DOCUMENT OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT

TELECOMMUNICATIONS, INFORMATICS AND MEDIA

OPERATIONS POLICY

CONTENTS 1. TELECOMMUNICATIONS, INFORMATICS AND MEDIA IN THE BANK’S COUNTRIES OF OPERATIONS ........................................................................................................1

1.1 SECTOR DEFINITION ...................................................................................................................1 1.2 RECENT DEVELOPMENTS ............................................................................................................1 1.3 EBRD INVOLVEMENT IN THE SECTOR TO DATE .........................................................................5

2. STATE OF THE SECTOR: ISSUES AND REQUIREMENTS...............................................7

2.1 CURRENT POSITION ....................................................................................................................7 2.2 REQUIREMENTS: REFORMS AND INVESTMENT ...........................................................................15

3. BANK’S OBJECTIVES IN THE SECTOR .............................................................................17

3.1 PROMOTION OF PRIVATE SECTOR INVOLVEMENT .....................................................................18 3.2 COMMERCIALISATION AND LONG-TERM FINANCIAL SUSTAINABILITY.......................................20 3.3 DEVELOPMENT OF REGULATORY STRUCTURES AND CAPACITY ...............................................22 3.4 ENVIRONMENTAL IMPROVEMENT AND ENERGY EFFICIENCY....................................................24 3.5 PROJECT EVALUATION AND LESSONS LEARNED.......................................................................24

4. INVESTMENT PRIORITIES AND OPERATIONAL APPROACH....................................26

4.1 OPERATIONAL PRINCIPLES: STAYING AHEAD OF THE MARKET ................................................26 4.2 TECHNICAL CO-OPERATION ......................................................................................................37 4.3 CO-FINANCING SOURCES..........................................................................................................38 4.4 PROJECTED LEVEL AND COMPOSITION OF EBRD FINANCING ..................................................40 4.5 PROCUREMENT .........................................................................................................................41

ANNEX 1 TRANSITION IMPACT OF PROJECTS IN THE TELECOMMUNICATIONS, INFORMATICS AND

MEDIA SECTOR

SUPPLEMENTARY INFORMATION (Separate Booklet)

SECTION 1 OVERVIEW OF BANK COMMITMENTS IN THE TELECOMMUNICATIONS, INFORMATICS AND MEDIA SECTOR

SECTION 2 TELECOMMUNICATIONS REGULATORY PROJECTS

SECTION 3 TECHNOLOGY CHOICES

SECTION 4 TELECOMMUNICATIONS, INFORMATICS AND MEDIA GLOSSARY

ii

EXECUTIVE SUMMARY

This document reviews issues and requirements in the EBRD’s Telecommunications, Informatics and Media Sector (the “Sector") and sets out objectives and strategy for the Bank’s involvement. Through its activities and investments in the Sector, the EBRD makes an important contribution to the transition process with the objective of establishing a fully liberalised, market-led, financially self-sufficient Sector. In its financing of operations in the Sector, the Bank pursues the following transition-related objectives:

• Promoting sustainable network expansion, increasing the density of telephones and improvement in quality of service

• Fostering emergence of innovative and advanced communications services crucial for overall competitiveness of businesses within the country

• Assisting the incumbent operator and the government to accelerate privatisation • Developing appropriate regulatory and legal frameworks • Extending development of the Sector beyond basic telephone services, including

media, which promotes access to communications and information. The relative focus on these objectives will depend on the transition stage of any particular country. The Bank's unique capability to cover the full private-public spectrum of operations allows it to help the Sector throughout all stages of the transition from state-owned monopolistic operator to liberalised competitive market-led environment. This is achieved through a number of steps, for example, establishing a regulatory framework, promoting sound corporate governance and responsible market behaviour by Bank clients, promoting competition by encouraging introduction of mobile operators, second operators and advanced service providers, efficiency improvements in the incumbent operator and, in many cases, its privatisation. This evolution has led to a move from sovereign guaranteed to corporate financing, thereby giving the EBRD the operational flexibility needed to assist the public sector whilst maintaining its priority for private sector participation. In response to progress in economic and political transition, commitments and pipeline development have increasingly been focussed on the private sector and privatisation activities. This shift is even more pronounced in the pipeline where all projects under preparation now involve private and non-sovereign operations. Increasingly, the Bank will look for opportunities beyond basic telephone service development in this technology-driven industry, such as data, informatics, media, internet and other value added services. The decreasing share of sovereign operations has been accompanied by a shift in geographical focus. To date, the majority of the Bank's activities in the Sector has been concentrated in advanced transition economies and EU accession countries. Increasingly, the EBRD is working in medium or early transition countries with a reliable foreign sponsor on private sector projects or participating in privatisation activities. It will use its capacity to manage transition-related risk to mobilise support from private investors and commercial banks for investments in the Sector. In countries where the economic transition process is less advanced and where macroeconomic conditions and uncertainty over fiscal capacity adversely affect the

iii

credit quality of public sector borrowers, the EBRD may need to secure its loans through sovereign guarantees. In such difficult circumstances, the Bank will leverage its activities by close co-ordination with other IFIs which may be better suited to address related macro-economic issues. The Bank's operations in these countries will generally be selective, transition-oriented and of a strategic nature; in any event, such operations would be accompanied by conditionality to promote Sector reform and would require a clear undertaking by the Government to pursue the path to liberalisation of the Sector through appropriate regulation. The EBRD will also continue to play a special role in Emergency Reconstruction Projects, e.g. in Bosnia and Herzegovina and, possibly, Tajikistan. The Sector’s development involving a mix of public and private sector participants is especially well suited to the Bank’s mandate. As a catalyst for economic development, the Sector will support all other sectors by extending access to a wide variety of essential services, delivering information transfer and promoting popular access to information. Transition progress in this Sector will have a high demonstration factor on other sectors. The Bank ensures that its activities in the Sector are additional. The Bank assumes and manages transition-related risk that commercial banks are not willing to take and provides financing with tenors/terms that match the specific needs of the Sector and which are not otherwise available in the market. The Bank has significant experience in Telecommunications, Informatics and Media throughout the Region and its potential role in the Sector's investment financing is well understood by the market. The demand for EBRD financing indicates that it is seen as a key player in the Sector, a position which has been reinforced since the recent events of the emerging markets financial crisis and the contagion to other countries in the Region. The EBRD intends to fully utilise the range and flexibility of its financing instruments in the Sector, increasingly providing equity as part of its financial structuring and exploring means of providing local currency funding, and, through continuous innovation and risk absorption, play a leading role in rapidly developing markets, thereby paving the way for future commercial financing. The proposed strategy provides a flexible approach, tailored to the transition stage of the host country, that responds to the highly complex, varied, technology driven and ever-changing needs of the Sector, promotes required reforms in the provision and financing of Telecommunications, Informatics and Media infrastructure and services, furthers good governance and reflects the comparative advantage of the Bank.

1

1. TELECOMMUNICATIONS, INFORMATICS AND MEDIA IN THE BANK’S COUNTRIES OF OPERATIONS

1.1 SECTOR DEFINITION

The Telecommunications, Informatics and Media Sector (the “Sector”) – or more generally the Communications Sector – covers traditional fixed-line switched telephony services, principally voice-based, value-added services such as cellular mobile and data transmission, advanced services such as satellite phones and internet, entertainment, information technology and media services such as cable television, TV network distribution, and publishing. Traditionally, there has been a clear distinction between the various elements within the Sector but with the global convergence within the telecommunications, informatics, consumer electronics and related industries, this is no longer the case. Even within the basic voice services market segment, the traditional transport mechanism of fixed line has been augmented by new technologies such as wireless in the local loop, cellular and, soon, widely available satellite communication technologies, together with internet-based voice service.

Historically in the Bank’s countries of operation (the “Region”), Telecommunications, Informatics and Media has essentially been limited to voice services provided by a supply-led, monopolistic, wholly state-owned operator. With the availability of, and demand for, new services, opportunities increasingly exist for private sector operators to enter the market, hence, creating significant demand for financing. Whilst there continues to be an appetite for investment in the Sector globally, the Bank continues to be highly additional in attracting foreign investment into the Region, especially in the less advanced countries. This position has been reinforced since the events in August 1998 which led to the emerging markets financial crisis and resulting contagion to other countries in the Region.

1.2 RECENT DEVELOPMENTS

The telecommunications authorities of Central and Eastern Europe and the Former Soviet Union are undertaking major infrastructure development programmes and structural reforms to adjust to new market pressures and to enhance prospects of further economic growth through better communications. This is being done against a background of rapidly evolving new services, convergence with information technology and related industries and a fundamental shift in the Sector worldwide from concentration on a single voice service towards an all embracing multi-media service. Convergence (Figure 1) manifests itself through the integration of communications, computers and customers equipment with one objective – interchange of information in any form. Global change in industry structure and the move towards liberalised, competitive, private sector markets is having – or will have – an increasing impact. The general trend for lower telephone charges, especially for international settlement rates, will have a negative financial impact on many countries in the Region – see Section 3.2.

2

There has been significant progress in the Sector in moving towards an open and competitive market economy in the Region, perhaps more so than in most other infrastructure sectors. A dynamic and efficient Telecommunications, Informatics and Media Sector can have important spillover effects into other parts of the economy and society, stimulating economic development by lowering transaction costs and assisting the transition to democracy through everyday access to basic communications services and information. Promoting competition and private sector participation are key for dynamism and efficiency in the Sector and remain central elements of the Bank’s strategy. Resources have primarily been targeted towards private sector operations and assistance to the privatisation of the dominant operator which have acted as the major spur for Sector development, establishment of an independent regulatory regime and competition.

Telecommunications

IT Industry • Computers • Operating

systems • Set-top boxes • Databases • Applications

Entertainment and Information

• Broadcasting • Publishing • Films • Music • Education

• Intelligent networks • Computer -

telephony integration

• Internet service provision

Interactive Multimedia

• Database • Cable industry • Online services

• Computer games

• Conditional access systems

• Digital film effects

• Fixed networks • Mobile networks • Satellite networks • Value-added networks • Virtual networks

Source: Spectrum

Figure 1: Convergence

3

The Bank has played a crucial catalytic role in accelerating reform in the Sector on the Region’s Governments’ agendas through both its direct intervention and conditionality in its banking operations. Technical assistance has been focussed on supporting development of a framework for regulation in those market segments where regulation is appropriate and necessary, thus creating an environment in which a liberalised, competitive private sector can flourish. Although this two-track approach has been very successful in most cases (as reflected in improvements in the performance of the dominant operators and the emergence of private sector providers in niche value-added market segments), the underlying tension between transition and competitive environment should not be underestimated. A major challenge is to seek harmonisation between privatisation and liberalisation to ensure balance between (1) the need to attract a strategic investor (perhaps by offering a period of monopoly operation) in order to maximise privatisation receipts to the Government, and (2) the benefits to the consumer through increased competition and choice at the earliest opportunity.

Despite significant achievements during the past seven years, there remains a critical shortage of Telecommunications, Informatics and Media services in the EBRD countries of operations as indicated by the low penetration of telephone lines, long waiting lists and shortage of non-basic telecommunications services. Widening differences exist between countries in terms of access availability, quality of service and general sector development - particularly between CEE and CIS countries. The key lever for addressing this imbalance is private sector entry, especially in Telecommunications, Informatics and Media services and related businesses. Much will be technology driven (in the sense of applications and services made available by technological advances), but the main challenge will be to mobilise the significant private sector capital required. This will only be achieved by simultaneously addressing the weaknesses in the Sector structure and the legal and regulatory framework. Rapid advances in technology and availability of services will increasingly provide the opportunity for deregulation within the Sector as has already happened with internet services.

