita gross national income (GNI). The fundamental characteristics of low income and high incidence of poverty combine to make the affordability problems facing providers of essential public services far more challenging in most of Sub-Saharan Africa than in other regions.

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Figure 7:

Gross national income by region GNI /capita(2007) 952 5440 6051 2180 2794 37566 7958

Sub Saharan Africa Latin America & Caribbean Eastern Europe & Central Asia East Asia and pacific Middle east & North Africa OECD World Source: World development indicators World Bank Data

When GNI is displayed at the country level, we can see where the affordability challenge is likely to be most acute.

Figure 8: Country

GNI per capita by country in SSA Population in m 8.5 62.4 GDP in GNI Billion /capita US$ (2007) 1 110 9 140

Burundi Democratic Republic of Congo Liberia Guinea Bissau Ethiopia Eritrea Malawi Sierra Leone Niger Madagascar Mozambique Rwanda The Gambia

3.7 1.7 79 4.8 13.9 5.8 14.1 19.6 21.3 9.7 1.7 29

0.7 0.4 19 1 4 2 4 7 8 3 0.6

150 200 220 230 250 260 280 320 320 320 320

Togo Central Africa Republic Guinea Tanzania Burkina Faso Mali Chad Benin Ghana Comoros Kenya Senekal Mauritania Sao Tome e Principe Cote dIvoire Nigeria Somalia Sudan Lesotho Cameroon Djibouti Congo R Cape Verde Angola Swaziland Namibia Mauritius South Africa Botswana Gabon Seychelles Equatorial Guinea

6.6 4.3 9.3 40.4 14.7 12.3 10.7 9.0 23.4 0.6 37.5 12.4 3.1 0.15 19.2 147.9 8.7 38.5 2.0 18.5 0.8 3.7 0.5 17.0 1.1 2.0 1.2 47.5 1.9 1.3 0.09 0.5

3 2 5 16 7 7 7 5 16 0.5 30 11 3 0.1 20 166 n/a 48 2 21 1 8 1 59 3 7 6 278 12 11 0.7 10

360 380 400 400 430 500 540 570 590 680 680 820 840 870 910 930 Est