text:
SBP deserves appreciation for preparing guidelines on 'non-recourse
finance' or 'limited-recourse finance' considered difficult to handle
even in many developed societies
By MUHAMMAD BASHIR CHAUDHRY
Dec 06 - 12, 2004
The State Bank of Pakistan (SBP) has placed on its
website the Draft Guidelines for Infrastructure Project Financing (IPF)
and invited suggestions by 30th November 2004. The Director, Banking
Policy Department, SBP, has introduced the Guidelines to facilitate the
banks/DFIs (the banks) develop expertise for undertaking IPF and enable
the private sector funding of infrastructure projects, especially those
under long-term government concession agreements. Under the traditional
corporate finance, primary source of repayment is the borrowing company
backed by its entire balance sheet whereas, the IPF ideally requires
'non-recourse financing', wherein the lenders look solely to the cash
flows of the project for debt service. However, in the context of
Pakistan 'limited-recourse financing' is preferable, wherein lenders in
addition to the cash flows generating ability of the project for debt
repayment also have access to the sponsor's credit and legal security
for debt servicing. Infrastructure projects (IPs), by their nature and
design, require relatively large investment, besides needing longer
gestation period with large transaction costs for structuring. The
Guidelines are fairly detailed and cover main areas of project finance
such as appraisal, risk coverage, security, monitoring, exposure,
regulatory compliance, etc.
The SBP deserves appreciation for preparing
guidelines on 'non-recourse finance' or 'limited-recourse finance'
considered difficult to handle even in many developed societies. The
introduction of IPF guidelines is timely as presently Pakistan is
embarking on developing its infrastructure with private sector resources
jointly with the local and foreign banks. Augmenting local authorities'
resources with bank loans can improve infrastructure situation on fast
track provided all stakeholders play their due roles efficiently and
wisely. The IPF would be a big challenge to the creditor banks but would
also offer lot of opportunities for investing their funds. As a student
of Project Finance, I feel, SBP after considering suggestions from
different stakeholders, would place, the revised draft on its website
for final comments. Suggestions on main areas covered in the draft
Guidelines are briefly given below.
The Guidelines, for promoting 'limited recourse
financing', essential for IPF in the private sector, encourage the banks
to accept a "Concession Agreement/License" (CAL) issued by a
Government Agency as a collateral, in the overall collateral
arrangements, if CAL is free of all encumbrances, is irrevocable, is not
detrimental to interest of the lenders and is assignable to lenders in
the event of default. Further, the Government Agency issuing CAL to
undertake to facilitate lenders in CAL transfer to them in case of
default and that the banks are satisfied regarding the secure nature of
CAL. It may be mentioned that CAL is one of the many inter-linked
agreements/contracts to be carefully negotiated and executed between
different counterparties before the loan is effective.
The Guidelines require that the banks, while
undertaking IPF under 'limited recourse financing' to prudently secure
their interest by a combination of Primary Security/Collateral, such as:
(i) First
charge on all receivables and different Project/Company Accounts;
(ii) Mortgage over all assets of project company and that of
the contractors; (iii)
Assignment of all insurance policies to cover risks including political
and force-majeure; (iv)
Pledge of sponsor's share in project company, (v)
Assignment by way of security of all government
approvals/undertakings and the implementation agreement; (vi)
Assignment of company's rights under project agreements (vii)
First charge/assignment of corporate/bank guarantees furnished by the
contractors to the project company.
The Guidelines, in my view, are sort of a blue-print
to the banks for properly starting IPF. However, at present most local
banks reportedly do not find it easy to successfully handle traditional
long term corporate finance and prefer short term credit including
consumer finance. For the local banks to confidently and expertly handle
IPF work will be an uphill task, at least in the initial few years. For
that the banks might have to commit/train their best human resources
with ample financial support for many years. For early initiating of IPF,
it is suggested that the Long Term Credit Fund (originally known as
PSEDF) presently managed by the National Bank of Pakistan, is developed
into a full-fledged Municipal and Infrastructure Bank for lead financing
the infrastructure projects in the country. The banks might also
expeditiously develop and improve their expertise for traditional
corporate finance and the non-recourse project finance.
From definitions of 'License' and the 'Borrower', it
is clear that IPF is not meant for providing bank loans for the
financing/construction of IPs in the public sector. Local and relatively
small infrastructure projects within municipal limits of towns and
cities, though unattractive for recovery of user charges, are important
for the welfare of the people and for all-round development. Such
projects might not qualify under IFP but otherwise might be justified
and should be implemented. The SBP might allow the banks to finance such
projects in the public sector. If need be the present Guidelines may be
suitably amended or a new set of guidelines for financing of municipal
projects in the public sector might be issued. The International
Financing Institutions (IFIs) have been financing IPs in the public
sector. This sector might also be opened for local banks. The IFIs have
reportedly offered support to the government as well as the City
District Government Karachi for improving physical infrastructure.