Although many countries have introduced some competition in non-basic services, competition in basic fixed-line service is rare. This is expected to change during the next few years as commitments made under EU Accession or WTO obligations are implemented. One of the remaining challenges is to support the establishment of an effective regulatory framework. In most countries, the regulatory framework is inadequately developed so that even when competition is permitted, the reality is that there are many barriers to the emergence of new services or to new operators trying to penetrate the market, particularly in the areas of licensing, pricing and interconnection rules. Such unpredictability deters private investment. Another particular challenge that needs to be addressed is a legacy of the past, where the Government was simultaneously owner, operator and regulator of the telecommunications industry, which led to inevitable conflicts of interest. This makes the Telecommunications, Informatics and Media Sector particularly sensitive to political influence. Reform of tariffs from historically low levels, which are highly cross-subsidised, to cost-based structures also brings specific social issues.

Privatisation of the incumbent fixed line operator. The incumbent fixed line operator tends to provide the ideal candidate for early privatisation amongst the major state-owned entities, both within and beyond the Region. A number of such privatisations have already taken place and more are slated during the next two years. Privatisation by

4

attracting a strategic investor with the benefit of financial resources and management with operating know-how has been the preferred privatisation mechanism, but other methods including IPO have been successful. In the case of Matav (Hungary), three stages of privatisation have been undertaken (two stages involving a strategic investor and the third stage using an IPO) and in 1999, Eesti Telecom (Estonia) followed up its earlier strategic investor privatisation with an IPO on local and international markets. Privatisation proceeds have generally funded Government budgets and have provided a valuable source of income available for non-telecommunications related uses. However the proceeds may also be used to finance the privatised company, as was the case with SPT in the Czech Republic, or to provide support to the Sector through establishing rural development or universal service funds.

Improving corporate governance. The conditionalities contained in Bank operations and preparation for privatisation have been major drivers in encouraging the incumbent operators to become more efficient. The Bank has been a major catalyst for improvements in corporate governance by encouraging creation of autonomous legal entities separate from direct ministry control. Significant pressure has been exerted on these entities to change their financial and accounting systems to international accounting standards. Progress to adopt such standards has been slow in some countries, despite undertakings from the Bank’s clients (through Loan Agreements) and Governments (through Guarantee Agreements), due to the delay of the national accounting commissions to move national standards towards the international norm.

Growing private sector involvement. Private sector financing continues to play a significant role in fostering new companies, generally in cellular network operations, paging and value added services such as internet. The more successful examples have generally involved a joint venture operation between local investors and western operating companies with in-depth experience of the particular field. The conditions for private sector participation are generally improving across the Region, although greatest progress is being made in the more advanced countries, especially the EU accession countries where open markets within the next few years is a pre-condition of accession. Economic and financial fundamentals are also more positive, particularly in the advanced transition countries, reducing affordability constraints of higher tariffs for user charges and increasing the debt absorption capacity of the service providers. The less advanced countries have not made so much progress due to delay by the authorities in implementing effective legislation, particularly in respect of corporate governance, bankruptcy, tax regime and facilitation of inward investment. On the supply side, a growing appetite for risk among international operators and investors is contributing to better and more diversified conditions in the market, although evidence suggests that this may have taken a setback due to contagion effects of the recent emerging market crisis.

EU accession. For the ten countries concerned (Czech Republic, Estonia, Hungary, Poland, Slovenia, Bulgaria, Latvia, Lithuania, Romania and Slovak Republic), accession to the EU exerts special pressures for liberalisation of markets to full, open competition with consequential pressure on the incumbent operator for investment in the Sector and rebalancing of tariffs. The large gap in penetration, quality and range of services between acceding and present EU members in Telecommunications, Informatics and Media services will have to be narrowed for both accession and economic reasons. Prolonged persistence of such gap would place a strain on the cohesion of an enlarged EU and distort competition within the single internal market.

5

The European Union stipulates adoption of the telecommunications acquis communautaire as a pre-condition of its pre-accession strategy. This requires accession countries to adopt EU directives on policy, regulation and legislation. Other countries are working towards adoption of the EU directives even though they have not yet signed an Accession Document. EU provides significant technical assistance to help countries adopt its directives via its Phare and Tacis programmes. A further factor is that a number of countries have joined, or have applied to join, the World Trade Organisation (WTO) which requires members to make commitments with regard to opening of markets within specific timeframes.

Alignment of national legislation with the telecommunications acquis communautaire and the WTO agreements and stricter enforcement are already prompting structural changes in the Sector and driving significant preparatory work in legal and regulatory reform. It is clear, however, that countries making these changes will require significant external assistance in order to devise and implement the radical changes which will be necessary both within the sector itself and for commercial legislation. Not surprisingly the strategic objectives of the Bank are well aligned with those of the other institutions and it is expected that the EU, the World Bank and EBRD will continue to play a major role through co-ordination of their respective activities.

1.3 EBRD INVOLVEMENT IN THE SECTOR TO DATE

As of December 31, 1998, the EBRD had approved cumulative financing totalling euro 1.2 billion for 45 Telecommunications, Informatics and Media projects, with total project costs of euro 6.4 billion, (Figure 2). In addition, a further 12 projects with project total cost of euro 1.0 billion are under preparation where the EBRD funding amounts to euro 312 million1.

Figure 2: Cumulative Signed Projects, mEuro

0

200

400

600

800

1000

1200

1400

1992 1993 1994 1995 1996 1997 1998

mill

ion

Eur

o

Private sectorPublic sector

1 Supplementary Information Section 1 provides a detailed overview of Bank financing committed to this Sector.

6

During the last seven years, the Bank has responded flexibly to changes in Sector demand. In the early years, the majority of financing was committed to the public sector but latterly, private sector projects have dominated. This reflects the change in the Sector status in the more advance countries from a wholly state-owned monopolistic incumbent operator to a more liberalised, competitive market allowing private sector participation. Change in market demand is measured in the private:public sector portfolio ratio which has changed from 33% in 1996 to 52% in 1998. Future projects are expected to be predominantly in the private sector, or pre-privatisation financing required to assist the transformation of the incumbent state operator towards the private sector.

The telecommunications portfolio is particularly robust and there continues to be no payment defaults or classified projects. Following the TPSA equity acquisition in 1998, equity (including equity fund commitments), comprises 23% of the total portfolio commitment. Approximately 75% of the equity commitment is in publicly quoted companies, primarily Matav and TPSA.

Latterly, new operations have been concentrated in the more advanced countries – consistent with their progress in Sector and regulatory reform – and in those countries seeking EU accession where the demand for private sector financing has been growing.

7

2. STATE OF THE SECTOR: ISSUES AND REQUIREMENTS

2.1 CURRENT POSITION

2.1.1 Regional variances in access availability, industry and market structure

The 1992 Telecommunications Operations Policy identified three fundamental shortcomings and issues in the Region’s Telecommunications, Informatics and Media Sector, namely:

• Severe imbalances between the demand and supply of Telecommunications, Informatics and Media services;

• High operating inefficiencies and inadequate return on capital employed due, in particular, to low tariffs; and

• Lack of commercial focus and basic management skills needed for successful operations and sustainable growth for the Sector.

The significant progress made in some countries of operation, less so in others, has resulted in wide variation in access availability and general sector development from country to country. The Bank has made a significant contribution through its 45 signed operations. Access to service2 (see Figure 3) has increased in most countries, with significant increases in individual countries, for example, Hungary 28% vs 10% in 1990, Czech Republic 28% vs 16%, Estonia 30% vs 20%.

Figure 3: Penetration Ratio (1994-1996)Source: ITU, EBRD

0

5

10

15

20

25

30

35

CentralEurope

BalticStates

EuropeanCIS

Caucasus CentralAsia

Mai

n Te

leph

one

Line

s pe

r 100

Pop

ulat

ion

19941996

2 Access to service or penetration ratio is defined as number of main telephone lines per 100 population

8

For convenience the Bank’s countries of operation are grouped into five regional areas (Caucasus3, Central Asia4, European CIS5, Baltic States6, and Central Europe7). Access availability remains significantly below western European levels (EU average 52%), but generally higher than peers in the rest of the world with similar economic performance (GDP) (see Figure 4). This figure depicts the Penetration:GDP relationship for the Region versus the world average. However, the penetration is particularly low in the rural areas where the investment costs are high and the revenues very low.

Figure 4: Telecommunications and Wealth (1996)Source: ITU, EBRD

0

10

20

30

40

50

60

70

$345 $765 $1937 $3035 $40630

GDP per Capita

Pene

trat

ion

Region AverageWorld Average

The large investment programmes which have been undertaken in many countries have resulted in significant progress regarding modernisation where obsolescent analogue systems have been replaced with modern digital systems which are essential for providing advanced services, including internet, see Figure 5.

3 Azerbaijan, Georgia and Armenia 4 Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan 5 Russia, Ukraine, Moldova and Belarus 6 Estonia, Latvia and Lithuania 7 Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, FYR Macedonia, Hungary, Poland, Romania, Slovak Republic, Slovenia,

9

Figure 5: Digitalisation Level (1994-1996)Source ITU, EBRD

0102030405060708090

100

WesternEurope

CentralEurope

BalticStates

EuropeanCIS

Caucasus CentralAsia

Dig

ital L

ines

per

100

Mai

n Li

nes

19941996

Waiting lists have declined in many countries but it is estimated that the demand exceeds more than 25 million across the Region, although it is difficult to be precise because waiting lists inevitably do not always reflect true demand (see Figure 6). For example, there are people who do not apply because the chance of success is slight or, alternatively, those who indicate they would like to receive a telephone line irrespective of their ability to pay. At an average investment requirement of typically euro 900 per line, the total investment requirements of euro 22 billion cannot be underestimated. However, to reach European fixed line penetration levels within the next ten years, investments in excess of euro 100 billion would be required.

Figure 6: Waiting List / Main Lines (1994-1996)

0

2

4

6

8

10

12

14

16

18

CentralEurope

Baltic States EuropeanCIS

Caucasus Central Asia

Wai

ting

list (

mill

ions

)

0

5

10

15

20

25

30

35

40

%

1994 W aiting List

1996 W aiting List

1996 Ratio

Source: ITU, EBRD

Significant progress has been made in the introduction of mobile telephone services (Figure 7). This is an important market segment which lends itself to introduction of

10

competition as well as contributing to the overall availability of telephone service. Although mobile penetration is generally low by European standards, Estonia already has a similar penetration (14.3%) to France (14.3%) and Spain (14.2%) and higher than Germany (13.5%), Belgium (13.3%) and Greece (12.7%). Single digit penetration exists in other countries in the Region but is growing rapidly and the more advanced countries are likely to achieve similar penetrations to western European countries in the medium term. The Bank has been particularly effective in working with foreign sponsors and local shareholders throughout the Region in developing mobile telephone companies and this segment is seen as a significant contributor to the transition process.

Figure 7: Analogue and Digital Cellular Penetration

0

2

4

6

8

10

12

14

16

Bul

garia

Cro

atia

Cze

ch

Esto

nia

Hun

gary

Latv

ia

Lith

uani

a

Mac

edon

ia

Pola

nd

Rom

ania

Slov

akia

Slov

enia

% 19961998

Cellular telephony is a market where competition has flourished in a number of countries, notably Estonia and Poland with four networks, Ukraine (six), and Czech Republic, Hungary, Lithuania and Romania with three each. Russia has seen strong growth in metropolitan areas such as Moscow and St. Petersburg, but is somewhat handicapped by the proliferation of national and regional technology standards. Strong growth of mobile operators in some countries is challenging the traditional role of the incumbent national operator and viable alternatives or substitutes to fixed networks are emerging. The legacy of the previous political regime has provided incumbent, monopolistic dominant operators in the Region with operational efficiency significantly below world standards due to inherited obsolescent design, ageing technologies and equipment, and non-optimal operation. Staffing levels tend to be much higher than those commonly found in competitive environments. The telecommunications market remains dominated by basic voice services.

