The Project Finance Law Review: Multilateral Lenders and Regional Development Banks

I Introduction to and role in project financings

i Nomenclature and identification of development banks

Outside of commercial banks, there is a wide range of multilateral financial institutions that provide loans for international project financings, with a wide range of terminology looking to distinguish between them and their purposes, especially to the extent this purpose is non-commercial. Equally, there are some non-multilateral financial institutions that perform similar functions to multilaterals and are helpfully considered in this context.

The multilateral aspect is a critical distinguishing feature, with key institutions being established by more than one country as international financial institutions (IFIs), which are subject to international law from an organisational perspective (although in practice their loans in project financings will tend to designate a country or state governing law such as English law or New York law).

Historically, key IFIs were established following World War II as a way in which to rebuild countries devasted by war and to bring back balance and stability to the global financial system, with the first being the International Bank for Reconstruction and Development (IBRD) in 1944. This is now part of the World Bank Group of five international institutions, with the initial mission of providing financing to war-torn countries changing over the years to a focus on economic development.

The World Bank Group now consists of:

  1. the IBRD (established in 1944 and focused on financings where a sovereign guarantee is in place);
  2. the International Development Association (IDA) (established in 1960, and focused on concessional financings usually with sovereign guarantees);
  3. the International Finance Corporation (IFC) (established in 1956 and focused on financings without sovereign guarantees in the private sector);
  4. the International Centre for Settlement of Investment Disputes (established in 1965 and focused on assisting governments in reducing country risk); and
  5. the Multilateral Investment Guarantee Agency (established in 1988 and focused on providing insurance against political and certain other risks to the private sector).

Within the World Bank Group, the IFC is the institution that is seen most often performing a development bank role.

The distinguishing feature of a development bank as the term is usually used is that it provides financing (debt but sometimes also equity and other products) for strategic economic development purposes on a non-commercial (or not fully commercial) basis. Within this there is a distinction between multilateral development banks, which may be regional in focus or global (together, MDBs), development banks that are highly active globally as well as domestically but are not IFIs (the most active of these being China Development Bank), development banks that are active primarily in their domestic market, and finally banks that have the words 'development bank' in their name or self-describe themselves as such but lend on a commercial basis only.

Given that MDBs will typically not be regulated as banks in specific jurisdictions and not deposit-taking in the ordinary sense of the word, alternative terms such as multilateral finance institutions, development finance institutions or similar may be seen as more accurate; however, colloquially these types of institutions continue to be usually referred to as development banks.

ii Key development banks in project financings and their focus

MDBs are created when a group of countries agree on a common mission that they believe the private sector is not adequately covering, with the majority of institutions being mandated to encourage economic development and catalyse international cooperation, integration and trade objectives.

While the IBRD was set up in 1944, its constitutional documents provide that it can only lend to governments of member countries, and so it is not a source of financing for non-recourse or limited-recourse project financings. Recognising the importance of mobilising and supporting private sector development, in 1956 the IFC was established as part of the World Bank Group, and the IFC is able to lend to private sector projects (including on project finance terms), along with providing a range of investment and advisory services to support private sector developments.

Following the establishment of the World Bank Group, the major regional development banks were established: in 1959 the Inter-American Development Bank (IADB), in 1963 the African Development Bank (AfDB), in 1966 the Asian Development Bank (ADB) and in 1991 the European Bank for Reconstruction and Development (EBRD). These MDBs were focused on specific geographic regions at a continent level, and there are also a number of MDBs that have been established over the years that are focused on even narrower regions such as the Development Bank of Latin America, the Eurasian Development Bank and the West African Development Bank. Less commonly, some MDBs are focused on non-geographic regions, such as the Islamic Development Bank (IsDB) that was established in 1975. More recently, two China-headquartered MDBs have been established, namely the New Development Bank (NDB) in 2014 and the Asian Infrastructure Investment Bank (AIIB) in 2015.

The missions of the MDBs do evolve over time. The original mission of the World Bank Group (as it became) linked into the reconstruction of Europe, whereas the World Bank Group's mission is now stated to be to end extreme poverty and promote shared prosperity. The countries covered by MDBs also change over time, so for example in the case of EBRD, Mongolia became a 'country of operations' (i.e., a country where projects could be supported) in 2006, and Morocco became a country of operations in 2012 – in fact, the country of operation of EBRD that received the most support by quantum over the past couple of years is Egypt, which is not traditionally seen as part of Europe.

iii Capitalisation, governance and shareholders

The number of member countries of an MDB varies dramatically. The IFC has 185 countries as member countries, thus including the vast majority of the countries in the world, whereas the NDB has only five member countries, namely Brazil, Russia, India, China and South Africa – hence it is sometimes referred to as the 'BRICS Bank'. The IFC follows the original model of mixed ownership between borrowing and non-borrowing member states; however, there are institutions that only lend to non-member states such as the OPEC Fund for International Development (OFID), and institutions that only have borrowing countries as member states such as the NDB and the European Investment Bank (EIB) (although being a member state is not a requirement to be a borrowing country of these two institutions).