The Guidelines list 16 categories of IPs, which fall
into four main sectors as under: (i)
Communication: roads, mass transit, urban rail, rail-bed, station
system, telecommunication, airports, ports, shipping, channel dredging,
container terminals, inland waterways; (ii)
Energy: Power generation, transmission and distribution network, natural
gas, LPG, LPG import terminals, Petroleum, extraction, refinery,
pipeline; (iii)
Water: Dam, barrage, canal primary and secondary irrigation, tertiary
irrigation; and (iv)
Municipal: water supply, irrigation, water treatment system, sanitation
and sewerage system, solid waste management system project.
In the context of eligible IPs, following suggestions
are offered: (i)
The Guidelines are generic in nature covering a broad spectrum of IPs.
Comprehensive guidelines specific to different sectors might be more
useful; (ii)
IPs include highly risky projects such as natural gas exploration and
Petroleum/LPG extraction, which are mostly financed through equity and
loan funds are rarely used; (iii)
Some of the IPs might not be generating enough of cash for debt
servicing. Roads, flyovers, bridges, water supply, water treatment
system, sanitation and sewerage system or solid waste management system
project, etc. Perhaps it would be better if banks are allowed to finance
such municipal projects under traditional finance to public sector
entities under acceptable securities;
(iv) List of IPs include power generation and petroleum
refineries for which there exist special policies of the government, to
which the Guidelines might be made compatible; (v)
Many IPs will be implemented under Public-Private Partnership, for which
broad parameters might be developed; and (vi)
Compensation to the project company and/or the creditors might be
provided for changes in government policies in future or delay in the
award of different approvals adversely affecting IPs.
For suitably conducting credit appraisal the
Guideline require the banks to obtain comprehensive/detailed Feasibility
Report containing information relating to project's anticipated economic
conditions, capital investment, and financing. The Guideline requires
that the Feasibility Report is endorsed by an Auditing Firm either
approved by SBP or on the panel of SBP. The question is whether the
Auditing Firm will be held liable if the information or statements in
the Feasibility Report are actually found lacking or incorrect and the
project had problems? The role and responsibility of the Auditors might
be clearly stated. Moreover, for preparation of the Feasibility Report,
the Guideline might require the selection and use of reputed independent
consultants having experience and expertise in their respective areas.
This would add value to the document.
The Guidelines cover activities under different
stages of credit-cycle such as Appraisal, Construction, Follow up and
Operation. Some ideas have also been offered for joint technical
appraisal in case of large projects needing loan financing from a number
of banks and DFIs. This aspect might be debated more under legal advice
and the actual experience of industrial financing in the past,
particularly when the loans went sour and different creditors tried to
save their own interest, in many cases disregarding the interest of
other institutions. Under consortium or syndication arrangements, the
prudent course might be that the banks agree on the detailed outline of
the Feasibility Report (FR) and the experienced consultants for its
preparation. This FR coupled with required minimum information should
form the basis for every bank to appraise the project for financing
decision. The banks might share their individual reports among each
other but without confirming the viability of the project or assuming
any liability whatsoever.
The Guidelines encourage the banks to develop
expertise for appraising technical/environment/financial/economic
viability and bankability of infrastructure projects, with particular
reference to the risk and sensitivity analysis whether the project will
be able to generate sufficient cash flows to repay debts and produce a
satisfactory rate of equity return. As IPF calls for special appraisal
skills and expertise, the banks may consider constituting appropriate
screening committees/special Divisions for appraisal of credit proposals
and monitoring the progress/performance of the projects. For IPF
purposes, each creditor institution shall have to devise detailed
guidelines and extensively train the personnel handling appraisal,
monitoring and negotiation functions.
The Guideline provide that IPs usually go through
development, construction, start-up, and operation stages, all of which
should be assessed separately for risk mitigation by the banks during
the credit appraisal process. The lenders better avoid funding the
development phase, during which the sponsors using their equity assesses
the project's scope, seeks regulatory and concession approval from the
government or municipal authorities, and attempts to attract financing.
The risk during construction/start-up phase is high as the construction
may not be completed on time or the project may have large cost overruns
or there is failure to meet project specifications. Duration operation
stage the risk might reduce. The Guidelines advise the banks to cover
their risks by a number of precautionary/contractual measures, some of
which are:
2. To negotiate that the risks during completion
phase of the project are the responsibility of the project company, its
sponsors, contractors, equipment suppliers, and insurers. Moreover, for
mitigating force majeure, the banks have been advised to ascertain that
the sponsors purchase the risk insurance;
The requirements as above are important but the
project sponsors might not agree to assume all risks or make commitments
for additional financing as the lenders might wish. The guarantees,
financial commitments, etc are very costly and therefore might be used
sparingly for large IPs only. To protect their interest the private
sector can engage the best legal/technical help, which might not be
available to the banks and public sector DFIs. It may be noted that very
strict requirements from the creditor banks might discourage private
sector participation in the financing of IPs and thus the country might
not attain the goals of having improved infrastructure within the
desired timeframe. A gradual and approach coupled with fair and
equitable treatment might be more useful.