Modern telecommunications services support the development of new businesses, as evidenced by the enormous growth throughout the world in recent years of cellular

Source: ITU, EBRD

11

and internet-based services8. In return, the growth of business activity and general increase in economic activity drives the demand for additional telecommunications services, thus forming a virtuous circle. Increasingly as business, especially private sector business, develops in our countries of operation, there is a need within those countries to address and develop the market for advanced telecommunications services. One consequence is a strong support to the development and transition of the economy as a whole.

Privatisation of the incumbent operator in the Region has generally involved a strategic investor which is often a major operator in its own home country. This brings the benefit of management know-how, advanced technology, contribution to the globalisation of the industry, as well as financing to support the necessary investment programmes normally required by the licence. The Bank strongly supports this approach and has already participated in a number of such projects. It further expects this model of privatisation to be used in a number of countries in the Region where privatisation remains to be effected. Experience has shown that early entry of a strategic investor can provide the necessary investment and management control which can rapidly accelerate the development of access to the network, as witnessed in Hungary (Matav) and the Czech Republic (SPT) (Figure 8).

Figure 8: Comparison of penetration trends

-

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

1991 1992 1993 1994 1995 1996 1997 1998

Sale of 30% Matav toTelekom/Ameritech

Voucher privatisation26% SPT Telecom stake

DT/Ameritech raiseMatav stake to 37%

Sale of 27% stake inSPT Telecom toKPN/Swiss PTTSPT Telecom

Matav

TPSA

Pene

tratio

n %

Most incumbent operators have already begun the transition from a government-owned department to commercial independent entities, with the first stage usually in the form of a joint stock company. Financial performance of such entities is generally improving but remains weak. Revenues per line (see Figure 9), although improving in some countries, notably the Baltics, are generally low leading to serious difficulties in supporting large scale investment. In such cases, commercial development, especially in the rural areas, may have to be complemented with support through 8 British Telecom estimates that 20% of its traffic is internet related.

12

universal access/service funds, access deficit charges, or innovative community funding schemes.

Management and corporate governance of incumbent national operators are generally not up to industry standards and there is often lack of independence and transparency in management due to Government interference. A key objective for the Sector must be to liberalise and allow easy entry to the market for potential investors. Even in countries where potential for competition exists, players frequently encounter barriers to entry9.

Figure 9: Annual Revenues per Line (1994-1996)

0

100

200

300

400

500

600

700

800

900

1000

WesternEurope

CentralEurope

Baltic States EuropeanCIS

Caucasus Central Asia

$US 1994

1996

Development of the informatics and media market segments will be highly dependent upon the availability of information technology within business and the home. Whilst penetration of computers in businesses in the Region has increased considerably over the last few years, it is still significantly below the levels found in developed European economies, (Figure 10). Significant increase in penetration levels in computers, especially in the home, and home entertainment consumer goods will be geared to the wider macro-economic conditions existing in the country. Notwithstanding this, there will be opportunities, especially for SMEs, to develop niche businesses, especially in commerce oriented data and internet services. Although there is a wide distribution of TV sets throughout the Region, there are very few commercial broadcasting stations. Electronic publishing and related industries are expected to be a growth area which will aid access to information.

9 PriceWaterhouseCoopers’ “Obstacles to Investment in Telecommunications in CEE Countries” (1998) identified a range of obstacles associated with entry penetration such as licence acquisition, radio frequency acquisition, financial structuring, tariff distortion (including interconnect charges), operations and network development and capital extension. Each investment phase features obstacles and enablers which may be common to CEE countries or specific to an individual country.

Source: ITU, EBRD

13

Figure 10: In form ation Technolog y, 1996

0.0

200.0

400.0

600.0

800.0

1000.0

1200.0

1400.0

1600.0

1800.0

Central Europe Baltic S tates W estern Europe

per 1

0000

inhi

bita

nts

In ternet hostsNo of PC 's

Figures 11 and 12 suggest the drivers which must be satisfied and the barriers which must be overcome if the information age is to progress in the Region.

Figure 11: Drivers of Demand for the Information Age

Macro-economic environment

Understanding and acceptanceCulture of the Industry

Competitive pricingand packaging

Access to skills

Access to advanced infrastructure

STRONG DEMAND

STRONG SUPPLY

EstablishedIndustry

Willingnessand ability

to invest

Access toskills

Role of the GovernmentEffective regulatory and legislative environment and government initiatives

Competitiveness

Demand Drivers Supply Drivers

Source: Spectrum

Source: ITU, EBRD

14

Bank strategy in the Sector will be to focus its operations on enhancing access to the advanced infrastructure necessary to support the new services and by its willingness and ability to invest in market segments critical to the transition, and provide support and encouragement to others willing to enter this segment. Underpinning this, the Bank will continue its work in assisting the authorities to create an effective regulatory and legislative environment.

Figure 12: Barriers to the Progression of the Information Age

Information Age

Low Skill Base Negative Attitudes

High Prices Absence of Infrastructure

Source: Spectrum

2.1.2Regulatory framework; liberalisation and competition Progress in privatisation of the incumbent national operator varies tremendously throughout the Region from majority private ownership to full state ownership. The majority of countries have introduced competition in mobile services, data services and value added services but competition in fixed line services is rare. This, however, should rapidly change over the next few years as countries begin to meet their commitments made under EU Accession or WTO obligations.

In most transition countries, the regulatory framework is far from being acceptable and based on the assumption that telecommunications services are to be provided by a monopolist state-owned operator fulfilling the political objectives of the government. As a result, even when some limited competition is permitted, there are no regulatory instruments to facilitate the emergence of new services or to assist new operators in penetrating the market.

The structure of the tariff policy of most national operators in the Region constitutes a serious impediment to both liberalisation and privatisation. Tariffs for local telecommunications services are often substantially below cost and need therefore to be subsidised by income generated through the provision of

15

international and long-distance services. Further cross-subsidisation may take place from business to state-budget funded entities and residential customers resulting in additional costs to commerce. Reform is required to introduce transparent and robust mechanisms which enable the transition to cost-based tariff structures.

Competitive procedures for awarding licences or concessions for developing networks and/or providing services are not yet universally accepted and effective. However, licences for major fixed line and mobile operators are normally awarded through open competitive tendering.

2.2 Requirements: reforms and investment

2.2.1 Sector Reform

Traditionally telecommunications was regarded as a public utility where economies of scale, political sensitivities and the need for a ubiquitous subscriber access network resulted in a typical public service believed to be a natural monopoly. Technological change and exponential increase in demand over the past decade has changed economic thinking so that the sector is now viewed as a commercial market best exploited by a profit-driven private sector. Throughout the developed world this has resulted in liberalisation of the sector and recognition that there is no strategic reason to keep the incumbent operator under state ownership. Indeed private sector management of the incumbent is likely to greatly enhance the economic performance of the company and improve the quality of service to customers. Furthermore such a structure allows independent regulation of the sector. This approach has been supported by the Bank as an essential prerequisite for the development of the sector and, where appropriate, its investment operations have included conditionalities targeted at meeting these objectives.

The Bank has strongly promoted the concept of privatisation of the incumbent operator seeking, via transparent and competitive international tender, a strategic investor with management control over the company. This has been successfully achieved in a number of countries including Hungary, Czech Republic, Poland, Lithuania, Estonia, Latvia, Armenia and Romania. Bulgaria will complete the first stage of its privatisation shortly. Other countries including Ukraine, Albania, Croatia, Belarus, Kazakhstan and Kyrgyzstan are currently in the earlier stages of preparation for privatisation.

The Bank has facilitated through technical assistance the elaboration of a robust and predictable Telecommunications Sector policy in the Region. Encouragement and direct assistance to individual countries has been given for the adoption of a modern telecommunications law providing safeguards of transparency, predictability, clarity and creating regulatory instruments designed to facilitate the emergence of new services and the penetration of new operators. The Bank has actively assisted in the introduction of competition in all telecommunications markets and the adoption of measures that will facilitate and enable telecommunications liberalisation. The importance of establishing an independent regulatory body with no structural or

16

functional link with any of the telecommunications operators is well proven and has formed a fundamental tenet of developing Sector policy for reform. This has been accompanied by actively assisting in the efforts to rebalance tariffs.

2.2.2 Investment Priorities Investment priorities within the Region are driven by the need to extend access to basic telecommunications service, the introduction of advanced services such as data, mobile and internet primarily to support business, and related market segments oriented more to private users eg cable TV, media and publishing. These can be broadly categorised as follows:

• Pre-privatisation financing where financing is required primarily to develop the network. This provides an opportunity to influence the future development of the company, and possibly the sector through restructuring and regulation, and provides a strong demonstration effect. • Participation in privatisation by directly financing the newly-privatised company with equity or syndicated loans, including underwriting. • Private sector operators in high growth service areas, (e.g. mobile telephone, value added services, internet, data communication, information technology), which will begin the process of stimulating competition and customer choice. • Alternative or second operator financing as well as local telecommunication operators, which will provide engines for change as the first real competition to the dominant incumbent operator. • Media and commercial broadcasting, which are progressively more important to support the democratic process. • New start-ups, small and medium size companies, in particular in technology driven areas, through funds.

17

3. BANK’S OBJECTIVES IN THE SECTOR

The EBRD’s objectives build on the progress made under the 1992 Telecommunications Operation Policy and reflect the developments in technology which continue to be a driving force for change in available services, network platforms and market structure within this sector. The key difference is that the approach to project selection will now be highly dependent upon the stage in transition which the specific country has reached, particularly the progress made in the Sector. EBRD activities and investments in the Sector aim to make an important contribution to the transition process through promoting private sector activity within a well regulated environment. Recognising the operating principles of the EBRD (transition impact, additionality and sound banking principles), the Bank will pursue the following objectives through careful project selection and transaction structuring:

• promote sustainable network expansion, increase the density of telephones and improve the quality of service • foster emergence of innovative and advanced services crucial for overall competitiveness of businesses within the country • assist the incumbent operator and the government to accelerate privatisation

• develop appropriate regulatory and legal frameworks

• promote the development of the Sector beyond basic telephone services, including media related, and which promote access to communications and information.

The relative focus on these objectives will depend on the transition stage of any particular country. The Bank's unique capability to cover the full private-public spectrum of operations allows it to help the Sector throughout all stages of the transition from state-owned monopolistic operator to liberalised competitive market-led environment. This is achieved through a number of steps, for example, establishing a regulatory framework, promoting sound corporate governance and responsible market behaviour by Bank clients, promoting competition by encouraging introduction of mobile operators, second operators and advanced service providers, accompanied by efficiency improvements in the incumbent operator and, in many cases, its privatisation. This evolution has led to a move from sovereign guaranteed to corporate financing, thereby giving the EBRD the operational flexibility needed to assist the public sector whilst maintaining its priority for private sector participation.

The Bank will primarily support the establishment and development of private sector operators through equity and debt financing. The Bank can be highly additional in mobilising private sector financing, particularly in the cellular and fixed line market segments, but also in value-added and information services such as cable TV, satellite communication services, publishing, and internet. Opportunities may arise in any of the Bank’s countries of operation but are likely to be focussed in the more advanced countries where sound regulatory frameworks exist. The Bank will critically evaluate its additionality taking into account the transition stage in the Sector of the individual country, the nature of the telecommunications or media project, and the regulatory environment.

18

The Bank will assist in the transformation of the incumbent national telecommunications operators into commercially-oriented, privatised companies. The approach will include pre-privatisation financing through debt and quasi-equity, privatisation participation and post-privatisation financing, including equity, underwriting and syndicated loans. Technical assistance will be given through institutional development programmes targeted on Sector legal reform and establishment of an independent regulatory regime. Support will be targeted at those countries where the Government has demonstrated greatest commitment to implementing reforms as part of pre-privatisation preparation. In addition, the beneficiary countries will be asked to establish a policy of progressive regulatory reform and market liberalisation in order to secure the Bank’s financial support. Opportunities are foreseen in Albania, Bulgaria, Slovak Republic, Central Asia, Croatia and Ukraine.