MDBs are funded in a variety of ways. For example, the IFC has paid-in capital and callable capital from member states, but also has an AAA credit rating from Standard and Poor's and Moody's, and the IFC also (as it states on its website) 'issues bonds in a variety of markets, formats, and currencies—including global benchmarks bonds, green and social bonds, uridashi notes, private placements, and discount notes'. As the IFC is focused on non-concessional financing, it also has net earnings accrued from interest payments on loans. Other MDBs have similar sources of funding, although the exact mix varies from institution to institution.

From a governance and voting perspective, control tends to follow the size of contributions by members, typically counting both paid-in capital and callable capital. For example, looking at paid-in capital for the IFC, the top five shareholders are the United States, which has paid in 22 per cent, Japan (6 per cent), Germany (5 per cent), France (5 per cent) and the United Kingdom (5 per cent). By contrast, the top five countries of exposure for the IFC are India at 14 per cent, Turkey at 7 per cent, China at 7 per cent, Brazil at 5 per cent and Argentina at 3 per cent (the order changes for new commitments, in that Argentina falls down to ninth place with South Africa being in fifth place). The disproportionately large paid-in capital means that the US has veto power over major decisions at the IFC. The US is also the largest shareholder in the EBRD and IADB, the joint-largest in the ADB (along with Japan) and the second-largest in the AfDB (after Nigeria).

iv Purpose and evolving mission

As development banks are definitionally focused on non-commercial considerations, it is critically important to be clear what the purpose of a particular development bank is (or, more generally, what development banks should and should not be for). While in wide terms, development banks are typically seen as being there to encourage economic development and catalyse international cooperation, integration and trade objectives, there are risks if the mission is not carefully managed.

One key mission of development banks is typically seen as to help bring private financing to fund critical projects and correct market failures, while leaving the funding of bankable projects to the private sector. To the extent a project could be financed by commercial banks without development bank support, the development banks should focus on other projects. To the extent that a project does need development bank support to be bankable, this should ideally be done in a way that 'crowds-in' private finance, thus helping to develop the private sector while also multiplying the impact of the limited resources of a development bank. Development banks have been focused on developing innovative products (other than or in addition to direct lending) that help with this mission, as further discussed in Section III.

Another focus of development banks is economic development of a type that governments and countries are focused on from a policy perspective. These may be at an institutional level or across a group of development banks.

At the institutional level, an example would be EIB, established by the European Union and with its focus on boosting the EU's potential in terms of jobs and growth, supporting action to mitigate climate change, and promoting EU policies outside the EU. EBRD similarly supports the transition to a green, low-carbon economy, looks to promote equality of opportunity through access to skills and employment, finance and entrepreneurship, and support for women, young people and other under-served communities. The newer institutions of AIIB and NDB intentionally focus more on critical physical infrastructure.

At the group level, an example would be that in 2020 a group of key development banks (the AfDB, ADB, AIIB, EBRD, EIB, IADB, the IFC, IsDB, NDB, the World Bank Group and the Council of Europe Development Bank) came together to solidify their collective support for the sustainable development goals (SDGs) that were adopted in 2015 as part of the 2030 Agenda for Sustainable Development. This meeting of the heads of these development banks looked at how they could support countries in achieving the SDGs by way of 'finance, technical assistance, policy support and knowledge'.

II The benefits and challenges of development banks in project financings

Development banks can provide critical support to sustainable economic development as their focus is not primarily commercial, and so they look at their impact more widely.

The first is to facilitate and encourage private sector investments and financings. Involvement of a development bank in a project financing goes far beyond the financial support provided by the development bank. The involvement of a development bank usually gives a 'halo' to the project in question, with commercial financiers seeing it as a badge of credibility and also giving significant comfort (at a political if not legal level) that the project is less likely to be interfered with by a host government. Furthermore, commercial financiers in developing markets in particular are becoming increasingly aware and sensitive to non-commercial aspects of projects, such as environmental social and governance considerations, and the involvement of a development bank again gives significant comfort that the project meets these criteria, and is less likely to risk reputational damage in the future.

The second is to finance sectors that are critical for the development of a country, but that may not be able to access, or access sufficient, private financing. Private financing clinically assesses risk and country track record before financing a project. This can mean that private financing stays away from the countries and regions of most critical need, and the industry sectors where projects will have the greatest impact on the lives of people in the country. This means that commercial financing can be less available in frontier markets, and can be more readily available in sectors such as oil and gas and mining, than public good assets such as roads and hospitals.

