The Project Finance Law Review: Multilateral Lenders and Regional Development Banks
I GENERAL ROLE IN PROJECT FINANCE
Multilateral development banks and regional development banks (MDBs) are international financial institutions created by a group of countries with the primary function of mobilising finance, knowledge and expertise to address the biggest challenges faced by developing countries, including poverty and environmental problems. MDBs are creations of multiple nations and the main features for distinguishing among them is the composition and number of member countries,2 and the region for which financial assistance and the promotion of economic and social development is made available.
The most well-known multilateral development banks are: the World Bank, the European Investment Bank, the Asian Development Bank, the European Bank for Reconstruction and Development, the Development Bank of Latin America, the Inter-American Development Bank Group (IDB), the African Development Bank and the Asian Infrastructure Investment Bank. Among the most recognised regional development banks are the Eurasian Development Bank and the East African Development Bank. Each of these institutions has its own role in helping to design and coordinate approaches relating to global and regional development issues.
As set out in a paper jointly prepared by several MDBs and endorsed by the World Bank and the International Monetary Fund for the Development Committee3 meeting of April 2015, the world needs to move 'from billions to trillions' of dollars in order to meet the international community's need to maximise finance for development and meet the 2030 Sustainable Development Agenda4 and the relevant sustainable development goals (SDGs), such as promoting social inclusion, sustainable growth, reducing poverty and inequality, and protecting the planet.
In this context, the MDBs coordinate with each other through many working groups to address practical issues across the development landscape, supporting and engaging in partnerships and platforms for a broader cooperation across multilateral, regional, national and bilateral development institutions and NGOs.5
The worldwide landscape requires agility, innovation, new players in the development space, new technologies and financing models to accelerate the rate of global change. This scenario results in greater convergence of the business and development worlds, in line with growing corporate and investor interest that aims to achieve social value combined with financial returns. As stated by the IDB, 'companies are realising that staying competitive and growing now and in the future means looking beyond short-term gains and toward addressing salient economic, social, and environmental challenges that affect both their business and society.'
In the light of those shifting parameters, MDBs are committed to strengthening those working relationships, particularly through providing financial and non-financial support at the regional, national and subnational level, and have joined forces to harmonise methodologies to catalyse other financing (private sector and domestic revenues), always aiming to maximise resources such that the SDGs become a reality. According to the United Nations website, the achievement of the SDGs could open US$12 trillion of market opportunities and create 380 million new jobs by 2030.6
The value proposition for MDBs consists in their ability to be trusted partners who can provide the best services at the lowest cost, using a strong presence in the countries in which they act, which allows them to tailor solutions to their clients' (usually national shareholders) needs on a case-by-case basis.7 MDBs' project finance operations consist of a leverage structure on which the investor can deliver profit and generate measurable, positive, social or environmental impact, combined with a financial return. MDBs' financial structure and financing capabilities enable them to leverage their capital to provide finance in many forms ('blended' finance, loans, guarantees, equity investment) and purposes.
MDBs use the money contributed or 'subscribed' by the relevant member countries to support the assistance programmes. They fund their operating costs from money earned on non-concessional loans to borrower countries. To offer non-concessional loans, MDBs borrow money from international capital markets (in many cases backed by the guarantees of their member governments, which are callable capital) and then re-lend the money to developing countries. This backing is provided through share ownership to which countries subscribe because of their membership in each bank. Only a small portion (typically less than 5–10 per cent) of the value of these capital shares is actually paid to the MDBs.8 By leveraging these amounts, the MDBs' banking model attracts substantial resources from capital markets at interest rates reflecting their strong financial structure and high ratings.9
With regard to engagement with their clients, MDBs help to design and implement demand-based, country-driven, cross-sectoral technical and financial development solutions, and provide policy advice and technical assistance on tax matters related to the financed projects. In addition, MDBs support investment in systems, institutions and marketing. With respect to climate change matters, for instance, MDBs can assist through collective work with its global clients on actions aiming to generate multiple local health, agricultural, employment and resilience benefits.
According to the United Nations, global, regional and subregional multilateral development and finance institutions have embraced the SDGs and taken significant steps to incorporate them into their operations.10 However, to achieve the SDGs, annual investment requirements across all sectors have been estimated at around US$5 trillion to US$7 trillion.11 Given the ambitious targets set out by the SDGs and the considerable financial resources needed to meet such commitments, MDBs have a role to play in engaging in relevant projects to mitigate risks and support the required financing through public or private partners (or both).
II LOAN PROGRAMMES
i Instruments, guarantees and eligibility requirements
The implementation of project financing solutions by MDBs is established in each contractual instrument involving the relevant players, which may require certain types of guarantees, risk insurance, blended finance and other risk-mitigation measures to be structured and customised on a case-by-case basis to solve specific issues.