The Bank will support smaller communications projects and seek diversification through participation in equity funds specifically aimed at SMEs engaged in media, publishing, internet, information technology and related businesses.

Apart from these objectives, the Bank will continue to play a special role in supporting the Telecommunication Emergency Reconstruction Project in Bosnia and Herzegovina and, potentially, Tajikistan. Special attention will be given to the development of telecommunication services in the rural areas, particularly in the early and intermediate transition stage countries. Through its projects and related technical assistance and policy dialogue, it will support countries in their efforts to implement the EU Acquis Communitaire and adhere to the WTO Telecommunication Agreement.

The Bank’s capability to tailor its approach to the specific requirements of each case across the full public-private sector spectrum gives a flexibility with which it can complement the other IFIs and commercial financiers. The Bank has in-depth capacity in banking and industry experience which can be combined with specific regional experience. Its ability to complement its financial experience with its regulatory institutional experience and resources increases the additionality the Bank can bring to its operations.

As the Bank increasingly extends its activities into the media and informatics market segments it may be necessary to supplement its in-house expertise by using the services of external consultants for specific due diligence activities.

3.1 Promotion of Private Sector Involvement

Market forces and competition have been proved to be the major prerequisite for a dynamic and efficient Telecommunications, Informatics and Media Sector. The Bank's mandate to foster the transition towards market-oriented economies and to promote private initiatives uniquely positions it to facilitate and optimise private sector participation in the financing and provision of telecommunications infrastructure and services in its countries of operations.

Historically, most countries throughout Europe have had a Telecommunications Sector structured primarily on a monopoly basis, certainly so far as basic telephone

19

services were concerned. Indeed, telecommunications has often been described in the past as a “natural monopoly” because of the very significant investment costs of the local access network. During the last decade or more as cost effective alternative access mechanisms have become available, this has been shown to be no longer the case and most western European countries, and indeed some of the more advanced transition countries, have progressively liberalised their telecommunications markets. This process has been accelerated by the introduction of new services where free competition is clearly necessary and desirable if the market is to progress, e.g., internet, data service provision, mobile telecommunication. Experience has proved that the emergence of effective competition in the sector is often dependent on the existence of a robust regulatory framework which will force the incumbent operator10 to provide access to its network on fair, reasonable and transparent terms, will provide fair allocation of scarce resources such as numbering and radio frequencies, and ensure a level playing field for all players in the market.

The primary goal of private sector involvement and increased competition is to improve capital and operating efficiency. This is achieved by the private sector assuming project risks relating to the design, construction, financing and operation of an infrastructure or service asset. A key element of private sector involvement in EBRD financed operations, therefore, is the genuine risk adoption by those parties best able to manage them, thereby providing incentives for sustained effective performance.

Bank operations in the Sector have to be designed to achieve efficiencies that most naturally come from the private sector: stronger financial discipline in investment appraisal; experience with a wider range of technological solutions; focus on least-cost solutions; better integration of capital and operating costs; shorter design, procurement and construction processes; innovation in the financing and operation of services; and globalisation.

A further goal of private sector involvement in telecommunications infrastructure and services is to increase the pool of available sources of investment funds. First-rate sponsors, typically major telecommunications operators in their own country, will have access to equity funds, foreign capital markets and loans that would not otherwise be available. The Bank’s participation in a project can be highly additional in securing the release of such funds, especially in those countries where the risk through poor regulatory framework, is perceived to be unduly high.

The Bank will actively support new network operators (local, domestic long distance and international) and mobile operators as the most direct route to achieve competition. In parallel, the Bank will promote sound and transparent privatisation strategies which will be actively supported by assisting the preparation for privatisation, including pre-privatisation financing. The Bank will continue its policy of looking for opportunities to participate in the privatisation itself through provision of equity or long-term debt financing to the newly-privatised company.

The Bank will support opportunities to develop the Telecommunications, Informatics and Media Sector beyond basic telecommunications services, e.g. information

10 The incumbent operator will normally have a de facto dominant position, i.e. the ability to behave independently of its customers and suppliers.

20

technology, e-commerce (transactions using electronic methods), computer hardware and software manufacturing, TV network distribution and broadcasting, publishing, internet service provision, satellite communications, and media in general. As the internet is still in its early stages, many electronic commerce opportunities are available creating new business opportunities for SMEs who are taking advantage of a global presence via their own online e-commerce services as customers are progressively utilising more online sources to purchase products and services. New technology via computer hardware/software and increasing speeds of computation and magnitudes of memory coupled with decreasing prices of chips are enabling businesses to embrace e-commerce and use it as a market differentiator to reach new consumers. The marketing and sales potential of the internet in addition to the growth of electronic business has prompted a strong expansion in the IT market. In some cases, the most appropriate financing will be via Funds in which the Bank is participating. With increasing convergence, there will be more opportunities in related industries, including media and publishing where the Bank will support service providers e.g. distribution. Media and publishing have proven to be the most efficient tools in representing diverse opinions, choice, and democracy in general. The Bank will support such a critical transition force in the Region whenever possible. In addition, the Bank’s approach to these projects will be in accordance with the Guidelines for Bank Involvement in Electronic Media and Broadcasting Projects [SGS94-79 (Rev 1)].

The Bank will continue to be involved in mobile telephone projects where the newly developed Universal Mobile Telecommunications System (UMTS) will provide the wireless access networks for the new information society. UMTS will offer more advanced services that will drive up penetration rate and usage, overcoming the limitations in respect of voice and data services of current second generation technology. UMTS will offer a range of mobile services that until now have only been available on fixed line networks thus facilitating competition.

3.2 Commercialisation and long-term financial sustainability

A key objective pursued by the EBRD in its operations, especially important in the early and medium transition countries, is the commercialisation of incumbent national operators. Historically, in the Bank's countries of operations, the state-owned telecommunications operator worked within, or as a department of, the Ministry of Posts and Communications. Commercialisation usually begins by corporatisation and during the last few years, many countries have begun this process by separating the telecommunications operating activities from postal functions to form new independent state entities, typically wholly Government-owned joint-stock companies or similar structures. Nevertheless, the legacy of the past means that these new entities are frequently characterised by inadequate accounting methods that under-record the true cost of capital, deficient financial planning, programming and budgeting practices, lack of cost control, and low levels of cost recovery. The fundamental aims of reform in the public sector are to place these entities onto a commercial footing, to improve their corporate governance and to take measures to ensure long-term financial viability. This requires changes in the organisational status of the entity, reform of tariff policies, accounting rules and administrative practices, and the introduction of competition.

21

Corporatisation and commercialisation. An important first step in improving the operational efficiency of incumbent telecommunications operators is to corporatise, thus converting them into legally, managerially, financially and operationally autonomous organisations separate from direct ministerial control. This will help to insulate the utilities from political interference and enable them to operate in a more transparent and accountable manner. By obtaining independent corporate status, publicly-owned service providers become subject to standard commercial and tax law, accounting criteria and competition rules. Corporatisation will compel them to adopt commercial procedures and practices in accounting, revenue administration, and financial planning and budgeting.

Tariffs and Cost Recovery. One of the legacies of central planning is that the tariffs paid by consumers for the use of telecommunications services are typically set far below operating and capital replacement costs. Tariff-setting procedures often lack predictability and remain subject to political discretion. Also, except in the most advanced countries, there is a high degree of (economically inefficient) cross-subsidisation between classes of consumers — particularly from industry and commerce to households. In many transition countries, most prominently in the CIS, tariffs are largely determined by political and social considerations that may omit bad debt provisions or rely on inadequate depreciation charges. In countries of the CIS, including the Russian Federation, the difficulties caused by inadequate tariff regimes are aggravated by poor revenue collection and low levels of cash receipts. As a result, many incumbent operators, especially the smaller operators in the Russian Federation and the less advanced countries, cannot generate sufficient cash surplus to fund or borrow for capital improvement. Given the world-wide trend to base telecommunications tariffs on cost-based systems, strongly supported by WTO, EU and ITU, and the reciprocity between operators, especially on international routes, major rebalancing of tariffs will be required over time throughout the Region. Although the economic efficient system is to have cost-based tariffs, in practice, the transition period through tariff rebalancing is long, even for western European countries. A major consideration in this respect is the degree to which services in certain subsectors can be financially self-sufficient without cross-subsidisation, notably services provided to residential customers and having regard to the Universal Service obligations of an incumbent operator.

Efficiency Incentives. Besides failing to cover the full economic cost of service provision, the prevailing tariff policies are often economically inefficient. In (mostly advanced transition) countries where the principle of economic pricing has been accepted, tariffs are set on an increased cost basis, providing little incentive for productivity gains and cost efficiency. In many countries, the level of operating surplus is capped without consideration for investment needs.

The Bank has made, and continues to make, a significant contribution to the transition towards commercialisation in these entities through conditionality whether in the Borrower’s loan agreements or in the Government’s sovereign guarantee. Such corporatised entities that receive Bank support are required to adopt international accounting standards (IAS). They should be subject to general commercial law, to accepted international accounting and auditing standards and to hard budgets. These companies should be allowed to charge customers through a transparent tariff system for the services they provide at levels that will enable them to be financially viable on

22

their own. An important focus of corporatisation is financial and operational performance, which publicly-owned companies have to improve as a standard feature of EBRD projects. The commercialisation and corporatisation of service and infrastructure provision is generally the prerequisite for, and often the first step towards, private sector involvement at a later stage.

3.3 Development of Regulatory Structures and Capacity

Telecommunications regulation is one of the five core areas being addressed by the Bank in its Legal Transition Development Programme in liaison with other IFIs and the EU. A key requisite to improving the quality and cost-efficiency of the Telecommunications Sector is to have a proper regulatory structure and capacity in place. Commercialisation of public utilities or the profit motive of private firms alone does not suffice to assure high-quality services, improvements in efficiency or an equitable sharing of gains. Telecommunications regulatory reform projects undertaken by the Bank11 aim at promoting the emergence of competition within the Sector and the elaboration of a modern regulatory framework likely to attract and foster private investment.

The Bank considers that the performance of the Sector improves immensely when there is effective competition between several privately-owned players. However, telecommunications has hitherto long been considered as a public-service, the provision of which could only be ensured if entrusted into the hands of a state-owned monopolist. Transforming the Sector into a dynamic multi-operator environment is quite challenging. Apart from the obvious need to change mentalities and remove exclusive rights from the incumbent operator, one also needs to elaborate rules that will facilitate the entry of new competitors into the market, provide new investors with the necessary safeguards of transparency, objectivity and clarity and permit competition to emerge.

Obliging the incumbent to interconnect on fair and reasonable terms with competitors that threaten or encroach on its cosy monopoly is obviously a difficult task. The problem can only be addressed by adopting a set of rules designed to force the incumbent to provide new entrants with transparent, objective and non-discriminatory access to its network and by creating strong and efficient institutions that will oversee the market and ensure effective implementation of these rules.

3.3.1 The Policy In accordance with its established policy and practice, the Bank provides technical assistance to countries which have expressed a genuine interest in undertaking a major reform of their telecommunications policy. Projects will only be launched if no other law reform facilitator is providing adequate assistance and the project is directly related to a specific Bank investment or potential investment or investment strategy in general. In providing technical assistance, the Bank promotes:

11 Supplementary Information Section 2 provides further details of telecommunications regulatory projects carried out by the Bank.