The third is to provide countercyclical financing, reflecting that critical infrastructure and other economic development projects that are key to the development of countries should not wait for challenging private financing times to pass. This for example meant that development banks were expected to become more heavily involved in financing critical infrastructure after the 2008 global financial crisis with private sector financing pulled back significantly. Unlike commercial banks, development banks are not restricted by the new regulatory requirements introduced following 2008, prohibitive tax restrictions or the need to maximise profits for their shareholders. We may well be moving into a similar period, with challenges for private financing post- covid-19 emerging, and it being likely that development bank and other non-commercial funding sources will be necessary to meet the SDGs and other priorities of governments in the next decade.

An example of a project in a critical sector and challenging jurisdiction, which was assisted during a countercyclical period and where development bank assistance was used to leverage private sector involvement, was the IFC's assistance to Wataniya Palestine, a greenfield telecoms operator in Palestine, during 2009 to 2012. This involved, among other things, a US$30 million share of an initial US$80 million initial financing, an equity investment during a public offering (of circa 1 per cent of publicly offered shares, showing IFC support), and a subsequent financing and refinancing, providing US$60 million, with other lenders providing a further US$65 million.

The above sets out some significant advantages for sponsors considering development bank involvement in a project; however, there are some challenges that development bank involvement can bring. Development bank processes can be longer and more involved than those for commercial banks, although on occasion this is arguably more perceived than real, as development banks are often involved in projects that any financier would need more time to evaluate and proceed with. The willingness of development banks to be involved is also often dependent on the private sector being unable to finance the project, as the aim of development banks is not to compete with private finance, rather to step in when the market does not adequately provide finance to an otherwise noteworthy project. Furthermore, development banks have limited resources and almost unlimited projects that could be financed or assisted, and so their wider mission will be critical in the choice of these projects. For example, the EIB will not support oil and gas projects, and when it finances into developing countries it is particularly focused on critical infrastructure or social goals. For example, electricity is a prerequisite for economic development and improving lives, and so development banks have been instrumental in encouraging off-grid electricity products, such as EIB's financing and other assistance in 2018 to d.light design for solar systems to be installed across Ethiopia, Kenya, Nigeria, Tanzania and Uganda.

III Key products for project financing

There is no one-size-fits-all approach, with each MDB able to bring its own focus, financial products and learning to a project; however, there are commonalities in their products as discussed below.

While the World Bank Group separates out its different products to different institutions, with the IBRD focused on support with sovereign guarantee, IDA on concessional support with sovereign guarantee and the IFC on the private sector, the majority of development banks bring all these types of support under one umbrella. For example, the ADB would supply all these types of support (albeit grants are provided by the Asian Development Fund, a slightly separate institution under the ADB umbrella).

i Direct loans

The most stereotypical product offered by MDBs for project financings are loans, be those on concessional or non-concessional terms, which leverages not only the funds provided by member countries, but also the ability of MDBs to borrow money from international capital markets and re-lend it on projects in borrowing countries on more generous terms. EIB, for example, specifically notes that it can provide these directly to a borrower with attractive pricing, and with long tenors to match the economic life of a project. Post-2008, the long tenor is often as attractive as the rates, given the challenge that commercial banks now have with long tenors. It should be noted that attractive pricing may not necessarily be low in the context of commercial financings in more liquid jurisdictions, given that development banks are focused on challenging projects where the private sector is not willing or able to provide financing.

MDBs are increasingly looking to leverage their financings in direct loans, and so would typically look for their direct loan to unlock substantial private sector financing capacity for a project. For example, the EBRD is normally prepared to provide for private sector projects, in the form of debt or equity, up to 35 per cent of the long-term capital requirements of a project (or company), with these loans usually starting from a minimum of €3 million up to €250 million, with the average amount being €25 million.

ii Guarantees

In the past decade there has been increasing recognition that in addition to direct loans, in which the MDB takes all risks and uses its financial resources from the start to support a project, guarantees can be used to target and eliminate the risk or risks that are impeding private sector financing for a project that is desirable for economic development purposes, whereby financiers can transfer such risks that they cannot absorb or manage on their own to the MDB. Different MDBs have different criteria regarding in what circumstances guarantees can be offered. For example, in the case of ADB, guarantees can be provided when ADB has a direct or indirect participation in a project, be that through equity, a loan or even technical assistance.

These guarantees may be comprehensive or limited coverage depending on the MDB involved and what is appropriate for a particular project; however, in general terms there are two key guarantees offered by MDBs: partial credit guarantees, and political risk guarantees.