Beyond the traditional undertakings provided in the project finance instruments commonly used in the private sector (such as loans, equity investment and guarantees), the 2015 'Billions to Trillions' Discussion Note outlined the following categories of financing solutions used by MDBs, each one comprising specific approaches and tools for customisation purposes to achieve a project goal:
(1) adding, pooling and enabling instruments to generate new flows, or more results for the same money; (2) debt-based/right-timing instruments that match flows to when cash is needed; (3) risk management instruments to manage or reduce risk for investors (i.e., correcting market failures, reducing regulatory risk) or consumers (e.g., weather insurance for farmers, local currency matching for micro, small and medium-sized enterprises (MSMEs)); and (4) results-based financing where payments are made specifically for desired results.12
Public-private partnerships (PPP) are supported by several MDBs by means of assistance to the member countries to build capacity and knowledge to structure and implement quality PPPs, including complex emerging-market infrastructure projects. For this purpose, the World Bank has several tools and mechanisms to develop the PPPs, such as the Public-Private Partnership Legal Resource Center (PPPLRC), which provides easy access to legal materials that can assist in the planning, design and legal structuring of infrastructure projects.13
MDBs also provide advisory services to structure PPP transactions in infrastructure and other public services. As an example, the Inter-American Development Bank provided advisory support to Argentina to assist in the structuring of contracts and bidding documents for the first PPP road project under Argentina's new PPP law. The advisory support was successfully provided and as a result the Argentine government requested additional support from the bank to structure transmission line projects. The bank also provides similar technical assistance for other member countries, such as The Bahamas, Bolivia, Brazil, Dominican Republic and Guatemala, in response to each one's regional demands.14
With respect to eligibility criteria, most of the regional and sub-regional MDBs require existing membership of a specific organisation or region for countries to join as members or borrowers. Although all MDBs have a common mandate to support private development finance to implement the proposed SDGs, each one has its own internal operations and strategic goals in serving their relevant region and improving its own internal operations. In the context of project finance, MDBs consider that an assessment of the potential impact of changes in each regional context is fundamental for the success of efforts to develop a relevant project. Depending on the result of that assessment, the legal and financing structure of a project will be adapted accordingly, to accommodate the relevant region's particularities and development stage.
The World Bank group was founded in 1944 and it is currently the world's largest source of funding and knowledge for developing countries. It is composed of five institutions: the International Bank for Reconstruction and Development, the International Development Association, the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency and the International Centre for the Settlement of Investment Disputes. In 2019, the commitments of the World Bank Group in loans, grants, equity investments, and guarantees to partner countries and private businesses amounted to around US$62.3 billion and the disbursements around US$49.3 billion.15
The World Bank was created initially to focus on providing financing for large infrastructure projects. Over time, the bank has broadened its scope to include social projects and policy-based loans. Certain criteria are applied to determine if a relevant project or policy is eligible for support. The project must implement the bank's policies, and be capable of meeting the bank's environmental, social and anti-corruption guidelines in the member country. There must be a clear and defined development impact and the necessity to mobilise private investment or mitigate government payment risk.
The World Bank requires the execution of contractual agreements typically used in project finance transactions reflecting the direct relationship between the bank and the relevant member country. The parties to those agreements are the World Bank (as guarantor), the relevant government (as obligor) and the private investors (as beneficiaries).16 The World Bank also provides a 'guarantee programme' to enhance the credit quality of sovereign and sub-sovereign obligors to reduce costs and improve financing terms for projects and governments, and ensure the long-term sustainability of projects.17
Similarly, the Asian Development Bank was also initially established in the early 1960s with the purpose of providing financing for large infrastructure projects rather than social projects or direct poverty mitigation. Nowadays, the main infrastructure projects developed by the bank are related to transport, water, energy, urban development, and information and communications technology. Its mandate consists of promoting economic growth and cooperation in Asia and the Far East, and contributing to the acceleration of the process of economic development of the developing member countries. The bank's support is made through loans and grants, as well as by means of technical assistance to its member countries, to the private sector, and through PPP structures. As a demonstration of the bank's focus on infrastructure, its projected transactions will have increased by 50 per cent, from US$14 billion in 2014 to more than US$20 billion in 2020, of which 70 per cent is addressed to infrastructure projects.18
The IDB was created in 1959 to support Latin American and Caribbean economic development, social development and regional integration. It is the largest source of development financing for the region.19
In addition to the IDB, the Development Bank of Latin America (CAF) also plays an important role in Latin America and the Caribbean. The main difference among these MDBs is that CAF has a strong focus on infrastructure and projects that promote connectivity and integration within the region (such as transport and energy), with almost 70 per cent of its financing portfolio directed to those types of projects. Geographically, the bank's operations are mainly focused on Venezuela, Ecuador, Argentina, Peru and Colombia. Most of the IDB's loans, on the other hand, aim to accelerate the process of economic and social development in member countries: Brazil and Mexico are the two largest beneficiaries of such loans.20
The European Bank for Reconstruction and Development was founded in 1991, at a time of transition to a free market economy in the former communist countries of central and eastern Europe and the former Soviet Union. The bank differs from other MDBs given its historical provenance and its political mandate to focus on supporting democracy-building assistance targeting the private sector.21
The Asian Infrastructure Investment Bank started its operations recently in 2016, targeting social and economic development in Asia through investments in sustainable infrastructure, such as energy generation, water supply, sanitation and environmental matters. Its membership includes several advanced European and Asian economies, consisting of regional members (e.g., Australia, Cambodia, Fiji, India and Malaysia) and non-regional, prospective members (e.g., Argentina, Brazil, Canada, Spain and the United Kingdom). The United States and Japan are not members of the bank.