23

a) the gradual liberalisation of all telecommunications services; the Bank takes the view that both the Telecommunications Sector and the overall economy of the country concerned will benefit greatly from the rapid emergence of competition in all telecommunications markets. The Bank, however, also recognises that in some cases, the grant of a monopoly right to the incumbent operator for a well-defined transitionary period in respect of basic fixed line switched voice service may be justified in view of the size of the investment required for the fulfilment of its Universal Service or similar obligations, the modernisation of the network and the inherent risks of the relevant national economy. The Bank considers that these transitory periods should be specifically defined and strictly limited, desirably consistent with the WTO target of 2003 for the total liberalisation of basic telecommunications service in its member countries.

b) the establishment of an independent regulator with no structural or functional links with the incumbent telecommunications operator; the Bank considers that the effective separation of the regulatory authority from the owner of the incumbent operator is vital for the creation of a level playing field for new entrants. The Bank therefore supports the efforts to create an independent regulator with the powers and the means to sanction any anti-competitive behaviour of the incumbent operator and to foster the emergence of competition in the Sector.

c) the progressive rebalancing of tariffs; the Bank considers that the structure of the tariff policy of most dominant operators in the Region constitutes a serious impediment for both liberalisation and privatisation. Tariffs for local telecommunications services are often substantially below cost and need therefore to be subsidised by income generated through the provision of international and long-distance services. This has the following repercussions:

Unbalanced tariffs create an obvious opportunity for cream-skimming in the event of competition, thus constituting a deterrent to liberalisation.

Unbalanced tariffs offer little incentive to provide local telecommunications services, in particular to remote or sparsely populated areas. Hence, the demand for telecommunications lines exceeds that available and the Universal Service obligation of the incumbent operator remains unfulfilled.

In order to compensate the likely adverse social effects of rapid tariff rebalancing, the Bank supports all efforts to develop Universal Service and/or Universal Access mechanisms which will permit less privileged customers to benefit from a direct subsidy but which do not disrupt the development of the market by creating competitive advantages or disadvantages.

d) the elaboration of a set of rules designed to facilitate the emergence of competition; the main objective of these rules will be to enable new entrants to obtain access into the dominant operator’s network on fair, objective and transparent terms. The Bank takes the view that effective competition can only emerge if regulatory constraints preclude predatory use of market dominance by the incumbent operator and unfair practices versus its new competitors.

The policy advocated by the Bank is consistent with the WTO agreement on basic telecommunications services and with the telecommunications policy and legislation

24

of the European Union. In the case of pre-accession countries, the Bank encourages and supports the efforts of those countries to achieve full compliance with the acquis communautaire.

3.4 Environmental Improvement and Energy Efficiency

A key objective for the Bank is to promote environmentally sound and sustainable development by reducing environmental damage and securing improvements in environmental quality and energy efficiency. Projects in the Telecommunications, Informatics and Media Sector seldom give rise to significant environmental issues. Indeed, telecommunications services can make an indirect contribution to the environmental agenda by reducing the need for travel; it can save resources by efficiently transferring information and can provide the knowledge to act on environmental issues. The deployment of telecommunications infrastructure is generally quicker than the building of roads and railways and can be a cost-effective and environmentally-efficient way to modernise and regenerate less accessible areas of the Region. The Sector can also act as a catalyst for developments in other sectors which have a positive environmental application e.g. widespread use of solar energy panels at remote communication stations, including roadside, where conventional power provision may be costly or overly disruptive.

However, just because its services have the potential to provide environmental benefits does not mean the telecommunications industry can ignore the environmental impacts of its own operations. In fact, it places an additional burden on the industry to pay attention to these issues. In the context of the Bank’s telecommunications projects, environmental concerns are normally confined to the planning process where the Bank requires clients to follow transparent consultative practices, eg when deciding on sites for radio infrastructure or the laying of cables in public and private property. Upstream processes will also be taken into account e.g. chemical treatments of wooden poles which may present a toxic hazard to health. Disposal of surplus equipment, especially where hazardous substances may be involved, are required to follow national and European Union standards. Some of the Bank’s telecommunications clients have already signed up to the European Public Telecommunications Network Operators Association (ETNO) Environmental Charter which is committed to continuous improvement through action in the areas of awareness, regulatory compliance, research and development, procurement, information and environmental management systems. Such initiatives will be encouraged.

3.5 Project Evaluation and Lessons Learned

The Bank continues to post-evaluate a representative sample of its telecommunication projects and to draw out the lessons learned. Projects are evaluated to assess their performance in terms of transition impact and additionality, project business performance (sound banking principles), profit contribution and overall success rating. Lessons learned are disseminated within the Bank, and where appropriate, to other IFIs, and have been taken into account in preparing this Operation Policy.

25

The key thematic lessons learned include:

• The Bank can play a useful role in assisting with the development of the legal and regulatory framework. This will help to provide investors with confidence that the “rules of the game” are transparent and sustainable and should promote competition within the sector.

• Strong sponsors and their ability and willingness to work with local management is a critical success factor.

• Turning around a formerly state-owned monopoly telecommunication operator to meet the demand of service and perform in a competitive environment takes a long time and cannot be achieved solely by the company’s existing management. The changing force can be a) a new owner who contributes know-how and financing and/or b) direct competition which forces the company to change to compete in the new market environment.

• The Bank should seek equity-based investments in telecommunications, informatics and media projects in order to improve the operation’s risk/return balance and to maximise its additionality. The Bank can play a constructive role as “honest broker” through being the bridge or balancing shareholder between state and private interests.

• Where corporatisation and/or privatisation of an entity is a project objective, loan disbursement should, to the extent possible, be linked with progress achieved.

• It is preferable, though seldom the case, that privatisation proceeds, or part thereof, benefit the privatised entity.

26

4. INVESTMENT PRIORITIES AND OPERATIONAL APPROACH

4.1 OPERATIONAL PRINCIPLES: STAYING AHEAD OF THE MARKET

4.1.1 Demand for EBRD investment financing The demand for investment financing in the Sector has been rapid throughout the Region — although geographically uneven. The most advanced transition economies, particularly the EU accession countries, quickly recognised the need to improve their telecommunications, and have made rapid strides in developing infrastructure and services. Nevertheless it is estimated that the Region needs euro 12-15 billion per year to reach the current EU level of service within the next 10 years. A significant part of this financing will be needed to improve access in countries (or rural areas) where the level of GDP is such that commercial financing is not possible.

Relative improvements in the regulatory and legal framework in these countries have increasingly encouraged high quality investors to enter the market, especially where the incumbent operator has been privatised and liberalised cellular telephone opportunities have been given. Notwithstanding this, the Bank plays a vital role in providing complementary financing instruments providing investors with reassurance and confidence.

The Bank ensures that its activities in the Sector are additional. The Bank has significant experience in Telecommunications, Informatics and Media throughout the Region and its potential role in the Sector's investment financing is well understood by the market. The Bank assumes and manages transition-related risk that commercial banks are not willing to take and provides financing with tenors/terms that match the specific needs of the Sector and which are not otherwise available in the market. With its unique mandate, the Bank can intervene in the Sector in ways that no other international or commercial financial institution can. The demand for EBRD financing indicates that it is seen as a key player in the Sector, a position which has been reinforced since the recent events of the emerging markets financial crisis and the contagion to other countries in the Region.

The bankable part of this demand is concentrated in countries where regulatory frameworks have become sufficiently stable and predictable, based on law, and where private sector investment is facilitated by political and sustainable economic, financial and legal conditions. Such conditions are currently experienced in the advanced transition economies including most of the EU accession countries. Demand for financing in less advanced transition economies is more dispersed and driven primarily by investment needs associated with network development of the dominant fixed-line operator.

The EBRD intends to utilise fully the range and flexibility of its financing instruments in the Sector, increasingly providing equity as part of its financial structuring and exploring means of providing local currency funding, and, through continuous innovation and risk absorption, play a leading role in rapidly developing markets, thereby paving the way for future commercial financing.

27

4.1.2 Market selectivity Given the sheer volume of investment needs and the Bank's limited capacity to meet these needs, a selective approach is needed. Operations in the Sector will therefore focus on:

• private sector operations, and where the Bank’s particular Sector expertise and project development capacity is most useful;

• projects with demonstration effect in early and intermediate transition economies where Sector reform requirements are high and liberalisation and privatisation is an integral part of the government’s economic reform programme;

• operations where EBRD funds can be leveraged with co-financing from other commercial banks or international financial institutions;

• projects which make a major contribution to access to information, especially media and publishing activities.

A key aspect of Bank selectivity is the need for the EBRD to maintain its additionality, the capacity and willingness to assume ever changing transition-related risk, and stay ahead of the market. This has already been demonstrated by a quantitative change in the Sector’s product mix away from public sector, sovereign guaranteed loans, towards private sector equity investments and debt project financing.

4.1.3 Investment priorities The Bank considers telecommunications as a key element of basic infrastructure which is vital for business development and economic growth and will continue to support development in this area.

EBRD operations in the Sector fall into four broad categories (Table 1) which can be directly related to the stage of transition of any specific country. This is turn determines the type of financing instrument and transaction structure appropriate for the Bank to provide.

To date, the majority of the Bank's activities in the Sector has been concentrated in advanced transition economies and EU accession countries. Increasingly, the EBRD is working in medium or early transition countries with a reliable foreign sponsor on private sector projects or participating in privatisation activities. It will use its capacity to manage transition-related risk to mobilise support from private investors and commercial banks for investments in the Sector. In countries where the economic transition process is less advanced and where macroeconomic conditions and uncertainty over fiscal capacity adversely affect the credit quality of public sector borrowers, the EBRD may need to secure its loans through sovereign guarantees. In such difficult circumstances, the Bank will continue to leverage its activities by close co-ordination with other IFIs in order to better address the related macro-economic issues. The Bank's operations in these countries will generally be selective, transition-oriented and of a strategic nature; in any event, such operations would be accompanied by conditionality to promote Sector reform and would require a clear undertaking by the Government to pursue the path to liberalisation of the Sector through appropriate regulation and de-regulation.

28

Table 1

NATIONAL FIXED LINE TELECOMS

OPERATOR

MOBILE, SECOND OPERATORS,

VALUE ADDED SERVICES, MEDIA AND FUNDS

BEFORE PRIVATISATION

PRE-PRIVATISATION

PRIVATISATION AND POST-PRIVATISATION

PRIVATE SECTOR

Typical Instruments

• sovereign guaranteed long-term/convertible debt

• technical co-operation

• non-sovereign guaranteed quasi-equity/long term debt

• pre-privatisation equity warehousing • convertible debt

• privatisation equity • privatisation quasi-equity/long term debt

and syndicated loans • underwriting of IPO

• corporate (convertible) loan, syndicated loans

• local currency instruments • (quasi) equity • capital market instruments • political risk carve-out (to sponsors) • guarantees and underwritings

Operational Objectives and Benefits

• prepare ground for private sector involvement

• support Government efforts to reform Sector through regulatory framework development with TC

• immediate access to capital for restructuring and development

• Increase valuation of company by injecting funds for investments

• provide political comfort to potential investors • syndicated loan to commercial banks • mobilise commercial funds for company • prepare company for privatisation within 12-24

months • provide company with “anchor” investor

• Acquisition of new equity ensures receipt of privatisation proceeds

• Government realises proceeds if the IPO size exceeds market demand

• provide political comfort to investors • mobilise commercial funds • attract best strategic partner • provide support for uncertain or

insufficient commercial underwriting • “plug” demand for large size of offering or

capital needs

• mobilisation of domestic and foreign capital • involvement of commercial banks, other IFIs,

and ECAs for strong co-financing • foster private sector • encourage competition • strengthen transition impact by affording

customers more choice

Challenges • political acceptance of direction towards private sector involvement

• evolving legal/regulatory framework for commercialisation/privatisation

• operation preparation/appraisal time • procurement issues

• long development time

• political acceptance of direction towards private sector involvement

• evolving legal/regulatory framework for commercialisation/privatisation

• operation preparation/appraisal time • procurement issues • pricing and syndication challenge • foster corporate governance

• acceptability of EBRD pricing and conditionality in view of growing competition

• overall timing issue • desire by sell-side investment banks to

sever relationship to not encumber process

• harmonisation between privatisation and liberalisation

• acceptability of EBRD pricing and conditionality in view of growing competition

• overall timing issue

EBRD Benchmark Transactions

• Romtelecom • Kyrgyztelecom • MATAV I (1991), Hungary • Bulgaria Telephone Co. • Macedonia Telecom

• MATAV II (1993)

• Romtelecom, Romania

• Armentel, Armenia

• MATAV III (1997) • MATAV Bond (1998) • TPSA IPO, Poland

• Netia, Poland • NW GSM & Moscow GSM, Russia • MobiFon, Romania • Baring Communications Equity (Emerging

Europe) BCEE Fund • TV2, Hungary

29

Investments in the incumbent or in entities with significant state ownership will be accompanied by a commitment to regulatory reform. In practice, this means:

• Countries which are candidates for EU accession will be encouraged to move towards the adoption and implementation of the Acquis Communautaire in good time for accession.