Partial credit guarantees cover financiers against non-payment risk on the guaranteed portion of the debt, and typically can be issued in respect of most forms of debt, including to support loans (including shareholder loans), public bonds and private placements, and other debt (e.g., financial leases, letters of credit).

Political risk guarantees (sometimes called partial risk guarantees) are useful in the situation that private sector financiers are willing to take commercial or credit-related risks, but are unable or unwilling to take some or all political risks that may arise in a project. It could thus cover specific risks that are perceived in that jurisdiction such as expropriation, or could cover the project-specific risk that a public entity or country does not comply with its contractual obligations that could lead to non-repayment, for example, where a state-owned entity is the offtaker in a power project. As an example, in a power project, a state-owned offtaker could enter into a power purchase agreement with a project company, the host government guarantees the offtaker's obligations, and then the MDB would be willing to issue a political risk guarantee to the financier of the project company, with the host government typically expected to enter into a counter-indemnity with the MDB (in some cases this can change the guarantee pricing, as between those without an indemnity being priced at a market rate, whereas those with a counter-indemnity being priced lower).

iii A/B loans, parallel loans and risk participations

As part of an MDB's focus on leveraging its capital to multiply its impact, a variety of instruments may be used to involve other financiers in a financing that the MDB is providing.

Commercial banks in particular often find lending under an A/B loan structure highly attractive. This involves the commercial bank participating in a loan agreement with the MDB acting as lender of record (this participation is referred to as the B loan, with the A loan being the MDB's retained portion). The B loan typically benefits from the full range of advantages that MDB debt benefits from, including exemption from various events and taxes in most countries given the MDB is an international financial institution (e.g., exemptions from currency conversion restrictions, remittance restrictions, withholding taxes, provisioning requirements), and also it is much less likely that MDB debt will be caught by rescheduling of external debt by a country. In effect, the B loan gives some political risk protection without any recourse to the MDB being given. There are also benefits for the project company, in that the MDB remains the sole lender of record, hence simplifying administration, and also it can enable longer tenor financings. This arrangement is effected by a loan agreement between the MDB and the project company, and then a participation agreement between the MDB and the commercial bank or banks. Where the B loan is in the domestic currency, the ADB refers to this as a C loan under its 'complementary financing scheme'; however, structurally this remains the same.

MDBs also use parallel loan structures, which would be the structure used when co-financing with other MDBs or sovereign entities, whereby each co-financier enters into its own loan agreement with the project company, and then a common terms agreement sets out the general terms of the financing, with any facility-specific terms being in the separate loan agreements. This is a particularly appropriate structure when it is inappropriate for a co-financier to benefit from the MDB's preferred creditor status and other privileges and immunities as set out above, and is also often used for domestic currency financings. On occasion, financings arranged by an MDB may involve both A/B loans and parallel loans, and there are differences in practice; for example, B loans generally have a shorter tenor than A loans, whereas parallel loans often have the same tenor as A loans.

Finally, many MDBs also enter into risk transfers, for example unfunded risk participations with insurance companies, or (in the case of the IFC and ADB) managed co-lending portfolio programmes with insurance companies and other institutional investors. The unfunded risk participation product typically reflects the differing approach of insurance companies to deal management, and so there tends to be limited voting and consultation with the insurance companies, as compared to B loans and parallel loans where the co-financiers would generally expect voting rights in accordance with their proportion of the financing. The managed co-lending portfolio programmes take this further, with the investor not actively choosing specific projects, rather these being selected by the MDB as appropriate according to agreed criteria, and with the MDB making all decisions. Each of these products also allows the risk participant to benefit from the MDB's preferred creditor status and other advantages referred to above.

IV Outlook

One of the key advantages of MDBs is that they are able to be countercyclical, and provide financing to developing countries at times when it is most needed. This role was critical during the 2008 global financial crisis, when key MDBs (the World Bank Group, IADB, ADB, ADB, AfDB and the EBRD) provided US$222 billion of financings. The MDBs have similarly stepped up financing during the covid-19 shocks impacting countries during 2020, with the UK Treasury estimating that MDBs approved US$132.5 billion of financings. Nevertheless, over US$39 billion of this amount was from EIB, which, given its role of funding within the EU, has a 'domestic' element to its work that is not linked to developing countries, and so the overall picture is that the MDB response to covid-19 so far has been less dramatic than during the 2008 global financial crisis.

This more limited response may be understandable from a projects perspective given that 2020 was a time of uncertainty, and so how and what to support was not entirely clear. Nevertheless, there will be significant demands on the MDBs to provide the countercyclical support that will be necessary in the coming years, particularly given their collective stated aims to achieve the SDGs by 2030.


Footnotes

1 Adrian Lawrence is a partner and Harriet Gray is a senior associate at Ashurst LLP.

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