The Eurasian Development Bank was created in 2006, by the Presidents of the Russian Federation and the Republic of Kazakhstan. The bank is primarily focused on projects related to energy, transport and infrastructure in the six member states (Russia, Kazakhstan, Armenia, Tajikistan, Belarus and Kyrgyzstan). According the bank's website, as at January 2020, the bank's investment portfolio comprises US$4.322 billion, involving 98 projects.22
The African Development Group was founded in 1964 and its current shareholders are 54 African regional countries and 26 non-regional member countries. Its operational priorities relate to infrastructure development, regional economic integration, support for private economic development, governance and institutional accountability, and improvement of skills and technology. As at 2017, the bank's approved transactions amounted to US$6.2 billion.23
As a final note on the various MDBs, it is worth mentioning the New Development Bank (NDB). The NDB was formed in 2015 by the BRICS countries (Brazil, Russia, India, China and South Africa), which together represent about 42 per cent of the population, 23 per cent of GDP, 30 per cent of the territory and 18 per cent of the global trade.24 In the period 2016 to 2017, NDB's board of directors approved loans involving financial assistance of over US$3.4 billion for projects in the areas of green and renewable energy, transportation, sanitation, irrigation and other areas.25 The bank is committed to continuing to mobilise development resources in BRICS projects, complementing the efforts of other MDBs to supplement and promote global development by attracting resources for the infrastructure sector.
ii Projects covered by MDBs
According to the report 'Mobilisation of Private Finance by Multilateral Development Banks and Development Finance Institutions 2018', which measures private investment in development projects structured and supported by MDBs and development finance institutions (DFIs), in 2018, in low and middle-income countries, MDBs and DFIs reported over US$69 billion in total private mobilisation, a significant increase over the US$53 billion reported in 2017.The total mobilisation includes US$20.1 billion in private direct mobilisation,26 which is a key priority of many MDBs.27
In this context, it is worth highlighting the following project finance transactions in the infrastructure sector that demonstrate the challenges related to catalysing private sector investment combined with public resources and its effective development impacts.
IFC, a member of the World Bank Group, provided a US$288 million long-term loan to Gas Natural Açu (GNA), for the development, construction and operation of an integrated liquefied natural gas to power (LNG-to-power) facility in Porto do Açu, in the State of Rio de Janeiro, Brazil. The project is expected to start commercial operation in 2021 and consists of an integrated 1.3-GW combined cycle gas turbine fired power plant, an LNG import marine terminal, a transmission line, and the expansion of an existing substation. The financing plan was completed with the participation of a local development institution (Banco Nacional do Desenvolvimento), which provided a 1.76 billion reais (around US$475 million) long-term loan, and which, in turn, was guaranteed by KfW-IPEX Bank and supported by Euler Hermes Aktiengesellschaft, the German Export Credit Agency. GNA is the third 'LNG-to-power' project supported by the IFC in Latin America and considered as a global strategic aim for the IFC in supporting countries to reduce the carbon intensity of power grids. In addition, the project is considered as part of the largest natural gas thermoelectric complex in Latin America, an important support for the diversification of Brazil's energy matrix, and critical for increasing the competitiveness of Brazil's natural gas sector.28
Another noteworthy example demonstrating a project supported by a blended finance structure is the Lima Metro Line 2, which comprises the design, construction, operation, maintenance and supply of equipment systems and trains for 35 kilometres of a greenfield underground metro line and aims to save up to 90 minutes in travel time during peak hours over the route. In addition to the transit efficiency, the project is expected to have significant environmental and climate change benefits and support sustainable urban development in the region. The project was estimated at US$5.8 billion, with the World Bank and IDB together providing over a billion dollars for the project through innovative project financing mechanisms.29 Recently, the project experienced a delay caused by the lack of rights of way by the government and failure of technical plans, which resulted in the need for additional financing. In July 2019, with commercial banks (Goldman Sachs and JPMorgan) running the books, the project raised US$563 million through government-backed senior secured notes due in 2036, demonstrating the strong market appetite for this kind of infrastructure bond deal.30
As a final example, in 2019 the World Bank approved the programme called the 'Renewable Energy Guarantees Programme Project for Ethiopia', which aims to support the government of Ethiopia's ongoing power sector reforms and leverage private sector financing for renewable energy generation. Nationwide access to electricity in Ethiopia is still low, covering 44.3 per cent of the population as of 2017,31 with most power generation coming from hydro sources, which has led to power rationing during droughts.32 The first phase of such guarantee programme consists of a US$10 million guarantee to the Metehara Solar IPP, a 100-MW solar photovoltaic plant in Oromia, Ethiopia.33 The project is expected to be operational by 2021 and is being developed by a consortium led by Enel Green Power, which will invest approximately US$120 million in the construction of the plant, with an estimated US$35 million of private capital mobilised. The World Bank representatives understands that this programme can create 'a platform for much-needed private sector participation in the crucial energy sector by lowering the risks of investing in Ethiopia' and it that 'has the potential to leverage over $1.5 billion in private sector investment'.34
The ambitious vision of achieving 'billions to trillions' and the achievement of the SDGs by 2030 will require global coordination and initiatives aimed at increasing the private and public resources devoted to national policies and programmes that focus on the world's biggest problems in their highly varied national contexts.