• Countries which have signed the WTO Agreement will be encouraged to make progress towards the adoption and implementation of the principles contained within the relevant Agreement.

• Countries which have not yet signed the WTO Agreement will be encouraged to progress towards the adoption of the principles contained within the WTO Reference Paper on Telecommunications Services, in particular, the adoption of a regulatory framework, the establishment of an independent regulator, the adoption of cost-based tariffs and the phasing of liberalisation in preparation for WTO accession.

EBRD Benchmark Transactions included in the table demonstrate how different countries are at different stages of transition. Notably it shows how two countries the Bank has been particularly involved with, Hungary and Romania, have progressed within the transition spectrum. Equally it has been more difficult in some countries, e.g. Russia, where the regulatory and legal framework is such that, so far, it has only been possible for the Bank to participate in a limited number of private sector mobile operator projects.

Today the relative positions of the Bank’s countries of operation vis-à-vis regulatory and legal development can be more easily determined and choice of future operations will tend to be determined on geographical lines. In the EU accession countries, (and eventually other countries as they make the transition to advanced economy), the EBRD will provide equity and long term debt financing primarily to private sector operations or soon-to-be privatised companies. It will typically assume risk that commercial banks or capital markets may not be willing to take, and will seek to leverage its participation by bringing in commercial banks under its security umbrella in syndicated loans. In countries where the economic transition process is less advanced and where macroeconomic conditions and uncertainty over revenues adversely affect the market, the EBRD will continue to play a greater role through its financing and security structures, supported by regulatory development technical co-operation projects. While in these countries investment needs in the Sector are pressing and vast, the EBRD's financing opportunities may be restricted by risk constraints. Hence, for Russia and Ukraine which represent over 50% of the Region’s population, macro- and micro-economic conditions will demand the co-ordination of IFIs, such as the World Bank and the IFC, and the EU, as financing requirements and regulatory improvements are simply overwhelming. Specifically, the Bank will have to seek a balance between risk and return including acceptable regulatory environment, tariff rebalancing and enhanced security to reflect the changed operational environment. Bank operations are likely to have major impact on the following areas:

30

Private Sector

The Bank will develop operations in the private sector whenever the opportunity arises as the prime instrument for promoting competition in the Sector. Given the need for predictable and stable legal, commercial and regulatory environments, such operations are more likely to be undertaken in the EU accession countries. Where the market segment is regulated through a limited number of licences, e.g. cellular mobile, the Bank will normally expect the project company to have been granted the licence through competitive bidding. The Bank will look to work with project companies which have sponsors with adequate financial and management resources and experience of similar operations in the sector. Projects are likely to be in the following market segments:

• Mobile operators which is a prime market segment for private sector companies and which can bring early benefits through competition to the incumbent and customer choice. These mobile operators could be second, third, or even fourth entrants in the market depending upon the availability of disposable income to support such number of players. This segment of the Sector has been characterised by several successful transactions for the Bank and consequently, a certain industry expertise has been built upon which can be replicated in other countries in the Region.

• Second operators and local telecommunication companies, which are increasingly becoming financially viable in the more advanced countries as the regulatory framework develops to support opening of markets as part of EU accession agreements or WTO commitments. Such second operators, which would be competing against the incumbent operator, require a regulated market environment relying heavily upon the concept of fair access to the local network with fair interconnection agreements. The Bank can play a pivotal role in supporting such companies and ensuring the introduction of competition on a phased basis. Equally the timing of such introduction and the manner in which it is brought about is vital to the incumbent player which should be strong enough to withstand competition without jeopardising its existing obligations such as providing universal service. It is notable that the concept of second local operators is only now being tested in western Europe where severe price-cutting measures are being deployed to add customers to the new networks, but thereby reducing profitability drastically.

• Value added services, including data transmission, electronic mail and internet, as well as satellite communications. Such services will grow in importance as it has been demonstrated in western Europe. The traffic demands on the networks will be heavy and investments will be required to support the additional traffic.

• IT and software development which is an increasingly global activity where a number of countries in the Region, in particular Russia, are seen to have a competitive advantage. In order to be able to bring about the current IT surge worldwide, several opportunities will exist to tap into a highly-educated pool of resources in the Region.

• Informatics and Media, including publishing and broadcasting, which can play a major role in furthering the democratic process. The relationship between the regulatory licensing bodies and the entities vying for such opportunities will be a critical area for the Bank to assist in. In addition, such transactions will clearly foster

31

and promote the transition process in countries where government-owned facilities are the only available choice to-date.

In the years to come some of the manufacturing companies will move to the Region to develop local production and the Bank will consider providing financing for these operations.

SME or specialised funds will be used for smaller projects or those in niche markets. Although these are targeted at the more advanced countries, limited opportunities may also arise in Central Asia, Caucasus and the Balkan countries.

PRIVATISATION AND POST-PRIVATISATION

The Bank will continue to support privatisation of incumbent operators. In many cases this support provides significant leverage for the introduction of liberalisation and regulatory regimes. This will include financing, through equity and long term debt, companies which have been privatised with a strategic investor through a transparent and competitive international bidding process. The overall objective is for the Bank to provide comfort to the potential investors and introduce the privatised company to alternative means of financing via the international capital markets. The Bank will also support second (and subsequent) tranche privatisations by participation in IPO (Initial Public Offering) and other capital market instruments, as it has already done in Hungary (MATAV) and Poland (TPSA), as well as introducing the newly privatised entity to the international syndicated loan market. Opportunities are foreseen in Lithuania, Poland, Armenia and Kazakhstan.

PRE-PRIVATISATION

The Bank will continue to focus on pre-privatisation financing where the Bank’s involvement will be highly dependent upon government commitment to reform and improvements in the legal and regulatory framework. EBRD will co-ordinate with other IFIs and the EU to ensure synergy between independent initiatives and optimisation of resources. The Bank will leverage its participation to influence the government towards liberalisation of the market and creation of a level playing field, thus facilitating the private sector and boosting investor confidence that the market is safe for business. Projects will be structured taking into account the country’s legal obligations to EU and WTO. Bank involvement will be conditional upon the government appointing privatisation advisors and the privatisation being undertaken through a transparent process within a certain time period. EBRD anticipates that privatisation of the remaining incumbent operators in the Region will involve a strategic investor. The Bank would require such an investor to be appointed by international competitive tender and to be given management control, irrespective of the degree of ownership of the company. Privatisations are slated to occur during the next two years in Slovak Republic, Bulgaria, Georgia, Ukraine and Belarus. The Bank will continue to work closely with the World Bank to assist the privatisations in Kyrgyzstan, Albania and Moldova.

BEFORE PRIVATISATION

The Bank will use its mandate to work with those countries which are still at the beginning of the transition process in the Sector.

32

In Russia where the Sector is extremely fragmented and still in need of severe regulatory reforms, the Bank will work closely with other ifis. As the scope of investments would be prohibitive for a single ifi and as structural reforms would be required as well, improvements in the legal, commercial and regulatory framework will demand several IFI participation. In the meantime, opportunities may arise for financing Regional telephone companies who commit to privatisation and have the ability to rebalance their tariffs.

The Bank will continue its special role in the Bosnia and Herzegovina Telecommunication Emergency Reconstruction project, and potentially Tajikistan where sovereign-guaranteed financing may be necessary. The Bank will explore opportunities to finance basic service development in the rural areas, in particular, in the early transition stage countries.

4.1.4 Adaptability to Changing Market Conditions As the legal and regulatory environments improve, and commercial investors become more willing to work in these countries, the Bank will need to continuously develop and innovate its financing instruments in order to satisfy the requirements of the market. To complement growing availability of investment financing from commercial banks and capital markets, the EBRD will need to adapt its instruments whilst at the same time maintaining its additionality, ensuring the acceptability of its pricing and conditionalities and improving its ability to respond rapidly and flexibly to financing needs.

The Bank recognises that not all projects can contribute equally to meeting its goals of helping the transition, sound banking principles and additionality. It will critically review its potential operations to ensure they meet minimum threshold standards for each goal whilst maximising contribution to the overall performance of the Bank. This will provide the Bank with flexibility to tailor its approach taking into account the conditions existing in the country and the nature of the project.

4.1.5 Financing The EBRD's approach to addressing the investment needs in the Sector vary according to differences in economic and regulatory frameworks in each country. The EBRD can offer a wide range of financing approaches, essentially depending on the public or private nature of the borrower, the size of the proposed investment programme, and a country's stage in the transition process. The EBRD can apply this flexibility both across and within its countries of operations.

The EBRD's singular capability to cover the full private–public spectrum of operations allows it to help the erstwhile state-owned incumbent to graduate from one transition stage to another over the life of an investment, for example moving from sovereign to private financing (see following text box on Matav and RomTelecom).

A key factor in the demand for EBRD financing is its capability to assume risks that commercial banks and investors are not willing to take at this stage in the transition process and to provide financing on terms that are currently not available in the market. Specifically, the Bank can take transition-related risks, such as those related

33

to the regulatory and licensing framework, which may have a fundamental impact on investment economics.

4.1.5.1 Loans The majority of the EBRD's financing in the Sector will continue to be provided in the form of senior loans with maturities typically below 10 years. Debt is the preferred instrument in certain cases, in particular because of the possibilities to link disbursement with commercialisation and creditworthiness covenants. Loan financing will be applied in countries in all stages of transition, and to all kinds of borrower. However, depending on the specific risk characteristic of the country or the project, the EBRD will provide loans in the form of subordinated debt, where needed to facilitate commercial bank co-financing.

The EBRD will continue to mobilise external financing through syndicated A/B loan structures and will offer standby commitments to enhance commercial banks’ terms under the B-loan (such as, refinancing guarantees to extend the B-loan maturity).

Graduation from sovereign to non-sovereign borrowing

Among the first EBRD loans in the Telecommunications Sector were those for the Hungarian Telecommunications Project in 1991 and RomTelecom Project in 1992. At that early stage in the transition process, the credit risk of these telecommunications operators which were just established as independent entities was such that non-sovereign financing could not be considered. Among the operations' main stated objectives were the corporatisation of operators and the improvement of their operational and financial performance. As part of its loan conditionality, the Bank required the borrowers to adopt modern accounting systems and to implement corporate development programmes. Loan covenants included tariff reform requirements and other specific measures aimed at financial and operational performance improvement. Implementation of these EBRD requirements by companies and Governments led to significant improvements in the companies' performance. Matav. The Bank extended to Matav a DEM 185 million loan backed by sovereign guarantee in 1991. Matav was able to attract strategic investor already in 1993 when Deutsche Telekom and Ameritech jointly acquired 30.2 % of the company. Just before the privatisation, the Bank provided the company with USD 60 million pre-privatisation convertible debt that was converted into equity at the time of privatisation. EBRD pre-privatisation financing helped fund additional development at a time when the strategic investors' investment was going to the Government, and also demonstrated commitment to privatisation in a difficult political context. Furthermore, EBRD provided syndicated loan of USD 300 million in 1995 at the time when the strategic investors acquired additional 37.2% stake in the company from the Hungarian Government. RomTelecom. In 1992 EBRD provided an ECU 142 million senior loan backed by a sovereign guarantee to RomTelecom. This financing enabled the company to construct a modern overlay network and expand network capacity. In early 1998, with the aim to facilitate RomTelecom's privatisation and continuation of its investment programme, the Bank extended to the company unsecured long-term pre-privatisation corporate loan of US$ 100 million as a private sector transaction. RomTelecom was successfully privatised in November 1998 when OTE of Greece obtained 35% stake in the company along with management rights.

The project companies will be able to mitigate potential foreign currency risk through local currency denominated financing. Such loans coupled with back-to-back EBRD bond issued in the local currency, will allow the companies to tap the demand in markets where their own credit rating would not allow them to access. The Bank will also arrange various hedging facilities to mitigate interest and cross currency risks in conjunction with any of its financing.

34

4.1.5.2 Strategic role of Sovereign Operations The Bank has become increasingly selective in its development of sovereign operations, which are likely to be used only in extremely difficult situations, eg as in Bosnia-Herzegovina and, potentially Tajikistan, as well as rural projects in early stage transition countries. Sovereign operations will, in general, only be pursued in order to:

• establish an early market presence in strategic countries where potential exists for future non-sovereign operations; or

• selectively address "hot spots" where the Bank's operations can achieve transition impact.

Strategic markets. The Bank will selectively develop operations on a sovereign basis in early or intermediate transition economies that are of strategic importance to the development of a market-oriented sector. In certain early transition countries where current conditions do not allow financing on a non-sovereign basis, the Bank's strategic objective is to assist the transition towards non-sovereign and commercial financing.

This approach was adopted by the Bank in the early days of its operations in many of the countries of operation and has worked well, eg in Hungary, Lithuania, Romania, Czech and Slovak Republics. In these countries, the EBRD established an early presence and has had successful projects which have made a major transition impact. This has enabled it to influence regulatory and policy development in the Sector and pursue a strategy of gradually progressing from sovereign to non-sovereign public and private lending.

"Hot spots". The EBRD will continue to play its part within the international community to address specific emergency and reconstruction programmes, as it is doing in Bosnia and Herzegovina. The Bank may be called upon to do this in Tajikistan and, in view of the current conflict in the Balkans, in Albania and neighbouring countries in the Region. In these cases, the primary operational objective is stabilisation and reconstruction while observing the EBRD’s principles of additionality, transition impact and sound banking principles. The EBRD’s participation will normally be part of a wider financing package including grant and concessionary funds provided by other IFIs and donor agencies.

4.1.5.3 Equity and Equity Related Instruments Equity is expected to provide an increasing component of the EBRD's financing in the Sector. Bank equity investments in the Sector may be driven by any of the following rationales:

• to find an appropriate balance in the financing package taking into consideration the frequent limitations of the client’s gearing capabilities; • to enable privatisation and ease political resistance to private sector involvement; • the Bank may be asked to take a pre-privatisation equity position that will encourage other investors during a private placement or stock market flotation; • where there is upside potential, e.g., in cellular companies.

35

The EBRD's role as impartial investor is reinforced by its capacity to participate in the equity capital of the project companies whose investments it finances. Both Government authorities and private investors expect the Bank to play a balancing role in private operations. Its presence in investment structuring and equity financing is expected to ensure that contractual arrangements provide appropriate economic and financial incentives for efficiency improvements and that the interests of Government authorities, consumers and private sector parties are fairly balanced.

The EBRD will offer convertible bonds or A/B syndicated convertible loans in the context of privatisation of state-owned telecommunications operators. Such financing would be offered at pre-privatisation stage and would be convertible into equity at the time of privatisation, whether this occurs by public flotation or by sale of shares to a strategic investor. Such pre-privatisation financing is a way of moving forward with relatively low political risk while the necessary regulatory reforms are undertaken.

The EBRD will continue to offer equity warehousing approach in privatisation of telecommunications companies. Under this structure, prior to privatisation, the Bank would invest in special convertible preference shares with accruing but unpaid preference dividend. If the privatisation does not occur within a certain pre-agreed number of years (e.g., 2-3 years) or under certain events of default, the shares could be put to the company itself. In certain cases, the EBRD could also underwrite shares to sell in the public offering with the ability to hold the shares for the medium term if the demand is weak.

In cases where there is an upside potential, the nature of the EBRD's equity participation will be full risk bearing. In cases where for reasons of risk management, the EBRD's presence is desired by the private sponsor, the EBRD's participation will take the form of portage equity with a put option at predetermined return ('floor') to the private sponsor.

4.1.5.4 Guarantees and Credit Enhancement Guarantees have considerable potential and can form an important complement to Bank loans and equity. Guarantees are well suited to mobilising private sector financing from both commercial banks and investor-operators. In the Sector, they would be targeted to mitigate political, regulatory and performance risks that the private sector may not be in a position to absorb or manage. Guarantees would also be used to extend terms on commercial bank loans to meet the need for long maturities in the Sector.

Partial risk guarantees. In private, limited-recourse projects in the Sector, investors are provided with undertakings regarding regulation, actions or payments that are under their control. In addition, to facilitate private sector financing, additional financial support can be given against risks that cannot be insured at reasonable cost. The Bank would provide guarantees not only to give credibility to these contractual undertakings but also to lower investors' risk perception and consequent risk premium.

Partial credit guarantees. At this stage in the economic transition process, commercial lenders may not be able or willing to provide loans at the required long

36

maturities. The Bank can provide guarantees that will allow commercial lenders to provide loans with a balloon payment, possibly under an A/B loan structure. Other ways in which the guarantee instrument can be used to extend commercial loan terms include: liquidity guarantees in the form of take-out financing or put options; or rolling guarantees that cover a fixed number of scheduled payments.

4.1.5.5 Revenue and General Obligation Bonds In cases where bond financing may be a suitable alternative to EBRD loan financing, the Bank may facilitate access by companies to capital markets, for example, by providing guarantees, or co-arranging or partially underwriting General Obligation bond issues or Eurobond issues.

As international capital markets become more accessible and domestic capital markets develop, there will be considerable potential for project-based revenue bonds where the cash flow generated by an investment project secures the bond (securitisation of revenue streams or receivables). The Bank should be able to play a key role in introducing project-based revenue bonds and facilitate their issuance through the provision of partial risk guarantees such as those related to the unilateral termination of service contracts by the authorities, or their refusal to pay the project company contractually agreed service fees or compensation or to set the tariffs at required and agreed levels.

4.1.5.6 Wholesale Instruments In certain cases, the scope for Bank financing in the Sector may be limited by the small size of investments making it uneconomic to undertake and finance projects on a stand-alone basis. Nevertheless, for strategic reasons relating to a specific subsector, country or investment type, the Bank will want to become involved in such investments. Such investment opportunities will be pursued broadly via two types of instruments:

Equity Funds:

The primary objective of equity funds will be long-term capital appreciation through equity and equity-related investments in a diversified portfolio of primarily unlisted companies that are well positioned to take advantage of the high growth potential of the media and communications industry within the EBRD’s countries of operations.

Through its equity investment, the EBRD will assist funds to facilitate the development of small and medium-sized operators and service providers in the Telecommunications, Informatics and Media Sector in order to increase the competition in the sector, thus, increasing the choice and range of offered services.

Holding Companies:

The Bank will make equity investments into holding companies that invest further into small and medium size local companies in the Region. The main feature of the regional holding company is that a private sponsor with the relevant Sector experience

37

and expertise will be the strategic investor/partner in the company, provide a part of equity financing and assume most management responsibilities. The Bank's participation as an equity partner would provide the project sponsor with comfort relating to political risks associated with such investments.

Other Financing Instruments:

In addition to these two instruments, SME’s in the sector will be catered for through other non-sector specific financing facilities employed by the Bank, including country or regional credit lines set up with intermediary banks.

4.2 Technical Co-operation

Technical co-operation has played a significant role in developing and supporting telecommunications projects. To date, euro 14.6 million has been committed to 95 projects in 21 different countries (Figures 13 and 14). The need for technical co-operation projects has significantly declined commensurate with the shift from project to corporate financing and in the future is likely to be limited to regulatory reform programmes, assistance to the Government in preparation for privatisation, or special circumstances such as the Emergency Reconstruction Programme in Bosnia and Herzegovina. Bank technical co-operation funds are not used to support private sector projects.

Figure 13: Technical C ooperation FundsProgram m e (TC FP)

0.00.51.01.52.02.53.03.54.04.55.0

1991 1992 1993 1994 1995 1996 1997 1998

R egulatory R eform

Sector R eform

C orporate B uild ing

P roject Im plem entation

Pro ject P reparation

EUR

O m

ln

In the future technical co-operation projects will be limited to countries where the government has demonstrated commitment to reform and where transactions are foreseeable. Close co-operation will be maintained with other IFIs and the EC to ensure synergy between project and optimisation of available resources.

38

Figure 14: Technical Cooperation FundProgramme

Cumulative Commitments as of Dec-98 Euro ( mln)

1.191.76

2.22

9.070.26

Central Europe

Baltic States

European CIS

Central Asia &CaucasusRegional

4.3 Co-Financing Sources

4.3.1 International Financial Institutions (IFIs) The EBRD has already co-financed a number of telecommunications operations with other international financial institutions (IFIs): the World Bank (IBRD/IFC) and the European Investment Bank (EIB). The Bank's approach complements that of other IFIs operating in the Sector. The EBRD is the only IFI with a full range of financing instruments, enabling it to work across the full public-private spectrum, and to offer new instruments to its clients as they move along this spectrum. See Figure 15 which depicts total EBRD financing which attracted co-financing (IFIs and commercial banks).

EBRD financing Cofinancing1 Total projectcosts

Figure 15: Projects Involving Cofinancing

ECU 561m ECU 935 m ECU 4,819 m

Note 1. Cofinancing comprises IFIs (ECU366m), Governments (ECU100m) and Commercial Banks (ECU469m)

The Bank will work with the IBRD/IFC on projects, mainly in early and in some intermediate transition economies, where reform requirements are particularly pressing and the combined weight of two IFIs can contribute to bring about changes

39

in policies and in the legislative and regulatory framework of the Sector. In co-operating with the IBRD, the EBRD will build on its comparative advantage, which lies in its local presence and its wider and deeper experience in the Region, especially in the Telecommunications, Informatics and Media Sector. The IBRD/IFC would tend to capitalise on its broader Sector-policy development expertise and its capacity to influence Sector policies at national levels of Government. The Bank will also work with IFC in private sector projects that have significant transition impact and demonstration effect in difficult economic conditions such as exist currently in Russia and Ukraine.

The EIB has played a major role in telecommunications in the Region contributing more than ecu1.2 billion in Central and Eastern European countries since 1990. The Bank will continue to look for opportunities to work with the EIB within the EU accession countries. Whilst the EIB can lend to organisations within the EU accession countries, unlike the EBRD, it normally does so with a sovereign or commercial bank guarantee.

In their co-operation, each institution will bring to bear its comparative advantage. The EBRD has a strong project development, finance appraisal and financing structuring capacity in the Sector. The EIB, for its part, can provide loan financing at longer maturities and usually on more advantageous terms than the EBRD. In its co-operation with other IFIs, the Bank may face a challenge in reconciling its specific transition objectives with the operational and policy goals of the co-financing institution. Especially in the advanced transition economies, the opportunities for the Bank to implement its transition objectives can be affected by the possibility of funding from other IFIs (and commercial banks) that do not have a similar mandate. The process of co-operation and resolution of differences in such situations will, however, be assisted by a common interest in robust financial conditionality. The EBRD, other IFI’s and the EC share common objectives in the Region and will co-ordinate with each other to pursue those objectives through individual agendas determined by their respective institutional priorities.