Although there are currently an estimated US$200 trillion in global financial assets, the United Nations notes that most of these resources are not yet being used to promote reaching SGDs.35 This is echoed in the 'Mobilisation of Private Finance' report prepared by a group of MDBs, published in August 2019, which notes that although there has been significant growth in MDB/DFI mobilisation of private finance in some areas, enormous efforts are still needed to achieve the billions to trillions objective towards promoting SDGs.36
The slow progress can be understood as reflecting the concerns of governments regarding the risks and uncertainties of business success in these projects, with success defined as generating a measurable, positive, social and environmental impact with an effective financial return. The tide may be changing rapidly though. In his 2020 letter to CEOs, the CEO of BlackRock, the world's largest asset manager, with US$7.4 trillion in assets under management as of 2019, points out that although markets have been slow to reflect the risks surrounding climate change, 'awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping in finance'.37 BlackRock went on to announce that sustainability will now be at the center of their investment approach, and posited that 'governments and the private sector must work together to pursue a transition [to a low carbon economy] that is both fair and just'.
The greater and more strategic use of MDBs will be fundamental to help governments mobilise much more private finance, including through blended finance, towards SDGs, and take full advantage of the increasing awareness of the private sector regarding the importance of promoting sustainable development and the need to improve resiliency of global infrastructure in the face of climate change.
MDBs can also play a key role in assisting governments to take a stronger role in infrastructure finance arrangements that aim to attract more proceeds from other sources by improving the legal instruments and protections for private investors. In this sense, although the investment circumstances vary from country to country considering the relevant context, development stage and specific country needs, MDBs can help countries develop an attractive environment to investment, which includes transparency, a predictable legal, regulatory and investment framework, as well as structures that support innovation.
Innovations in finance include, for instance, increasing the issuance of 'green bonds', which are conventional bonds, issued by corporations, commercial banks, MDBs and other participants, the proceeds of which are earmarked for projects with climate or other environmental benefits. The use of green bonds has been encouraged by the MDBs with the purpose of attracting additional resources. Over the past decade, green bond issuances by the World Bank amounted to US$13 billion in 158 transactions in 21 currencies. Laura Tuck, Vice President for Sustainable Development of the World Bank understands that 'this new instrument we helped create has revolutionised the way investors value sustainability in capital markets by bringing climate considerations to the heart of financial decisions.'38 Globally, green bond and loan issuances have topped US$200 billion in 2019, and are expected to reach US$350 to 400 billion in 2020.39
In addition, the use of blockchain technology or similar systems is creating new standards of keeping transaction records securely and across multiple locations, given that all users 'hold' the ledger in a distributed fashion, transforming the role of 'trusted' third parties. Blockchain technology is being used for applications as diverse as land ownership registries, individual identity records and custody of assets.
Lastly, the MDB's support for the harmonisation of the standards, involving the MDBs' agreement on a shared definition of private capital mobilisation, was an important milestone to facilitate additional long-term financing that can support countries in reaching the SDGs. At the request of the G20, the IFC has launched globally an MDB Toolbox that is grouped by region (Asia and the Pacific, Africa, Europe, and Latin America and the Caribbean) and offers a comprehensive inventory of instruments available from MDBs to support and enhance private investments in emerging and developing markets.40
All these efforts help not only promote SDGs but have the added benefit of improving local market conditions and investor confidence, thereby enabling project finance structures to be more widely adopted and improve infrastructure investments worldwide.