4.3.2 Commercial banks, ECAs, and private equity Commercial banks are becoming increasingly active in the Telecommunications, Informatics and Media Sector, especially in the advanced transition economies. However, apart from the most advanced companies, they generally seek to work with the EBRD in the Sector as they recognise the benefits of the Bank’s active participation in mitigating political and project risk. The Bank seeks to co-finance with commercial banks by extending its preferred creditor status through syndication under the A/B loan structure, through providing guarantees for the longer maturities not typically taken by commercial banks and by offering partial guarantees.

Export Credit Agencies (ECAs) are starting to become more involved in the countries of the Region as sponsors tend to use foreign-based technology which will seek ECA coverage to complement what the Bank offers. Such co-financing will add desired effect of bringing multiple sources of financial tools which will ultimately benefit the country.

40

Private equity co-financing is brought about by the participation of strategic investors via equity funds who become silent partners and add to the exposure by the company to the international capital markets. Such equity funds will usually participate in smaller tranches; also, such funds could basically plug financing needs which cannot be covered by other sources.

4.4 Projected Level and Composition of EBRD Financing

The annual total of EBRD financing commitments to Telecommunications, Informatics and Media projects has been relatively stable during the period 1993 to 1998 in the range euro 100 to euro 200 million. In 1998, the Bank committed over euro 181 million to the Sector.

Based on current trends in the growth and composition of the pipeline of projects under preparation (Figure 16), it is expected that annual volumes will remain in this window although the number of projects will probably increase due to the predominance of smaller private sector projects with no counterbalancing large public sector investments. Activity is expected to be predominantly in countries in early and intermediate stages of transition with attention focussed on the Caucasus, Central Asia, Balkans, Ukraine and Russia.

Figure 16: Pipeline Portfolio, mEuro

European CIS172.6

Central Europe70.4Central Asia

79.2

Caucasus 22.0Regional 8.8

A key aspect of the structural and geographical changes in pipeline composition is that Telecommunications, Informatics and Media operations are becoming more complex in their legal and financial structure, while the average size of EBRD-financed operations in the Sector decreases. The predominance of private sector financings creates a sharp increase in project development risk, which may lead to higher (pre-signing) project pipeline erosion than hitherto. Over time, potential

41

projects have become more vulnerable to market developments as commercial banks have been increasingly willing to accept risk in advanced transition economies, though this situation has reversed somewhat since the emerging market crisis in August 1998 and the resultant contagion. See Figures 17 and 18 for evolution of portfolio.

Figure 18: Signed EBRD Financing at the end of 1998

Baltics4%

CentralEurope

80%

EuropeanCIS15%

CentralAsia

1%

4.5 Procurement

All projects financed by EBRD are required to follow the Bank’s Procurement Policies and Rules (the “Rules”). Much of the equipment and services required to

Figure 17: Signed EBRD Financing at the end of 1995

Baltics6%

Central Asia1%European CIS

5%

Central Europe88%

42

build Telecommunications infrastructure are specified by international bodies, such as European Telecommunications Standards Institute (ETSI), American National Standard Institute (ANSI) or International Telecommunications Union (ITU) and are widely standardised. The supply chain is extensive and highly competitive, and competitive tendering to standard specifications is the industry norm.

The Bank’s public sector operations are required to follow public sector procurement via open tendering except in specific circumstances. The tendering method to be followed is specified in the procurement plan for the project and incorporated in the Loan Agreements between the Borrower and the Bank. A high percentage of contracts (in value terms) awarded for telecommunications projects have been procured through open tendering.

It should be noted, however, that with the increasing complexity of the latest generations of telecommunications equipment, especially digital switching and transmission systems which rely extensively on common software management and control, Borrowers are increasingly likely to have standardised on their preferred suppliers of such equipment via previous open tendering12. Thus it may be necessary to employ Selective or Single Tendering as provided for under the Rules in order to procure equipment which is fully compatible with that already deployed in their network. It will therefore be important to evaluate procurement plans for public sector projects taking this into account.

Private sector enterprises where the Bank holds equity or debt, are encouraged, but not obliged, to use international tenders to obtain goods and services economically. In practice, the procurement methods of the enterprise are fully evaluated during the due diligence stage to ensure that sound selection methods are used to procure goods and services at fair market prices. Particular attention is paid to all cases where the sponsor, or major shareholders, are also suppliers of goods and services to the project enterprise.

12 This is analogous to the position with IT systems where an early strategic decision on choice of computer operating platform limits future vendor selection.

Annex 1

TRANSITION IMPACT OF PROJECTS IN THE

TELECOMMUNICATIONS, INFORMATICS AND MEDIA SECTOR

The restructuring of infrastructure provision and services is central to the process of transition in the EBRD countries of operation. Historically, telecommunications infrastructure provision was decided under a central planning system, generally supply-led, and did not reflect economic planning principles. Furthermore, tariff structures were artificially low resulting in distorted usage patterns.

Following the collapse of the previous political regime, transition economies faced major reconstruction and development programmes, limited finance for investment and significant demand increases, especially for advanced information services critical to well functioning businesses. Hence, reforming infrastructure in a way that promoted efficient performance became an urgent priority.

The requirements for fostering the transition in infrastructure, as set out in the 1996 Transition Report, include entry liberalisation, commercialisation, the introduction of competitive pressures and services that respond to demand, the move to cost-based prices, the establishment of regulatory institutions and the reduction of environmental costs. With, perhaps, the exception of the last criterion, all of these are directly relevant to operations in the Telecommunications, Informatics and Media Sector and contribution to improvements to these transition factors are primary criteria in selection and evaluation of projects.

In order to quantify the progress in transition, the 1998 Transition Report introduced Infrastructure Transition indicators which included telecommunications. These are reproduced below. Transition in telecommunications is largely measured by the degree and quality of regulation, the degree of liberalisation and competition, and the barriers to market entry. For the future the Bank will extend the scope of these indicators to embrace informatics and media. Although similar criteria will apply, we expect that political and social factors will be given a larger weighting, especially with regards to media where political involvement and cross-ownership limitations become more important. We will take into account that regulation in the sector is constantly evolving, even in western Europe, which will require similar progress from such institutions in the Bank’s countries of operations.

Telecommunications Indicators The telecommunications transition indicators are designed to measure progress in reform across all EBRD countries of operation. The key dimensions used for the rating (see the box) are commercialisation and regulation. Under the first category are included initial steps made for legal corporatisation of the dominant operator, the gradual reduction of political interference in the management which should ultimately lead to its successful privatisation and widen the extent of private ownership. Under regulation is encompassed tariff reforms, degree of liberalisation in the market (focusing particularly on those segments of the market which are believed to justify

no economic restriction to entry in segments such as cellular and other value added services) and institutional design (separation of telecommunications from postal services, degree of independence of the regulator). There are five transition stages which are defined as follows:

Transition

Rating

Characterised by:

1

Little progress in commercialisation and regulation. That is, minimal degree of private sector involvement; strong political interference in the management decisions; lack of cost effective tariff setting principles and extensive cross-subsidisation. Few other institutional reforms to encourage liberalisation envisaged even for mobile phones and value added services.

2

Modest progress in commercialisation. That is, corporatisation of the dominant operator and some separation of operation from public sector governance, but tariffs still politically set.

3

Substantial progress in commercialisation and regulation. Full separation of telecommunications from postal services with reduction in the extent of cross subsidisation. Some liberalisation in the mobile segment and in value added services.

4

Complete commercialisation (including the privatisation of the dominant operator) and comprehensive regulatory and institutional reforms. Extensive liberalisation of entry.

4+

Implementation of an effective regulation (including the operation of an independent regulator) with a coherent regulatory and institutional framework to deal with tariffs, interconnection rules, licensing, concession fees and spectrum allocation. Existence of a consumer ombudsman function.

TRANSITION PROGRESS Key: Little or no progress Under preparation Completed Country

Privatisation of

Dominant Operator(Percentage of

private ownership )

New Telecoms

Law (Year of

enactment)

Separation of Post

and Telecoms

Independent

Regulator

Private Cellular

Competition in Value Added

Services

Early Stage: Turkmenistan Albania 1998 Azerbaijan Belarus Bosnia/ Herzegovina 1998 Tajikistan Kazakhstan 50% Kyrgyzstan 10% 1998 Uzbekistan FYR Macedonia 1996 Georgia

Country

Privatisation of

Dominant Operator(Percentage of

private ownership)

New Telecoms Law

(Year of enactment)

Separation of

Post and Telecoms

Independent

Regulator

Private Cellular

Competition in Value Added

Services

Medium Stage: Armenia 90% Croatia Moldova 1996 Slovak Republic Slovenia 13% 1997 Ukraine Bulgaria 1998 Romania 35% 1996 Russian Federation 25% Latvia 49% Advanced Stage: Lithuania 60% 1998 Poland 15% Czech Republic 49% Estonia 73% Hungary 94%

Bank projects in the Sector can contribute to the transition in a number of ways which are largely determined by the stage of transition extent in the specific country, the commitment of the Government to reform and the speed with which change can take place. The table below identifies the Bank’s transition objectives in the sector and provides illustrations of the Bank approach. Transition impact and Bank approach will be specific to each individual project.

Transition Impact Bank’s Objectives Bank’s Response (illustrative)

1. More intense competition in the project sector

• Number of operators • Intensity of price and quality competition

• Move towards cost-reflective tariff

structures and higher standards of quality

• Increase customer choice through provision of new services by incumbent operator and introduction of new players in the market.

Early reform stages

• Elimination of cross-subsidies More advanced reform stages

• Strengthen competition in cellular and value added services (supporting private sector providers)

• Support companies in related market segments

All stages • Promote competition among suppliers through the

application of EBRD Procurement Policies and Rules

2. Market expansion in other sectors

• Cost and reliability of access to the service

• Provide low-cost and high quality

services for downstream business users

• Increase general network accessibility

Early reform stages

• Network upgrading and expansion More advanced stages

• Introduction of value added services

Transition Impact Bank’s Objectives Bank’s Response

(illustrative) 3. Private ownership

• Ownership reforms • Entrepreneurship

• Maximise private sector involvement

and reduction of transaction costs throughout the economy

Early reform stages

• Corporatisation (of incumbent operator) • Pre-privatisation • Post-privatisation

More advanced reform stages

• Investment in funds specifically aimed at SME engaged in media and information technology

All stages

• Financing companies, especially those with a foreign strategic investor, where majority ownership and /or management control rests with the private sector.

4. Frameworks for markets

• Tariff reforms • Liberalisation in the market • Institutional design • Adequate legal and commercial frameworks

• Develop a sound regulatory

framework to support competition (through clear and transparent rules related to licensing, pricing rules –including interconnection- and spectrum auction allocation)

• Develop legal and commercial frameworks

Early reform stages

• Ensure government commitment to regulatory reforms • Provide education and support institutional building • Prepare for tariff reform

More advanced reform stages

• Establish an independent regulator, reduce length and breadth of exclusivity terms, introduce cost-oriented and fair interconnection rules

• Tariff reform, including rebalancing • Support governments in their efforts for EU accession

and WTO membership

Transition Impact Bank’s Objectives Bank’s Response (illustrative)

5. Transfer of technology and skills

• Upgrade technical and managerial skills

• Maximise the impact of the transfer of technology and know-how throughout the economy

Early Reform Stages • Develop appropriate training programmes

More advanced reform stages

• Ensure the best technological options are introduced as early as possible

6. Demonstration effects

• Innovative financing structure

• Successful restructuring

• Create replicable practices that

transfer the transition impact from the project level at an economy-wide level

Early reform stages

• Restructuring the dominant operator (through horizontal and vertical break-up, where appropriate)

More advanced reform stages

• IPO, Local currency funding for local services

• Entering into new sector related industries eg media publishing, information technology and software.

7. Enhancing standards for corporate governance and business conduct

• Protection of minority shareholders

• Improvement of business conduct rules

• Foster improvement in corporate

governance arrangements at the enterprise level

Early reform stages

• Adoption of commercial methods and management techniques

More advanced reform stages

• Set up effective incentive and monitoring systems to improve performance